Abstract
Reinsurance has long been used for tail risk protection. There is ample anecdotal information from practitioners about this dimension of reinsurance. The subject, however, remains largely unexplored in the academic literature given the lack of data about non-proportional reinsurance contracts. We develop a novel approach to measure the use of non-proportional reinsurance and use it to disentangle reinsurance used for catastrophe risk protection from reinsurance used for other motivations, for example regulatory capital relief. Our findings rely on a new measure of catastrophe risk that has strong explanatory power about insurers’ behaviour towards risk beyond what has been captured by existing measures.
Highlights
Property and casualty (P&C) insurers seldom go broke
We present evidence on how P&C insurers use reinsurance to mitigate the effects of such large losses
We introduce a new measure of the CAT risk faced by insurers and use it to study the use of reinsurance
Summary
Property and casualty (P&C) insurers seldom go broke. This is surprising in an industry frequently buffeted by large unpredictable losses. In 2005, when three of the 10 most devastating hurricanes in U.S history occurred, only two insurers shut their doors despite insured catastrophe losses of USD 100 billion. Theoretical models show that using reinsurance to cover tail events, such as hurricanes, can be the optimal choice for utility-maximising insurers (Vajda 1962; Borch 1962), few have studied this issue. This is in part due to the difficulty of measuring exposure to
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