CAT Bonds Research Articles

APPLICATION OF ASSET SECURITIZATION IN FINANCING AGRICULTURE IN SERBIA

This paper aims to point out the possibilities of applying asset securitization in financing the Serbian agriculture. Government subsidies and banking loans do not provide sufficient funds so new sources of financing are in need. The process of asset securitization will enable the inflow of funds for agricultural loans approval as well as hedging. Agricultural loans can be used as collateral for issuing securities, although warehouse receipt, repurchase agreement and future income can also serve as collateral. Securitization can enable transfer of risk from insurance companies to financial market through CAT bonds and credit default swaps (CDS). The experience of countries having structured financing in agriculture is valuable for first steps in applying asset securitization in Serbia.

Convergence of Capital and Insurance Markets: Pricing Aspects of Index-Linked Catastrophic Loss Instruments

Index-linked catastrophic loss instruments have become increasingly attractive for investors and play an important role in risk management. Their payout is tied to the development of an underlying industry loss index (reflecting losses from natural catastrophes) and may additionally depend on the ceding company’s loss. Depending on the instrument, pricing is currently not entirely transparent and does not assume a liquid market. We show how arbitrage-free and market-consistent prices for such instruments can be derived by overcoming the crucial point of tradability of the underlying processes. We develop suitable approximation and replication techniques and – based on these – provide explicit pricing formulas using cat bond prices. Finally, we use empirical examples to illustrate the suggested approximations.

Catastrophe Bonds and Systemic Risk

Do catastrophe bonds increase or decrease the exposure and contribution to systemic risk of the issuing insurance companies? And if such issues influence systemic stability, what design features of the bond and characteristics of the issuing insurer cause catastrophe bond issues to destabilize the financial sector? Contrary to current conjectures of insurance regulators, we find that the contribution of ceding insurers to systemic risk actually decreases significantly after the issue of a catastrophe bond. We empirically confirm that a higher pre-issue leverage, a higher firm valuation and previous cat bond issues all exert a decreasing effect on the issuer's systemic risk contribution.

What Drives Insurers’ Demand for Cat Bond Investments? Evidence from a Pan-European Survey

Although catastrophe bonds are continuing to gain importance in today's risk transfer and capital markets, little is known about the decision-making processes that drive the demand for this aspiring asset class. In the article at hand, we focus on one segment of the investor community. Our research goal is to identify major determinants of the cat bond investment decision of insurance and reinsurance companies. For this purpose, we have conducted a comprehensive survey among senior executives in the European insurance industry. Evaluating the resulting data set by means of exploratory factor analysis and logistic regression methodology, we are able to show that the expertise and experience with regard to cat bonds, the perceived fit of the instrument with the prevailing asset and liability management strategy, as well as the applicable regulatory regime are significant drivers of an insurer's propensity to invest. These statistical findings are supported by further qualitative survey results and additional information from structured interviews with the managers of four large dedicated cat bond funds.

Pricing and simulations of catastrophe bonds

The increasing number of natural catastrophes like floods, hurricanes, and earthquakes not only causes many victims, but also leads to severe production, infrastructure, and individual property losses. Classic insurance mechanisms may be inadequate for dealing with such losses because of the dependencies that exist, inter alia, between the sources of the losses, the huge values of claims, and problems with adverse selection and moral hazard. To cope with the dramatic consequences of extreme events, new financial and insurance instruments are required. One example of a catastrophe-linked security is the catastrophe bond (cat bond), also known as the Act-of-God bond. In this paper we price some catastrophe bonds. We apply models of the risk-free spot interest rate under the assumption that the occurrence of the catastrophe is independent of financial market behavior. We then use Monte Carlo simulations to analyze the numerical properties of the pricing formulas thus obtained. We make a twofold contribution to the literature of catastrophe bond pricing. First, we prove a general pricing formula, which can be applied to cat bonds with different payoff functions under the assumption of different models of the risk-free spot interest rate. Second, we price some new types of cat bonds with interest rate dynamics described by the CIR and the Hull–White model.

Determinants of the cat bond spread at issuance

The contribution at hand is a short summary of a working paper presented by Alexander Braun at the annual meeting of the German Insurance Science Association (DVfVW) in Hannover in March 2012. This working paper contains empirical evidence from the primary market for cat bonds, which provides new insights concerning the prevailing pricing practice of these instruments. For this purpose, transactional information from a multitude of sources has been collected and cross-checked in order to compile a data set comprising virtually all cat bond tranches that were issued between 1997 and 2011. In order to identify the main determinants of the cat bond spread at issuance, a series of OLS regressions with robust standard errors is run. The respective results indicate that, apart from the expected loss, the covered territory, the sponsor, the reinsurance cycle, and the spreads on comparably rated corporate bonds exhibit a significant impact. Based on these findings, a multifactor pricing model for cat bonds in the primary market is then proposed. This model is applicable across all considered territories and perils, exhibits a stable fit with regard to different subsamples used for calibration, and achieves a higher in-sample and out-of-sample accuracy than several competing specifications that have been introduced in earlier work.

