CAS Exam 9 Spring 2017, Question 15
Study guide: Exam 9
Consider the following information about reinsurance pricing and catastrophe (CAT) bond pricing:
- Industry average CAT bond spreads from secondary market transactions:
| 2005 | 2006 | |
|---|---|---|
| Expected Loss as a Percent of Principal | 2% | 3% |
| Ratio of Bond Premium to Expected Loss (Spread) | 2.7 | 3.3 |
- CAT reinsurance rate on line (ROL) and loss on line (LOL) from industry data:
| Loss on Line (LOL) | 2005 ROL / LOL | 2006 ROL / LOL |
|---|---|---|
| 1% | 5.9 | 12.9 |
| 2% | 3.6 | 7.1 |
| 3% | 2.9 | 5.2 |
| 20% | 1.7 | 1.8 |
- where ROL is defined as reinsurance premium divided by the policy limit, and
- LOL is defined as expected loss on the contract divided by the policy limit.
Part a (1 point)
Evaluate the cost of purchasing protection through a CAT bond market compared to purchasing through the traditional reinsurance market.
Part b (0.5 points)
Using the above information, explain why a company may choose not to purchase high excess layers of reinsurance.
Part c (0.5 points)
Discuss why CAT bonds may be preferable to traditional reinsurance for protecting higher layers of loss.
Answer this question and see the worked solution