Insurance Derivatives: A New Asset Class for the Capital Markets and a New Hedging Tool for the Insurance Industry |
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| Authors: | Michael S Canter Joseph B Cole Richard L Sandor |
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| Institution: | Vice President of Hedge Financial Products, a wholly owned subsidiary of CNA Financial Corp. dedicated to both the securitization of insurance risk, and the embedding of commod-ity and derivative features in traditional insurance products.;Chief Operating Officer of Hedge Financial Products.;Chairman of Hedge Financial Products. |
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| Abstract: | The number and severity of natural catastrophes has increased dramatically over the last decade. As a result, there is now a shortage of capacity in the property catastrophe insurance industry in the U.S. This article discusses how insurance derivatives, particularly the Chicago Board of Trade's catastrophe options contracts, represent a possible solution to this problem. These new financial instruments enable the capital markets to provide the insurance industry with the reinsurance capacity it needs. The capital markets are willing to perform this role because of the new asset class characteristics of securitized insurance risk: positive excess returns and diversification benefits.
The article also demonstrates how insurance companies can use insurance derivatives such as catastrophe options and catastrophe-linked bonds as effective, low-cost risk management tools. In reviewing the performance of the catastrophe contracts to date, the authors report promising signs of growth and liquidity in these markets. |
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