Risk Transfer Instruments Research Articles

Перспективы рынка киберстрахования США под влиянием новых вызовов

The article delves into the analysis of current trends in the cyber risk insurance market in the United States, which is both the driving force of the global insurance industry and a major victim of cyber attacks. The work highlights the key factors that define the current cyber insurance market landscape and influence the increasing frequency and severity of cyber attacks. Legislative initiatives to curb the activities of attackers and create an effective infrastructure to combat ransomware developers are examined, which in turn determine insurers' underwriting policies when assessing cyber risks. The research emphasizes the growth of alternative risk transfer mechanisms and instruments, as well as the increasing restrictions on underwriting risks of a systemic nature against the backdrop of escalating cyber threats. The article presents an assessment of the current state and outlines the prospects for the development of the US cyber insurance market with a focus on improving modeling mechanisms and attracting highly specialized personnel.

Autorecovery and everyday disaster in Mexico City’s peripheries

This article is concerned with urbanization as it shapes and is shaped by disaster finance instruments. It takes a critical look at the specific urbanizing qualities of these instruments by bringing an established theory of peripheral urbanization together with recent work on disaster urbanization to advance a theory of ‘everyday disaster’—or smaller-scale events that occur repeatedly in the same areas, or events with extended recovery periods so prolonged that they integrate with the precarities of everyday life; and ‘autorecovery’—or recovery processes that self-organize and improvise in response to the uneven distribution of state resources. It grounds these theories in extended ethnographic work done in Mexico City. It argues that where localized everyday disasters are ongoing, they fall through the cracks of existing financing schemes because of ongoing scalar mismatches between instruments and actually existing disaster conditions. These mismatches are compounded by state neglect and facilitated by the disconnectedness that defines peripheries. As disaster governance in global Southern states is pushed to global markets through risk transfer instruments, failure to effectively insure everyday disasters expands spaces of precarity that reproduce peripheral processes. These forms of governance affect urban spatial configurations, not only through disaster itself, but through modes of repair like autorecovery.

Macroeconomic co-benefits of DRR investment: assessment using the Dynamic Model of Multi-hazard Mitigation CoBenefits (DYNAMMICs) model

PurposeThe authors present a dynamic macroeconomic model for assessment of disaster risk reduction (DRR) policies under multiple hazards. The model can be used to analyze and compare various potential policies in terms of their economic consequences. The decomposition of these effects into multiple benefits helps policy makers and other stakeholders better understand the ex ante and ex-post advantages of DRR investments. The purpose of this paper is to address these issues.Design/methodology/approachA dynamic real business cycle model is at the core of this research. In the model multiple natural hazards modeled stochastically cause shocks to the economy. Economic outcomes, most importantly, output can be assessed before and after disasters and under various DRR policies. The decomposition of benefits aims to quantify the concept of triple dividends.FindingsIn case study applications in Tanzania and Zambia, the authors find that investments into physical infrastructure and risk transfer instruments generate a variety of benefits even in the absence of disaster. A land use restriction with planned relocation for example reduces output in the short run but in the long run increases it. Overall, policy effects of various DRR interventions evolve in a nonmonotonic manner and should be evaluated over a long period of time using dynamic simulation.Originality/valueThe novelty of this study lies in the economic quantification of multiple benefits described in the triple dividends literature. This helps comparing ex ante, ex-post and volatility-related economic effects of multiple disasters and related physical and financial DRR investment options. As observed in the case studies, the model can also identify overlooked temporal heterogeneity of co-benefits of DRR investments.