The Shareholder Wealth Effects of Insurance Securitization: Preliminary Evidence from the Catastrophe Bond Market

Insurance securitization has long been hailed as an important tool to increase the underwriting capacity for companies exposed to catastrophe-related risks. However, global volumes of insurance securitization have remained surprisingly low to date which raises questions over its benefits. In this paper, we examine changes in the market value of insurance and reinsurance firms which announce their engagement in insurance securitization by issuing catastrophe (Cat) bonds. Consistent with the hitherto underwhelming contribution of Cat bonds to global catastrophe coverage, we do not find evidence that Cat bonds lead to strong wealth gains for shareholders in the issuing firm. More importantly, we report large variations in the distribution of wealth effects in response to the issue announcement. We show that the wealth effects for shareholders in firms which issue Cat bonds appear to be driven by explanations according to which Cat bonds offer cost savings relative to other forms of catastrophe risk management (and less by the potential of Cat bonds to hedge catastrophe risk). Thus, abnormal returns are particularly large for issues by firms which face low levels of loss uncertainty (which reduces the information acquisition costs in financial markets) as well as for issues during periods when prices for catastrophe coverage (including Cat bonds) are low.

The Impact of the Financial Crisis and Natural Catastrophes on CAT Bonds

This paper employs secondary market data to examine how natural catastrophes or financial crises affect CAT bond premiums. We find evidence that both the financial crisis and Hurricane Katrina significantly affected CAT bond premiums. The premium increase resulting from natural catastrophes can primarily be attributed to an increased coefficient of expected loss calculated by catastrophe modeling companies. Furthermore, our results indicate a positive relationship between corporate spreads and CAT bond premiums. Thus, CAT bonds should not be regarded as zero-beta securities. Moreover, our results indicate that deal complexity, ratings, and the reinsurance cycle are significant drivers of CAT bond premiums.

Redevelopment after the Abruzzo Event

Natural disasters raise quite a number of interdisciplinary issues concerning regional growth and local de- velopment, as well as public finance and sustainability, to mention just a few of them: they deserve special attention in our globalized world, given the expectation of a growing impact of climate-related disasters; interesting lessons can be learned from the events under investigation and can be successfully shared as a payback to those who helped upon their occurrence. A case in point has to do with the devastating earthquake - known as the Abruzzo event - which occurred in L'Aquila and its environs on April 6, 2009 and revived the debate on recovery problems to be faced under similar circumstances. Due to the huge amount of money needed for redevelopment purposes, financial management plays a key role and useful insights can be gained by exploring the process of financial innovation, encompassing cat bonds and micro-finance: micro-credit might be resorted to even within the framework of new financial engineering instruments, such as Urban Development Funds; they include some initiatives recently promoted by the European Investment Bank and the European Commission (such as JESSICA, JEREMIE, and JASMINE), to be properly considered in sight of rebuilding L'Aquila and its surround- ing boroughs.

Accuracy of Premium Calculation Models for CAT Bonds—An Empirical Analysis

AbstractCAT bonds are of significant importance in the field of alternative risk transfer. Because the market of CAT bonds is not complete, the application of an appropriate pricing model is of high relevance. We apply different premium calculation models to compare them with regard to their predictive power. Without taking the financial crisis into account, a version of the Wang transformation model and the linear model are the most accurate ones. In contrast, under consideration of the financial crisis, all analyzed models are approximately equivalent. Furthermore, we find that CAT bond specific information does not improve out‐of‐sample results.

Cat Bonds and Other Risk-Linked Securities: Product Design and Evolution of the Market

This paper analyzes risk-linked securities as sources of risk capital for the insurance and reinsurance industries. Risk-linked securities are innovative financing devices that enable insurance risk to be sold in capital markets, raising funds that insurers and reinsurers can use to pay claims arising from mega-catastrophes and other loss events. The most prominent type of risk-linked security is the catastrophic risk (CAT) bond, which is a fully collateralized instrument that pays off on the occurrence of a defined catastrophic event. The CAT bond market has expanded significantly in recent years and now seems to have reached critical mass. Nontraditional risk financing instruments, including CAT bonds, industry loss warranties (ILWs), and sidecars, now represent a substantial component of the property catastrophe retrocession market.

