ART versus reinsurance: the disciplining effect of information insensitivity

Brandts, Silke and Laux, Christian (2005) ART versus reinsurance: the disciplining effect of information insensitivity. Discussion paper, 545. Financial Markets Group, London School of Economics and Political Science, London, UK.

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Abstract

We provide a novel benefit of "Alternative Risk Transfer" (ART) products with parametric or index triggers. When a reinsurer has private information about his client’s risk, outside reinsurers will price their reinsurance offer less aggressively. Outsiders are subject to adverse selection as only a high-risk insurer might find it optimal to change reinsurers. This creates a hold-up problem that allows the incumbent to extract an information rent. An informationinsensitive ART product with a parametric or index trigger is not subject to adverse selection. It can therefore be used to compete against an informed reinsurer, thereby reducing the premium that a low-risk insurer has to pay for the indemnity contract. However, ART products exhibit an interesting fate in our model as they are useful, but not used in equilibrium because of basis-risk.

Item Type:	Monograph (Discussion Paper)
Official URL:	http://fmg.lse.ac.uk
Additional Information:	© 2005 The Authors
Library of Congress subject classification:	H Social Sciences > HG Finance H Social Sciences > HB Economic Theory
Journal of Economic Literature Classification System:	D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information G - Financial Economics > G2 - Financial Institutions and Services > G22 - Insurance; Insurance Companies
Sets:	Research centres and groups > Financial Markets Group (FMG) Collections > Economists Online Collections > LSE Financial Markets Group (FMG) Working Papers
Identification Number:	545
Date Deposited:	30 Jul 2009 10:29
URL:	http://eprints.lse.ac.uk/24664/

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