Proposing a Framework for Catastrophic Risk Management through Alternative Risk Transfer Instruments

Proposing a Framework for Catastrophic Risk Management through Alternative Risk Transfer Instruments

The impact of counterparty risk on the basis risk of industry loss warranties and on (collateralized) reinsurance under (non-)linear dependence structures

PurposeThe purpose of this article is to investigate the impact of counterparty risk on the basis risk of industry loss warranties as well as on reinsurance with and without collateral under different dependence structures. The authors additionally compare the solvency and Sharpe ratio for different premium loadings and contract parameters.Design/methodology/approachThe authors propose a model framework extension to account for the counterparty risk of risk transfer arrangements. Copulas are used to also take into account non-linear dependencies between risk factors, and Monte Carlo simulation is employed to derive numerical results and to conduct sensitivity analyses.FindingsThe authors show that the impact of counterparty risk is particularly pronounced for higher degrees of dependencies and tail dependent losses, i.e. in cases of basis risk levels that appear low if counterparty risk is not considered. With respect to counterparty risk management, the authors find that already partial collateralization limits counterparty and basis risk to more acceptable levels.Practical implicationsThe study results are particularly relevant to practitioners, as insurers may not only underestimate the “true” basis risk of index-linked instruments, but also the effect of counterparty risk of reinsurance contracts along with the consequences for solvency and profitability.Originality/valueThe authors extend existing literature by allowing for the (partial) default of industry loss warranties and reinsurance under different dependence structures. Furthermore, the authors include profitability in addition to risk considerations. The interaction effects between counterparty risk and the basis risk of index-based alternative risk transfer instruments are largely unstudied, despite their considerable relevance in practice.

Introducing proactive sovereign disaster risk financing in India: Potentials and challenges

This study explores the possibilities and challenges of introducing ex-ante or proactive disaster risk financing (DRF) solutions such as mitigation funds, credit arrangements, risk transfer instruments for enhancing disaster resilience at the national and sub-national levels in India. A survey using a structured questionnaire was undertaken considering a select group of respondents directly involved in the development and execution of various disaster risk reduction (DRR) and risk financing strategies. The respondents were from the government and non-government entities, identified as key stakeholders with the assumption that the views obtained reflect the disaster-related funding needs of the government and supporting organizations, respectively. The identification of a set of enabling factors is based on the aggregation and systematic analysis of responses. The study, in doing so, offers an insight on the understanding of the respondents on DRF, the existing gaps and scope in disaster prevention and management policies, their limitations and implementation challenges. The analysis generates important policy recommendations for governments at different levels in India that could foster the initiatives towards building disaster resilience. The study argues in favour of a demand for developing a mix of both ex-ante and ex-post disaster financing measures in India rather than relying only on the latter. A diversified approach may safeguard the human and economic assets, control short and long-term fiscal consequences and minimize overall developmental losses due to disasters.

Offering Catastrophic Risk Management Framework by Alternative Risk Transfer Instruments to Islamic Capital Market with Cat Takaful (CT) Sukuk

Out of 64 possible catastrophic events in the whole world, about 34 of them have been experienced in Iran; more than 80% of the regions are exposed to natural disasters risks such as earthquakes exposure. Domestic insurance capacity does not cover this volume of risk and the need for external reinsurance capacity is always felt. Catastrophe bonds structure as a financial & insurance innovative solution (Alternative Risk Transfer Instruments) allows an issuing institution to transfer catastrophic exposures and risk to capital market's investors by creating capital relief and additional risk capacity for our insurance industry. We adjusted the formal cat bonds structure with the Islamic jurisprudence. According to the systematic review research method 8 steps, the Sukuk model was implemented based on the extracted concepts from 23 Farsi articles and 50 English articles. After that interviews by 18 experts who were selected by purposive & Snowball sampling, The Delphi method was used to obtain the opinion of experts and their opinion was modified and implemented in the final model. In the open coding stage, 415 concepts were extracted which were classified into 10 categories and finally presented in 4 Propositions/themes. The trustworthiness and authenticity did base on the four-stage model of Lincoln and Guba and also its complementary step. We finally suggested that the catastrophe bond instrument could be issued in the form of a cat takaful (CT) sukuk contract template, as a solution for transferring catastrophic risks to the Islamic financial market.

