How to Price Catastrophe Bonds for Sustainable Earthquake Funding? A Systematic Review of the Pricing Framework

Abstract

Earthquake contingency costs in traditional insurance cannot provide sufficient earthquake funding for a country because they often differ significantly from actual losses. Over the last three decades, this approach has been replaced by linking earthquake insurance to bonds in the capital market; this is now known as the earthquake catastrophe bond (ECB). Through the ECB, contingency costs become larger and more sustainable earthquake funds. Unfortunately, there are challenges in ECB issuance, as the pricing framework does not yet have standard rules and still needs to be studied. Therefore, the objective of this study is to systematically review how the ECB pricing framework is designed. The method used in this review is PRISMA. First, articles aiming to design an ECB pricing framework were collected from the Scopus, Science Direct, and Dimensions databases on 22 March 2023. Then, the results were selected, resulting in eleven relevant articles. Then, the articles’ pricing frameworks were reviewed based on variables, methods, trigger events, coupon and redemption value payment schemes, and the model solution forms. Finally, several research opportunities for academics are also outlined. This research constitutes a reference for ECB issuers during the pricing process and can motivate academics to design more useful ECB pricing models.

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Earthquake Bond Pricing Model Involving the Inconstant Event Intensity and Maximum Strength

“…For example, earthquake insurance in Turkey in 1992 and Japan in 1993 provided contingency costs of USD 10.8 million (1.44% of actual losses) [11] and USD 16 million (1.6% of actual losses) [12], respectively. Therefore, to overcome this shortcoming, in the last three decades, earthquake-prone countries have attempted to develop traditional earthquake insurance mechanisms to be more effective in providing post-earthquake contingency costs [13][14][15]. So far, this development has established an earthquake insurance mechanism connected to financial instruments in the capital market.…”

“…in the last three decades, earthquake-prone countries have attempted to develop trad tional earthquake insurance mechanisms to be more effective in providin post-earthquake contingency costs [13][14][15]. So far, this development has established a earthquake insurance mechanism connected to financial instruments in the capital ma ket.…”