Financing catastrophe risk in the capital markets

This article provides an overview of how insurance and reinsurance companies and institutions can use new methods to finance extraordinary or catastrophe risk in the capital markets as well as to split or swap it. These new methods are divided into two groups those that issue new assets (secondary financial assets) by securitisation and those that use derivatives structured products. Catastrophe or "act of God" bonds, contingent surplus notes, exchange-traded catastrophe options, catastrophe equity puts or catastrophe swap are useful instruments for insurers and for investors. From the insurers' point of view, those financial instruments are not used to replace traditional reinsurance, but to supplement it. From the investors' perspective, these forms of securitisation permit that investors use catastrophe models and exposure data to determine the rates of return they could expect from selling catastrophe options to insurers and also offer investors a new means of reducing portfolio risk through diversification.