Risk warehousing within insurance firms and the role of securitization
Name
749893776-MIT.pdf
Description
Full printable version
Size
3.1 MB
Format
Adobe PDF
Checksum (MD5)
a97b02e3f50ea7c0bebb9de533c0527e
Author(s)
Strydom, Johann J. (Johann Jurie)
Advisor(s)
S.P. Kothari.
Date Issued
2011
Publisher
Massachusetts Institute of Technology
Abstract
Insurance firms perform two key economic functions. First, they intermediate risk by marketing, selling and administering insurance policies. Second, they warehouse the risks underlying those policies. If viewed as separate businesses, intermediation and warehousing have very different risk profiles and characteristics. While intermediation is a function essential to the firm's role, the warehousing of those risks is mostly optional. It involves deciding to retain risks for the insurance firm's account rather than hedge the risk and thereby pass it on to a third party. The decision to retain or hedge risks is critical to a firm's financial outcomes. Insurance risks include underwriting factors like longevity, mortality and exposure to natural disasters. They also include economic factors like interest rates, currencies, counter-party default and equity markets. The consensus in the academic theory is that since insurance firms face significant frictional costs in raising capital, value-maximising firms will hedge all risks where the spread costs of the hedging instrument are low. This would seem to include most or all economic risks. As for underwriting risks, where hedging spreads are high, the decision will be a trade-off The firm will weigh up the reduced Risk-Bearing Costs offered by the hedging counter-party versus the Risk Transfer Costs incurred in these transactions. In practice it seems many firms hedge less than might be expected, retaining more economic and underwriting risk than may be explained by the theory. Factors which may be driving a bias towards risk are briefly explored, including regulatory drivers and an expectation of beating the market. Insurance-linked securitization offers benefits as a means of hedging risk and enhancing shareholder value through reduced Risk-Bearing Costs, although it faces informational problems that increase Risk Transfer Costs. Catastrophe Risk Bonds appear to have achieved a critical mass on the back of some historical capital shortages in the reinsurance industry. The life insurance securitization market could be poised for growth, but based on the history of Catastrophe Risk Bonds it may also require capital shortages in the life industry as a catalyst. Regulatory capital requirements will play a pivotal role in this regard.
Description
Thesis (M.B.A.)--Massachusetts Institute of Technology, Sloan School of Management, 2011.
Cataloged from PDF version of thesis.
Includes bibliographical references (p. 55-58).
Subjects
Sloan School of Management.
MIT Department
Sloan School of Management
Terms of Use
M.I.T. theses are protected by
copyright. They may be viewed from this source for any purpose, but
reproduction or distribution in any format is prohibited without written
permission. See provided URL for inquiries about permission.
copyright. They may be viewed from this source for any purpose, but
reproduction or distribution in any format is prohibited without written
permission. See provided URL for inquiries about permission.
Persistent DSpace Link
