Natural catastrophe reinsurance: essays on market design, risk modelling, and innovation

Natural catastrophe reinsurance has a positive impact on welfare and long-term economic growth. It plays a vital role in generating and distributing knowledge and the diversification of risk on a global scale. Understanding the economics of natural catastrophe reinsurance is important in addressing issues related to the availability and affordability of natural catastrophe risk transfer in general.

Current literature is constrained by limited access to privately held transaction data and the opaqueness of the reinsurance market system. Moreover, existing knowledge is challenged by climate change and technological developments affecting the nature of risk and transactions, respectively. In this context, this thesis aims to expand the understanding of the economics of natural catastrophe reinsurance, focusing on issues relating to loss shocks and risk modelling, alternatives to conventional natural catastrophe reinsurance, and the design of reinsurance marketplaces.

The first essay uses a sample of reinsurance contract data to examine the relative effects of loss shocks and catastrophe model updates on reinsurance supply and demand during 2005–2018. In a first in the literature, the impact of model-driven probability updating on reinsurance transactions is observed. Furthermore, the results provide evidence for an absence of supply related effects and a measurable influence of budget constraints on insurers’ demand decisions. The second essay addresses the high transaction costs for insurance linked securities and uses expert testimony to assess the challenges to the adoption of reinsurance derivatives. Against this backdrop, swap contracts’ proportional risk transfer capabilities are formally presented along with accounting and legal implications. The results suggest economically important aspects to alternative risk transfer that can address capacity constraints and financial market imperfections. In the third essay, the infrastructure, rules and customs of traditional reinsurance transactions, insurance linked securities, and reinsurance auctions are documented using semi-structured expert interviews. Additionally, the main challenges underlying natural catastrophe transactions are identified and auction theory is reviewed for general lessons learned. The essay initiates a market design discussion and provides missing insights into the transaction modes in natural catastrophe reinsurance.

Overall, this thesis addresses important gaps in the literature on reinsurance economics and provides policymakers, market participants, and researchers with practical implications and direction for future research.