Identifying the Information Polarities in Credit Risk Transfer Instruments; A Case for Regulatory Product Intervention and Product Liability Framework

Identifying the Information Polarities in Credit Risk Transfer Instruments; A Case for Regulatory Product Intervention and Product Liability Framework

Bundling weather index-based crop insurance and credit: A Cautionary Tale against Misunderstood and Misinformed Take-Up

The initial purpose of this study was to evaluate the effect of different bundling options of weather index-based crop insurance with agricultural credit on levels of insurance take-up. In a randomised controlled trial, 371 loan applicants were offered credit-linked insurance in three different ways: (1) mandatory bundling of products and incentivising insurance take-up by making it a partial supplement to loan collateral, (2) voluntary insurance with the same incentive and (3) voluntary insurance without incentive. However, we will quickly realize that the take-up of the bundle is mostly related to an issue of understanding, level of knowledge or information interpretation rather than to the way of bundling. Though the level of take-up appeared to be high, no matter the bundling option, results revealed that it was a misunderstood take-up based on the insufficient level of information or inappropriate interpretation of it. More effort is hence needed from development stakeholders to make sure the product value of insurance, namely a risk transfer instrument, is fully grabbed by farmers who purchase it.

Probabilistic risk assessment on wind turbine towers subjected to cyclone‐induced wind loads

AbstractA probabilistic risk assessment to estimate the economic impact on wind turbine towers subjected to cyclone‐induced wind loads is applied. An event‐based probabilistic framework is used to assess the risk parameters for selected hazard events. The results are integrated considering all uncertainties related to each part of the process in a probabilistic formal way. The hazard is defined by a set of nonoverlapping stochastic events that exhaust the considered sample space, including the spatial distribution, the annual frequency, and the randomness of the hazard intensity. The vulnerability is defined in terms of the first and second statistical moments: the expected damage and its corresponding variance (or standard deviation) for a certain type of wind turbine towers. The vulnerability component of the model is an important contribution of the study; it uses a realistic modeling of the wind field, and instead of one (as in other studies), three failure modes are considered to characterize the vulnerability. The risk is expressed in economic terms, namely, the single‐event expected loss, the average annual loss, the pure premium, and the loss exceedance curve. The approach is applied to a probabilistic tropical cyclone wind risk assessment on 3001 wind turbine towers from 65 wind farms in Mexico. It is concluded that the selected metrics are of especial importance for risk retention (financing), particularly if schemes or risk transfer instruments are to be defined, and therefore, they will be a very valuable contribution to further studies in defining strategies for financial protection of national infrastructure against wind disasters induced by cyclones.

Hedging Longevity Risk: Does the Structure of the Financial Instrument Matter?

Longevity-linked securities can be constructed either as cash flow hedging instruments or as value hedging instruments. This article studies the interaction between the structure of longevity-linked securities and shareholder value. Relying on a strand of literature that investigates corporate risk management decisions made in the interests of shareholders, we present a framework that compares cash flow hedges with value hedges. Both our theoretical model and numerical experiments show that value hedging dominates cash flow hedging in the context of management decisions being made to maximize shareholder value. This finding provides an explanation for the failure of some attempted issues of longevity risk transfer instruments and suggests efficient alternate structures.

Innovative health financing for refugees

BackgroundMore than 65 million persons are currently forcibly displaced, of whom more than 22 million are refugees. Conflicts are increasing, and existing ones are becoming more protracted; a refugee remains a refugee for more than 10 years. Funding for refugee assistance comes primarily from high-income countries after an emergency has occurred. The United Nations High Commissioner for Refugees spent approximately 12% of its budget on health, nutrition, food security, water, and sanitation in 2016. The current modalities used to fund refugee emergencies are not sustainable and will worsen as health needs increase and health services become more expensive, particularly in middle-income countries.Main ideaGiven the current number of complex conflicts and the magnitude of displacement, new sources of funding and innovative financing instruments are needed. This article explores diverse sources of innovative humanitarian health financing for refugees. Ultimately, the goal is to integrate refugees into a host country’s functioning national health system, which, if done thoughtfully, should improve health services and outcomes for both nationals and refugees. Addressing the increasing level of humanitarian needs for refugees requires a wide range of resources and a sophisticated financing toolkit that can be adapted to different refugee contexts. Improving health financing for refugees requires a paradigm shift towards pre-emergency and multi-year planning using risk-transfer instruments. It necessitates a wide range of public and private partners and varied resources that range from health insurance, bonds, and concessional loans to host countries with innovative methods for purchasing projects and services such as pay for performance. These modalities need to be employed according to specific refugee contexts, and the potential risks must be considered carefully.ConclusionWe propose the exploration of a Refugee Health Financing Model, or FinRef, for the acute phase of an emergency, and different forms of health insurance as well as pay-for-performance modalities in protracted settings. Such innovations will require traditional and non-traditional partners to work together to trial different financial schemes. Donors and investors need to be prepared to experiment and accept failure of some models in certain contexts. Ultimately, different innovative financing models will be able to provide more sustainable and effective health services to refugees and their host populations in the near future.

