Catastrophe Insurance in Asia and the Pacific

Singapore – Asia has experienced all types of calamities ever since the start of time. Disaster risks are higher in Asia than in other countries in the world as it will always be the trigger of typhoons, flood in Japan, tsunamis in Sumatra and Jakarta, Indonesia and other natural disasters. The region is indeed a natural disaster prone area. Axis Capital, with a group of insurance companies from its main branch in Bermuda to UK and US to its branch to Singapore and Jakarta also realizes the risk and the importance of catastrophe insurance in the region.

According to Asian Development Bank review, in order to understand the impact of new standards on the capital structure choices of companies, we build a model that derives the optimal targeted rating for the insurance firm. The unique feature of an insurance policy is that insurance buyers care about the credit risk of the insurer and are willing to pay a higher price for the policy that has lower risk. The buyer uses the credit rating of the insurer to assess its financial strength. Holding more capital increases the credit rating and allows charging higher prices. The amount of capital needed to satisfy a particular rating standard depends on the volatility of insurer’s liabilities. Since capital is costly, more volatile companies are more likely to admit lower rating. Ultimately, the capital structure decision depends on the cost of capital and the elasticity of aggregate demand for insurance with respect to financial quality.

Catastrophe insurance is different from other types of insurance in that it is difficult to estimate the total potential cost of an insured loss and a catastrophic event results in an extremely large number of claims being filed at the same time. This makes it difficult for catastrophe insurance issuers to effectively manage risk. Reinsurance and retrocession are used along with catastrophe insurance to manage catastrophe risk. When warnings are raised in the countries for typhoon signals and flood possibility, insurers are already on the edge of their seat.

Natural catastrophes are a major threat to sustainable development, especially in Asia and the Pacific. Asia Development Bank's developing member countries are particularly vulnerable. Catastrophe risk could be transferred through a regional public-private insurance partnership. This is the key finding of the Asian Development Bank Conference on Natural Catastrophe Risk Insurance Mechanisms for Asia and the Pacific held in Tokyo in November 2008. The major characteristic feature of catastrophe insurance is that all the losses in the area affected by the catastrophic event are highly correlated with each other. This violates a basic principle of ordinary insurance, which is based on combining a large number of independent risks of similar magnitude—which is what is meant by diversification of risks.

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