Working Paper: NBER ID: w7286
Authors: Kenneth A. Froot
Abstract: This paper examines the market for catastrophe event risk -- i.e., financial claims that are linked to losses associated with natural hazards, such as hurricanes and earthquakes. This market is in transition as new approaches for transferring risk are being explored. The paper studies several recent transactions by USAA which use reinsurance capacity from capital markets rather than only from reinsurers. We identify two puzzles concerning the cat protection purchased in these transactions: there is no coverage for the largest, most severe events; and premiums appear well above actuarial value. We demonstrate that both features deviate from what theory would predict, yet are characteristic of many transactions, not simply those of USAA. We then explore a number of possible explanations for the facts. The most compelling are combinations of capital market imperfections and market power on the part of reinsurers. Conclusions for broader capital market and risk management issues are discussed.
Keywords: No keywords provided
JEL Codes: G22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| USAA's choice to purchase reinsurance for relatively minor catastrophes (G52) | USAA remains exposed to larger events (G52) |
| High premiums paid by USAA (G52) | Lack of coverage for extreme events (G52) |
| Capital market imperfections and market power by reinsurers (D52) | High premiums and lack of coverage for extreme events (G52) |
| Reinsurance market conditions (G22) | High premiums paid by USAA (G52) |