The Shareholder Wealth Effects of Insurance Securitization: Preliminary Evidence from the Catastrophe Bond Market

Insurance securitization has long been hailed as an important tool to increase the underwriting capacity for companies exposed to catastrophe-related risks. However, global volumes of insurance securitization have remained surprisingly low to date which raises questions over its benefits. In this paper, we examine changes in the market value of insurance and reinsurance firms which announce their engagement in insurance securitization by issuing catastrophe (Cat) bonds. Consistent with the hitherto underwhelming contribution of Cat bonds to global catastrophe coverage, we do not find evidence that Cat bonds lead to strong wealth gains for shareholders in the issuing firm. More importantly, we report large variations in the distribution of wealth effects in response to the issue announcement. We show that the wealth effects for shareholders in firms which issue Cat bonds appear to be driven by explanations according to which Cat bonds offer cost savings relative to other forms of catastrophe risk management (and less by the potential of Cat bonds to hedge catastrophe risk). Thus, abnormal returns are particularly large for issues by firms which face low levels of loss uncertainty (which reduces the information acquisition costs in financial markets) as well as for issues during periods when prices for catastrophe coverage (including Cat bonds) are low.

Financial Adaptation to Climate Change via Public Interest Weather Derivatives and Catastrophe Bonds in the Wake of the Financial Meltdown

Anthropogenic climate change is rapidly becoming one of the most pressing and troublesome sources for systemic risk in the global economy. The potential impacts on developed and especially developing economies necessitates the employment of cutting edge and specifically tailored financial solutions to transfer various climatic risks to those in the capital markets who could bear them most economically. In the wake of the recent financial meltdown, however, risk transferring financial technology faces increased skepticism and suspicion with respect to its capability to reduce systemic risks. Rather, financial engineering is blamed for increasing systemic risks, as evidenced by the contribution of collateralized debt obligations (CDOs) and credit default swaps (CDS) to the evolution of the subprime crisis and the collapse of major financial institutions. Given the structuring similarities between catastrophe bonds and CDOs on the one hand, and between Over-The-Counter (OTC) weather derivatives and CDS on the other, two main questions must urgently be addressed: (1) whether the root causes for the recent financial crisis also apply to and call into question climatic risk shifting technology, and (2) what inherent drawbacks, if any, in Cat bonds and OTC weather derivatives should be addressed in order to lower the likelihood of a “climate bubble.” Shedding light on these key questions will contribute to the debate surrounding the future regulatory landscape of risk shifting financial technology in general, and that of climatic risk transfer in particular.

Dichotomy in the Emotional Approaches of Caretakers of Free-Roaming Cats in Urban Feeding Groups: Findings from In-Depth Interviews

ABSTRACTAlthough the occurrence of cat-caretaking of free-roaming cats is widespread, particularly so in countries with a climate suitable for cats to reproduce year-round, our knowledge of this relationship is still incomplete. People who engage in daily activities of feeding and caring for groups of free-roaming cats (cat caretakers) are known to be devoted to their cats and invest considerable resources in their care, including neutering and veterinary care. These caretakers often encounter difficulties, such as resentment by neighbors and lack of cooperation or financing by the municipal veterinary services. Despite the fundamental understanding of these caretakers' high daily commitment, and sometimes strong bond with the cats, detailed knowledge is still lacking regarding the nature of this bond, the difficulties that ensue from this daily occupation, and the relationship between the two. The purpose of this study was thus to acquire a deeper understanding, by means of an in-depth interview with cat caretakers. The study has identified, for the first time, two distinct emotional approaches that accompany extensive caretaking for free-roaming cats: emotional attachment and emotional detachment. We show how these two different responses affect both social and financial aspects in the caretakers' lives, and report on the ways in which these individuals experience cat caretaking. Our findings provide a first systematic understanding of the relationship between the level of technical caretaking (feeding, medical care, etc.) and the level of emotional involvement, and reveal the ambivalence often inherent in human–animal relations in general and the caretaker–cat bond in particular. The understanding acquired here can be put into practice to reduce the emotional and technical difficulties experienced by cat caretakers, as well as to improve free-roaming cat management efforts and cat welfare. By increasing public and municipal awareness of the possible contribution of cat caretakers to cat management, and of the emotional and technical difficulties they experience, both the caretakers and other community members can benefit.

