Reinsurance Of Catastrophe Risks

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Reinsurance of Catastrophe Risks

Introduction

Extreme events happen very seldom, however, they can inflict tremendous damage when they strike. The events are either natural occurrences (earthquake, flood, volcanoes, landslides, tsunamis) or man-made event (fire disasters, plane crashes, riots).

Increasing earthquake damage in recent years is evidence of rising vulnerability for the communities as more people with more valuable property are residing in earthquake-prone areas as it is observed by the rapid population growth. In developing countries most of the growth is in very large urban centres, for example, the Nairobi of today is very different from what it was 15 years ago both in population and property.

The destruction from a catastrophe is of great concern to individuals, communities, governments and private sectors. It interrupts life and can take quite a while before normalcy is restored. It is there critical to know how to manage this possible occurrence.

A catastrophe is defined as the final event of the dramatic action especially of a tragedy or a momentous tragic event or a violent and sudden change in a feature of the earth. A catastrophe is also defined as a sudden, violent, physical manifestation that causes widespread and severe property damage.

How are Catastrophic Risks Funded?

A catastrophic event affects insured and non insured lives and properties. Those who are turned to for support after a catastrophic event are: the governments/public agencies, insurance industry and capital markets as they all have a role to play with respect to providing financial protection against catastrophic losses. How do the players in the insurance industry prepare for such eventualities?

Insurance companies p...

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...encing catastrophic losses. Therefore, insurance companies need sufficient capacity to cover catastrophic risks. Although they build reserves to provide coverage for the risks, in catastrophic events, the expected loss may exceed the possibilities of the individual insurer. It has been noted that financing of catastrophic risks through reinsurance may be limited and a turn the capital market instruments to add financial capacity is increased. Financial instruments absorb the effects of a hard market and manage complex or difficult risk exposures which are often hardly insurable in the traditional insurance market. The emergence of catastrophe bonds, catastrophe derivatives, sidecars, industry loss warranties complement the catastrophe reinsurance market. Nevertheless, they should be characterized as a supplement, rather than an alternative to catastrophe reinsurance.
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