TY  - JOUR
AU  - Lakdawalla,Darius
AU  - Zanjani,George
TI  - Catastrophe Bonds, Reinsurance, and the Optimal Collateralization of Risk-Transfer
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12742
PY  - 2006
Y2  - December 2006
UR  - http://www.nber.org/papers/w12742
L1  - http://www.nber.org/papers/w12742.pdf
N1  - Author contact info:
Darius N. Lakdawalla
Schaeffer Center for Health Policy and Economics
University of Southern California
3335 S. Figueroa St, Unit A
Los Angeles, CA 90089-7273


Los Angeles, CA 90
Tel: 213/740-6012
E-Mail: dlakdawa@healthpolicy.usc.edu

George Zanjani
Georgia State University
E-Mail: gzanjani@gsu.edu
M3  - presented at "Insurance Project Workshop", February 10-11, 2006
AB  - Catastrophe bonds feature full collateralization of the underlying risk transfer, and thus abandon the insurance principle of economizing on collateral through diversification. We examine the theoretical foundations beneath this paradox, finding that fully collateralized instruments have important uses in a risk transfer market when insurers cannot contract completely over the division of assets in the event of insolvency, and, more generally, cannot write contracts with a full menu of state-contingent payments.  In this environment, insureds have different levels of exposure to an insurer's default.  When contracting constraints limit the insurer's ability to smooth out such differences, catastrophe bonds can be used to deliver coverage to those most exposed to default. We demonstrate how catastrophe bonds can improve welfare in this way by mitigating differences in default exposure, which arise with: (1) contractual incompleteness, and (2) heterogeneity among insureds, which undermines the efficiency of the mechanical pro rata division of assets that takes place in the event of insurer insolvency.
ER  -