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Alternative Alternatives: Risk, Returns and Investment Strategy by Sona Blessing

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2

Insurance Linked Risk Transfer

2.1 Introduction

Earthquakes, hurricanes, floods, longevity and pandemic led extreme mortality, for instance, are all naturally originating and occurring risks that are technically insulated from the vagaries of financial markets. An earthquake occurs irrespective of the level at which the S&P 500 is trading. Clearly, although it is not possible to invest in such a phenomenon/catastrophe ‘itself’ (as is the case with ‘physically’ investing in the biological growth of trees), investors can effectively get exposure to such unusual ‘risk premia’ via capital markets, by assuming a more direct role in providing mostly traditional risk-bearing entities such as insurers, reinsurers, retrocessional reinsurers or retro-reinsurers (reinsurers to reinsurance companies) with either capital, coverage and/or protection.

Typically insurers and reinsurers select and manage their portfolios of underwritten risks so they can stay solvent. This is broadly based on the underlying assumption that premium inflows > actual coverage/ indemnity outflows/expected average loss. This premise has and does see reversals as the underwriting of insurance and reinsurance contracts is not just complex but, among others, is expensive and is based on actuarial science – the ability to assess, ‘estimate’, price event and basis risk (the mismatch between actual losses and fixed contractual payout) of naturally occurring and often unprecedented phenomena. A case in point: the reinsurance ...

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