Question

discuss how the insurance industry will use disaster bond and weather derivative to transfer risk to the capital market

Answer 1

Disaster bond :- Disaster Bond is nothing but the bond which covers the risks due to disaster , and these losses due to disaster for an investor will be transferred to the Insurance company.

For example - Catastrophe Bonds is an example of Disaster Bond.

Weather Derivative - Weater Derivatives are bonds which covers te losses occured due o Weather risk,

In general the seller/dealer of the weather derivatives agrees to cover te risk occured by Weater /calamities.

Now we are required to clarify how these losses are handles by Insurance company & how they transfer i to capital markets.

Usually the Insurance company can transfer their risks to the Capital market. This methos is often refered to Securitization.

In this case also, the Insurance company can transfer the risk of weater derivatives & Disaster Bonds through securitization.

Securitization:Securitization refers to a financial instrument through which the Insurance company transfers its risk to capital market. The risks which the Insurance company has will be bundled together, and the rikswhich Insurance company has after treated together, it will be considered as Assets of the Insurance company.

Now these assets of the Insurance company will be traded as shares by the company itslf or through any Underwriters.

By selling these shares , the risks of the Insurance companies will be transfered to capital markets.

This metod is adopted by Insurance companies rather than transfering the risks to other insurance companies/re-insurance.Because, ere the risk is transferes to wider /broader capital markets.