ART Versus Reinsurance: The Disciplining Effect of Information Insensitivity

Silke Brandts and Christian Laux

No 2005/21, CFS Working Paper Series from Center for Financial Studies (CFS)

Abstract: We provide a novel benefit of Alternative Risk Transfer (ART) products with parametric or index triggers. When a reinsurer has private information about his client's risk, outside reinsurers will price their reinsurance offer less aggressively. Outsiders are subject to adverse selection as only a high-risk insurer might find it optimal to change reinsurers. This creates a hold-up problem that allows the incumbent to extract an information rent. An information-insensitive ART product with a parametric or index trigger is not subject to adverse selection. It can therefore be used to compete against an informed reinsurer, thereby reducing the premium that a low-risk insurer has to pay for the indemnity contract. However, ART products exhibit an interesting fate in our model as they are useful, but not used in equilibrium because of basis-risk.

Keywords: Cat Bonds; Risk Transfer; Index Trigger; Adverse Selection (search for similar items in EconPapers)
JEL-codes: D82 G22 (search for similar items in EconPapers)
Date: 2005
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Citations: View citations in EconPapers (1)

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Related works:
Working Paper: ART versus reinsurance: the disciplining effect of information insensitivity (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:cfswop:200521

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