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Risk transfer beyond reinsurance: the added value of CAT bonds

Tobias Götze () and Marc Gürtler ()
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Tobias Götze: Braunschweig Institute of Technology, Department of Finance
Marc Gürtler: Braunschweig Institute of Technology, Department of Finance

The Geneva Papers on Risk and Insurance - Issues and Practice, 2022, vol. 47, issue 1, No 7, 125-171

Abstract: Abstract Reinsurance and CAT bonds are two alternative risk management instruments used by insurance companies. Insurers should be indifferent between the two instruments in a perfect capital market. However, the theoretical literature suggests that insured risk characteristics and market imperfections may influence the effectiveness and efficiency of reinsurance relative to CAT bonds. CAT bonds may add value to insurers’ risk management strategies and may therefore substitute for reinsurance. Our study is the first to empirically analyse if and under what circumstances CAT bonds can substitute for traditional reinsurance. Our analysis of a comprehensive data set comprising U.S. P&C insurers’ financial statements and CAT bond use shows that insurance companies’ choice of risk management instruments is not arbitrary. We find that the added value of CAT bonds mainly stems from non-indemnity bonds and reveal that (non-indemnity) CAT bonds are valuable under high reinsurer default risk, low basis risk and in high-risk layers.

Keywords: CAT Bond; Reinsurance; Risk management (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1057/s41288-021-00234-6

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