Why and how do banks lay off credit risk? The choice between retention, loan sales and credit default swaps

We find that banks with capital and liquidity constraints are more likely to use credit risk transfer (CRT) instruments, including the credit derivative and the secondary loan markets. Relationship lenders and lead syndicate lenders are more likely to hold loans on their balance-sheets regardless of borrowers' riskiness. Finally, we find a separating equilibrium in the CRT market: loans to ex-ante riskier borrowers are more likely to be sold and loans to safer borrowers are more likely to be hedged with CDS. We view credit derivatives and loan sales as joint choice variables in determining the hedging instrument to use.

Country-Specific Variations in SME CLOs Trap Excess Spread Differently

Since the first securitization of small- and medium-sized enterprise (SME) loans in Europe in 1998, more than EUR 560 billion (estimated) has been securitized and transferred into the capital markets. Although the SME collateralized loan obligation (CLO) sector has weathered the financial crisis that started in 2008, the purpose of SME CLO issuance has shifted from funding and serving as a risk transfer instrument for banks to providing useful liquid assets that can be retained and used for European Central Bank liquidity operations. Despite existing for close to 20 years, SME CLO structures still are not standardized across Europe. Understanding their key structural differences and their effectiveness in different default scenarios is important to investors. The article explains some of the key structural mechanisms and compares their effectiveness under different assumptions. <b>TOPICS:</b>CLOs, CDOs, and other structured credit, developed

Hedging the financial risk from water scarcity for Great Lakes shipping

AbstractLow water levels in the Great Lakes have recently had significant financial impacts on the region's commercial shipping, which transports hundreds of millions of dollars' worth of bulk goods each year. Cargo capacity is a function of a ship's draft, the distance between water level and the ship's bottom, and lower water levels force ships to reduce cargo loads to prevent running aground in shallow harbors and locks. Financial risk transfer instruments, such as index‐based insurance contracts, may provide an adaptable method for managing these financial risks. In this work, a relationship between water levels and shipping revenues is developed and used in an actuarial analysis of the frequency and magnitude of revenue losses. This analysis is used to develop a standardized suite of binary financial contracts, which are indexed to water levels and priced according to predefined thresholds. These contracts are then combined to form hedging portfolios with different objectives for the shippers. Results suggest that binary contracts could substantially reduce the risk of financial losses during low lake level periods and at a relatively low cost of only one to three percent of total revenues, depending on coverage level.

A new approach to probabilistic earthquake-induced tsunami risk assessment

A new approach is proposed for the probabilistic financial risk assessment of earthquake-induced tsunami. The risk is evaluated in a probabilistic framework for a full set of hazard events including all uncertainties. The hazard is defined as a stochastic and historic set of events, collectively exhaustive and mutually exclusive, that describes the spatial distribution, the annual frequency and the randomness of the hazard intensity. The risk is expressed as losses in different terms: the average annual loss and the loss exceedance curve. These metrics are of particular importance for risk financing schemes and risk transfer instruments. As an illustrative example, this approach is applied to the probabilistic tsunami risk assessment for public schools in southern Mexico.