AAFP and ISFM Feline-Friendly Handling Guidelines

The number of pet cats is increasing in most countries, often outnumbering pet dogs, yet cats receive less veterinary care than their canine counterparts.(1) Clients state the difficulty of getting the cat into a carrier at home, driving to the clinic, and dealing with the fearful cat at the veterinary clinic as reasons for fewer visits.(2) Educating and preparing the client and the veterinary team with regard to respectful feline handling is necessary in order to avoid stress and accomplish the goal of good health care. Without such preparation, feline stress may escalate into fear or fear-associated aggression. The resulting stress may alter results of the physical examination and laboratory tests, leading to incorrect diagnoses (eg, diabetes mellitus) and unnecessary treatments.(3-5) Without compassionate and respectful handling by the veterinary team, clients may feel the team lacks skills and compassion, or does not understand cats. Injury may occur to the cat, client and/or veterinary team.(6) Clients who want to avoid stress for their cat may avoid veterinary visits or choose another practice instead. The use of feline-friendly handling techniques should reduce these problems. Handling is most successful when the veterinary team adapts the approach to each individual cat and situation. The goal of these guidelines is to provide useful information for handling cats that can lead to: ✜ Reduced fear and pain for the cat. ✜ Reinforced veterinarian-client-cat bond, trust and confidence, and thus better lifelong medical care for the cat. ✜ Improved efficiency, productivity and job satisfaction for the veterinary team. ✜ Increased client compliance. ✜ Timely reporting and early detection of medical and behavioral concerns. ✜ Fewer injuries to clients and the veterinary team. ✜ Reduced anxiety for the client.

The Risk Implications of Insurance Securitization: Do Catastrophe Bonds Lower the Default Risk of Issuers?

Catastrophe (Cat) bonds are insurance securitization vehicles which are supposed to transfer catastrophe-related underwriting risk from issuers to capital markets. This paper addresses key, unanswered questions concerning Cat bonds and offers the following results. First, our findings show firms that issue Cat bonds exhibit less risky underwriting portfolios with less exposure to catastrophe risks and overall less need to hedge catastrophe risk. These results show that the access to the market for insurance securitization is easiest for firms with less risky portfolios. Second, firms that issue Cat bonds are found to experience a reduction in their default risk relative to non-issuing firms and our results, therefore, demonstrate that Cat bonds provide effective catastrophe hedging for issuing firms. Third, firms with less catastrophe exposure, increase their catastrophe exposure following an issue. Therefore, our paper cautions that the ability to hedge catastrophe risk causes some firms to seek additional catastrophe risk.

Accuracy of Premium Calculation Models for CAT Bonds - An Empirical Analysis

CAT bonds are of significant importance in the field of alternative risk transfer. Since the market of CAT bonds is not complete, the application of an appropriate pricing model is of high relevance. We apply different premium calculation models in order to compare them with regard to their predictive power. Without taking the financial crisis into account, a version of the Wang transformation model and the linear model are the most accurate ones. In contrast, under consideration of the financial crisis, all analyzed models are approximately equivalent. Furthermore, we find that CAT bond specific information does not improve out-of-sample results.

Minimization of Trigger Error in Cat-in-a-Box Parametric Earthquake Catastrophe Bonds with an Application to Costa Rica

Catastrophe bonds are used by the insurance and reinsurance industry and by national governments to cede catastrophic risks to the financial markets. Triggers whose outcomes depend only on the earthquake parameter data published by respected third parties can be implemented to determine without moral hazard whether the bond principal is paid for a certain event. Sensitivity analyses to different design assumptions show that these transactions are often affected by trigger error, unless a sufficiently dense geographic discretization is selected to define the trigger zones. A process of general application to any geography is developed to minimize the trigger error. The methodology is illustrated with the design of a hypothetical cat bond for Costa Rica.

Calibrating CAT Bonds for Mexican Earthquakes

AbstractThis article examines the calibration of a real parametric catastrophe bond (CAT bond) for earthquakes sponsored by the Mexican government, which is of a high interest as it delivers several policy‐relevant findings. The results demonstrate that a combination of reinsurance and CAT bond is optimal in the sense that it provides coverage for a lower cost and lower exposure at default than reinsurance itself. A hybrid CAT bond for earthquakes is also priced in order to reduce the basis and moral risk borne by the sponsor and to reflect the value of the loss by several variables.

A simple robust model for Cat bond valuation

This note provides a simple closed form solution for valuing Cat bonds. The formula is consistent with any arbitrage-free model for the evolution of the Libor term structure of interest rates. The crucial inputs to the valuation formula are the likelihood of the catastrophe event, per unit time, and the percentage loss rate realized if an event occurs. The pricing methodology is based on the reduced form models used to price credit derivatives.