Abstract

Due to the recent increase in the severity and frequency of natural catastrophes, insurers believe that insured losses from such catastrophes can exceed $50 billion. There is not enough capital available in the insurance industry to cover such catastrophic losses. Therefore, insurers have begun looking for new sources of capital. The most promising solution is in the capital market, specifically in catastrophe insurance options. The options have a settlement index, which is the market's estimate of the losses for the covered quarter. While these options have advantages as well as disadvantages over reinsurance. The main problem hindering the market is the lack of a generally accepted pricing model. Neither option pricing models nor reinsurance pricing methods are suitable for the severity of recent catastrophes. Since a pricing model would probably dramatically increase the popularity of catastrophe insurance options, the search for such a model is the source of great discussion in the insurance industry.

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