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ART versus reinsurance: the disciplining effect of information insensitivity

By Silke Brandts and Christian Laux

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

Topics: HG Finance, HB Economic Theory
Publisher: Financial Markets Group, London School of Economics and Political Science
Year: 2005
OAI identifier: oai:eprints.lse.ac.uk:24664
Provided by: LSE Research Online

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Citations

  1. (2002). Moral hazard, basis risk, and gap insurance, doi
  2. (1987). Multi-period insurance contracts, doi

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