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Decomposition of Natural Catastrophe Risks: Insurability Using Parametric CAT Bonds

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  • Morteza Tavanaie Marvi

    (Civil & Environmental Engineering Department, University of Illinois at Urbana-Champaign, Champaign County, IL 61801, USA
    Current address: Newmark Civil Engineering Laboratory, MC-250, 205 North Mathews Ave., Urbana, IL 61801, USA.)

  • Daniël Linders

    (Amsterdam School of Economics, University of Amsterdam, Roeterstraat 11, 1001 NJ Amsterdam, The Netherlands)

Abstract

Nat Cat risks are not insurable by traditional insurance mainly because of producing highly correlated losses. The source of such correlation among buildings of a region subject to a natural hazard is discussed. A decomposition method is proposed to split Nat Cat risk into idiosyncratic (and hence insurable) risk and systematic risk (carrying the correlated part). It is explained that the systematic risk can be transferred to capital markets using a set of parametric CAT bonds. Premium calculation is presented for insuring the decomposed risk. Portfolio risk-return trade-off measures for investing on the parametric CAT bond are derived. Multi-regional and multi-hazard parametric CAT bonds are introduced to reduce the risk of the investment. The methodology is applied on a region with about 3000 residential buildings subject to flood hazards.

Suggested Citation

  • Morteza Tavanaie Marvi & Daniël Linders, 2021. "Decomposition of Natural Catastrophe Risks: Insurability Using Parametric CAT Bonds," Risks, MDPI, vol. 9(12), pages 1-19, December.
    • Handle: RePEc:gam:jrisks:v:9:y:2021:i:12:p:215-:d:692610
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    References listed on IDEAS

    as
    1. Charpentier, Arthur & Le Maux, Benoît, 2014. "Natural catastrophe insurance: How should the government intervene?," Journal of Public Economics, Elsevier, vol. 115(C), pages 1-17.
    2. Morteza T. Marvi, 2020. "A review of flood damage analysis for a building structure and contents," Natural Hazards: Journal of the International Society for the Prevention and Mitigation of Natural Hazards, Springer;International Society for the Prevention and Mitigation of Natural Hazards, vol. 102(3), pages 967-995, July.
    3. repec:hal:journl:hal-00536925 is not listed on IDEAS
    4. Christian Biener & Martin Eling, 2012. "Insurability in Microinsurance Markets: An Analysis of Problems and Potential Solutions," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 37(1), pages 77-107, January.
    5. J. David Cummins, 2008. "CAT Bonds and Other Risk‐Linked Securities: State of the Market and Recent Developments," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 11(1), pages 23-47, March.
    6. Niehaus, Greg, 2002. "The allocation of catastrophe risk," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 585-596, March.
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    Cited by:

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    2. Wulan Anggraeni & Sudradjat Supian & Sukono & Nurfadhlina Abdul Halim, 2023. "Single Earthquake Bond Pricing Framework with Double Trigger Parameters Based on Multi Regional Seismic Information," Mathematics, MDPI, vol. 11(3), pages 1-44, January.

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