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Customizing Indemnity Contracts and Indexed Cat Bonds for Natural Hazard Risks

DAVID C. CROSON (Assistant professor of operations and information management at The Wharton School of the University of Pennsylvania in Philadelphia.)
HOWARD C. KUNREUTHER (Cecilia Yen Koo Professor of decision sciences and public policy in the operations and information management department at The Wharton School of the University of Pennsylvania.)

Journal of Risk Finance

ISSN: 1526-5943

Article publication date: 1 February 2000

Abstract

This article examines how reinsurance coupled with new financial instruments can expand coverage to areas exposed to catastrophe losses from natural disasters, and demonstrates how reinsurance and the catastrophe‐linked financial instruments can be combined to lower the price of protection from its current level. A simple example illustrates the relative advantages and disadvantages of pure catastrophic bonds and pure indemnity reinsurance in supporting a structure of payments contingent on certain extreme events occurring. The authors suggest ways to combine these two instruments using customized catastrophe indices to expand coverage and reduce the cost of protection. This article states six principles for designing catastrophic risk transfer systems and discusses practical issues for implementation, and then concludes with suggestions for future research.

Citation

CROSON, D.C. and KUNREUTHER, H.C. (2000), "Customizing Indemnity Contracts and Indexed Cat Bonds for Natural Hazard Risks", Journal of Risk Finance, Vol. 1 No. 3, pp. 24-41. https://doi.org/10.1108/eb043446

Publisher

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MCB UP Ltd

Copyright © 2000, MCB UP Limited