Rameez Says

INDEX-LINKED CONTRACTS Traditional insurance and reinsurance contracts are based purely on direct indemnification of the insured or reinsured for the losses suffered. Another way to transfer insurance risk, which is particularly important in its transfer to the capital markets, is to link the payments to a certain value of an index as opposed to basing it only on the reimbursement of the actual losses suffered by a specific entity. An example of such an index would be that of the level of losses suffered from a hurricane in a particular region by the whole insurance industry. Another example would be a purely parametric one based on the intensity of a specified catastrophic event without referencing actual insured losses. The two main types of insurance-linked securities whose payout depends on an index value are insurance derivatives and industry loss warranties. Industry loss warranties (ILWs) and catastrophe derivatives (a subset of insurance derivatives) were the first insurance-li

CATASTROPHE MODEL STRUCTURE A catastrophe model that can be used in modelling insurance losses includes all the primary elements mentioned above. It starts with generating a natural catastrophe event such as a hurricane or an earthquake, then determines its physical characteristics at the locations where insured properties are situated, and finally determines the degree of damage caused to the properties and the total financial loss to the insurance companies. The model effectively simulates many (sometimes as high as a million or even more) hypothetical years and accumulates the loss statistics over these hypothetical years. The large number of simulations is essential when dealing with very rare events. The basic structure of the catastrophe models has been described in this and the previous chapter. Figure 4.16 shows a structure of a catastrophe model that is designed specifically for the hurricane hazard; it also shows some of the parameters that are generated by the model in inter

SEASONALITY OF THE HURRICANE RISK IN INSURANCE-LINKED SECURITIES The main hurricane risk of insurance-linked securities, that of North Atlantic hurricanes, is seasonal as opposed to following uniform distribution. The hurricane season officially starts on June 1 and ends November 30. Very few hurricanes occur outside the hurricane season. Approximately 97% of all tropical storm activity happens during these six months. As the the above diagram, there is a pronounced peak of activity within the hurricane season, which lasts from August through October. Over three quarters of storms occur during this period. The percentage of hurricanes, in particular major hurricanes, is even greater: more than 95% of major hurricane (Category 3 and greater) days fall from August through October. Definition of hurricane season is rarely used in the offering documents for insurance-linked securities. Instead, specific dates determine the coverage period. Knowing when the hurricane season officially start