The Risk Cubic Model with Cyclic and Transitory Effects for Pricing Mortality-Linked Securities

Abstract

Recently, the risk cubic model proposed by Lane (2000) has been used for pricing mortality-linked securities. The model considers the frequency and severity of the loss distribution in the insurance pricing framework and has been developed for pricing catastrophe risks. As mortality risk is not identical to catastrophe risk, the risk cubic model cannot be applied without further adjustments. Therefore the pricing model is extended by integrating a dummy variable for the mortality risk. The results of the analysis reveal that the price for a mortality-linked security is significantly smaller than for other insurance-linked securities. It could also be shown that a cyclic effect with a length of 4.5 years determines the pricing mechanism in the market for insurance-linked securities. Furthermore, the integration of transitory effects demonstrates a price reaction in the market after hurricane Katrina in 2005. The proposed pricing framework can be applied to calculate the premiums of mortality-linked securities.