What Drives Financial Innovation in the Insurance Industry?

This article addresses the trade-off between moral hazard and basis risk. A decision maker, e.g., a primary insurer, is considered who can purchase an index hedge and a (re)insurance contract that covers the gap between actual losses and the index-linked payout, or part of this gap. The results suggest that combining insurance with an index hedge may extend the possibility set and by that means lead to efficiency gains. Naturally, the results depend heavily on the transaction costs associated with both instruments. In particular, the authors show that if the index product is without transaction costs, at least some index-linked coverage is always purchased, so long as there is positive correlation between the index and the actual losses. So under these circumstances, there is in any case a benefit from the availability of index products. Furthermore, it is shown that the index hedge would always be supplemented by a positive amount of gap insurance.

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“…9 9 For a more comprehensive overview of insurance‐linked securities, see Belonsky, Laster, and Durbin (1999) or Laster and Raturi (2001). …”

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confidence: 99%

Moral Hazard, Basis Risk, and Gap Insurance

Doherty¹,

Richter²

2002

J of Risk & Insurance

106

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“…Така например все по-често се предлагат застраховки с многопредметно покритие, вместо застраховки срещу конкретен риск, предпочитат се многогодишни продукти вместо едногодишните застраховки и т.н. Нарастващият афинитет към алтернативните решения е еволюираща концепция, която е прераснала от потенциална възможност в модерно решение на един "смел нов свят" (Laster et al, 2001). ECONOMIC SCIENCES SERIES, vol.…”

Section: концептуален поглед върху алтернативните застрахователни решunclassified

The Alternative Insurance Solutions - from Cause to Effect

Kirov

2019

IJUSV-ESS

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The modern markets offer a huge variety of forms of risk management that build on functional parameters of traditional insurance products bringing them seriously compete. The increasing convergence of the capital, banking and insurance markets creates prerequisites for occurrence of new and new alternative solutions. Through them, companies have the opportunity to optimize their risk more efficiently, profitably and adaptively. It turns out that the market for alternative insurance solutions is growing at a rate greater than that of traditional insurance. There are many reasons for this expansionist development but perhaps most important among them is their potential to ensure the operating income of the companies rather than to focus on the physical damage from emerging risks. A natural disaster can round company property and not harm it but it can still put the company at a disadvantage in the context of a deteriorating overall market environment. The damaged infrastructure, delayed deliveries, redirection of savings and other consequences of a disaster can hinder an enterprise's sales even though the company is not in the role of an injured party. In this sense alternative insurance decisions should not be treated only as a transfer of risk but as an integral part of doing a profitable business. They can be an incentive for insurers to engage in product innovations, reduce their prices and pay attention to indirect damage, which is sometimes much more dangerous for companies.Considering the rapid development of alternative insurance markets this report seeks to argue their usefulness for corporate business and to dispel the myth that new opportunities are only a phenomenon of American practice. The regulatory harmonization, product innovation, digitalization of the environment and liberalization of supervision have blurred market boundaries globally and made alternative solutions accessible to all European companies. The author strongly supports the idea that alternative risk transfers that are not yet sufficiently recognizable in Europe, especially for small and medium-sized businesses, should be promoted. Increasing risk literacy and attracting qualified stuff are future directions for development because only through them the new opportunities will be mastered. Although alternative insurance solutions are a trademark for large companies they are fully suitable for all market participants. In addition, they can be successfully combined with traditional insurance if their holders do not trust the alternative instruments or have no experience in absorbing them. The diversification approach will be costlier but it will allow to overcome the disadvantages of both forms of risk transfer.

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“…The authors wish to thank Neil A. Doherty and two anonymous referees for helpful comments. 1 Bochicchio et al (1998);Laster and Raturi (2001). 2 Baur and Schanz (1999).…”

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Pricing Double‐Trigger Reinsurance Contracts: Financial Versus Actuarial Approach

Gründl¹,

Schmeiser²

2002

J of Risk & Insurance

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This article discusses various approaches to pricing double-trigger reinsurance contracts-a new type of contract that has emerged in the area of "alternative risk transfer." The potential coverage from this type of contract depends on both underwriting and financial risk. We determine the reinsurer's reservation price if it wants to retain the firm's same safety level after signing the contract, in which case the contract typically must be backed by large amounts of equity capital (if equity capital is the risk management measure to be taken). We contrast the financial insurance pricing models with an actuarial pricing model that has as its objective no lessening of the reinsurance company's expected profits and no worsening of its safety level. We show that actuarial pricing can lead the reinsurer into a trap that results in the failure to close reinsurance contracts that would have a positive net present value because typical actuarial pricing dictates the type of risk management measure that must be taken, namely, the insertion of additional capital. Additionally, this type of pricing structure forces the reinsurance buyer to provide this safety capital as a debtholder. Finally, we discuss conditions leading to a market for double-trigger reinsurance contracts.

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What Drives Financial Innovation in the Insurance Industry?

Cited by 10 publications

References 4 publications

Moral Hazard, Basis Risk, and Gap Insurance

Moral Hazard, Basis Risk, and Gap Insurance

The Alternative Insurance Solutions - from Cause to Effect

Pricing Double‐Trigger Reinsurance Contracts: Financial Versus Actuarial Approach

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