Evaluación probabilista del riesgo sísmico en Lorca mediante simulaciones de escenarios

A comprehensive and probabilistic seismic risk assessment has been performed for the buildings of Lorca, the most affected city in the region of Murcia, Spain, after the May 2011 earthquake. Seismic hazard is represented through a set of stochastic scenarios that allow accounting for small, moderate and extreme events in the future losses, also through spectral transfer functions the dynamic soil response has been considered. A building by building resolution level database has been used allowing the disaggregation of risk results in several categories besides allowing the generation of risk maps to visualize the geographical distribution of the future losses. For each of the identified building classes a vulnerability function has been assigned to determine the expected losses for different acceleration levels. Risk results have been obtained in terms of the loss exceedance curve from where other probabilistic risk metrics such as the average annual loss and the probable maximum loss can be derived. Risk results are useful for the decision-makers in the fields of emergency planning, existent building retrofitting schemes and financial protection through traditional insurance and reinsurance schemes or with alternative risk transfer instruments.

Analysis of Risk Premium Determinants on Cat Bonds

Abstract This paper presents an analysis of the risk premium determinants on catastrophe bonds (cat bonds). Firstly, from a theoretical point of view, the existing models used for determining the level of risk premiums will be presented through a comparative analysis. Then, through an empirical approach we’ll present our results by taking into consideration cat bonds covering earthquake risk issued during 1999-2012. The first model shows the existing relationship between the expected losses of the company that requires coverage through an alternative risk transfer instrument such as cat bonds and the level of risk premium. By estimating our model in different conditions, taking as parameters the location and the frequency of the events, the fluctuations of risk premiums can be observed. In case of cat bonds covering USA earthquakes the risk premium is greater than those covering Japan earthquakes. Through the second model we aim to observe the determinants that influence risk premium. The explanatory variables taken into consideration are: the issuing amount, the probability of event occurrence, conditional expected loss, the probability of exhaustion, maturity, the rating and the trigger type of each bond. The results show that the probability of event occurrence and credit rating of the bond are significant determinants of risk premium, being considered by the investors when they decide to diversify their portfolio through financial instruments that are not affected by the volatility from financial markets. These results are mostly consistent with existing theoretical models but can also be observed certain differences which will be discussed. The moment when investors start to lose money is perceived more serious than the amount they will lose. As regards the rating, it offers information about the quality of the bond. Given the importance of this risk premium determinant we’ll also present the main factors considered by the rating agencies in the moment of setting a certain rating for a cat bond.

Event-based approach for probabilistic agricultural drought risk assessment under rainfed conditions

An event-based approach for the probabilistic risk assessment of agricultural drought under rainfed conditions to estimate the economic impact is proposed. The risk parameters are evaluated in an event-based probabilistic framework for a set of hazard events; these results are probabilistically integrated including, in a formal way, all uncertainties related to every part of the process. The hazard is defined as a stochastic or historic set of events, collectively exhaustive and mutually exclusive, that describes the spatial distribution, the annual frequency, and the randomness of the hazard intensity. The risk is expressed in different economic terms: the average annual loss (or pure risk premium) and the loss exceedance curve; these metrics are of particular importance for risk retention (financing) schemes or risk transfer instruments. As an illustrative example, this approach is applied to probabilistic drought risk assessment of maize under rainfed conditions in Mexico. These results are the base of further studies in defining strategies for financial protection against agricultural losses and disasters.

Seismic Risk Management of Insurance Portfolio Using Catastrophe Bonds

AbstractParametric earthquake catastrophe bonds are emerging risk transfer instruments for governments and insurers. This study extends a current station‐intensity‐based trigger method for binary payments, which utilizes direct observation of ground motions at recording stations, by promoting a more flexible multiple‐discrete payment structure. A calibration procedure of the bond trigger mechanism for the new approach is demonstrated by focusing upon a realistic portfolio of conventional wood‐frame houses in Vancouver, Canada. Numerical results indicate that the new method with a multiple‐discrete payment structure decreases the magnitude of trigger errors significantly in terms of seismic loss, and facilitates the flexible adoption of various payment structures for catastrophe bonds. Furthermore, a synergy between the calibration of parametric catastrophe bonds and the current performance‐based earthquake engineering framework is highlighted.