This paper is based on a article that will appear in the June 2002 issue of Risk Analysis Vol. 22 No. 3 The terrorist attacks on the World Trade Center and the Pentagon have created a heavy demand for insurance against such events. However, it is difficult to price insurance against extreme events because the probability of such events happening again is highly ambiguous, and the potential loss is highly uncertain. This paper explores the analytic issues that insurers must resolve in offering such insurance, including the calculation of premiums, the capital necessary to provide insurance, and options for raising such capital. It also explores the possibilities for public-private partnerships for providing such insurance if private insurers are unwilling or unable to do so, drawing on experiences of other countries. Finally, it identifies a number of issues that must be resolved before the private sector can provide insurance against terrorist attacks and other extreme events

This paper examines possible barriers to securitization, focusing on behavioral responses to such novel instruments. These barriers include the difficulties of conveying the associated risks, even to investors who are sophisticated about finance (but still uncertain about model risk and structural uncertainties). Our analyses will draw on results in behavioral decision making and psychology. They will lead to proposals for empirical research and general strategies for making securities design more consonant with investor behavior.

Processes Center at the University of Pennsylvania is gratefully acknowledged.

Catastrophe bonds (cat bonds) often use index triggers, such as, for instance, parametric descriptions of a catastrophe. This implies the problem of the so-called basis risk, resulting from the fact that, in contrast to traditional reinsurance, this kind of coverage cannot be a perfect hedge for the primary’s insured portfolio. On the other hand, cat bonds offer some very attractive economic features: Besides their usefulness as a solution to the problems of moral hazard and default risk, an important advantage of cat bonds can be seen in presumably lower risk premiums compared to (re)insurance products. Cat bonds are only weakly correlated with market risk, implying that in perfect financial markets these securities could be traded at a price including just small risk premiums. Furthermore, there is empirical evidence that risk aversion of reinsurers is an important reason for high reinsurance prices. In this paper we introduce a simple model that enables us to analyze cat bonds and reinsurance as substitutional risk management tools in a standard insurance demand theory environment. We concentrate on the problem of basis risk versus reinsurers ’ risk aversion and show that the availability of cat bonds affects the structure of an optimal reinsurance contract as well as the reinsurance budget. Primarily, reinsurance is substituted by index-linked coverage for large losses.

Résumé: Keynes et Knight font une distinction claire entre deux formes d'incertitude: celle qui peut être caractérisée par une distribution de probabilités- elle est alors appelée risque- et celle que ne le peut pas. Nous nous intéressons ici à la prise de décision en incertitude véritable, en l'absence de support probabiliste. Nous considérons d'abord des critères qui permettent d'accepter un information incertaine comme fiable. Ensuite nous examinons la possibilité de représenter la prise de décision en incertitude d'une manière formelle qui généralise l'approche de von-Neumann-Morgenstern dans le cas du risque. Abstract: Keynes and Knight make a clear distinction between two kinds of uncertainty: the first one, called risk, may be characterized by probabilities, while this is not possible for the second one. Here we deal with decision-making under genuine uncertainty, no probability distributions being available. We first consider criteria to accept some piece of information as reliable. And we examine the possibility to formally represent decision-making under uncertainty in a way which generalizes the von Neumann-Morgenstern approach to decision-making under risk. Mots clés:

This empirical study provides evidence linking supply chain strategy and company risk structure. An event study on the stock performance of four major PC producers is performed focusing on the 1999 earthquake in Taiwan and the computer memory price increases that ensued. It is shown that investors associate pull-type supply chains for PCs with lower profitability after abrupt component price increases. A parallel analysis of push-type producer stock returns does not show similar results. Furthermore, in depth analysis of Dell Computer reveals that after the catastrophe-induced disruption the onset of losses to this major pull-type PC producer was very fast. Far from condemning pull-type PC supply chains, earthquake-induced disruptions, like the one researched, pose manageable risks.

This paper is an attempt to evaluate the effect a cat bond issue has on the stock price of the issuing company by conducting an event study including cat bond issues done by publicly traded insurers and reinsurers. We find no significant price effect in either direction. This is consistent with the hypothesis that paid premiums are justified and total costs and benefits of laying off cat risk in the capital markets offset each other. The results should confirm potential issuers that issues at prices currently demanded by investors are not value destroying and that it is not justified that “there are investors, but not enough supply”. *University of Lausanne, Switzerland.

The importance of public-private partnerships for disaster management has been stimulated by losses from catastrophes in the United States and other parts of the world. Hurricane Andrew that created damage to Miami and Dade County, Florida in September 1992 and California's Northridge earthquake together cost the insurance industry (US$28

This paper examines the potential of pre- and post-disaster instruments for funding disaster response and recovery and for creating incentives for flood loss mitigation in countries with emerging economies. As a concrete case, we discuss the disaster recovery arrangements following the 1997 flood disaster in Poland. We examine the advantages and limitations of hedging instruments, which are instruments for transferring the risk to investors either through insurance or capital market-based securities. We compare these mechanisms with financing instruments whereby the government sets aside funds prior to a disaster or taps its own funding sources after the event occurs. We show how hedging instruments can be designed to create incentives for the mitigation of damage to public infrastructure using the flood proofing of a water treatment plant on the River Oder in Poland as an illustrative example. We conclude that hedging instruments can be an attractive alternative to the financing instruments that have been traditionally used in developing countries to fund disaster recovery. Since very poor countries are likely to have difficulties in paying the price of protection prior to a disaster, we suggest that international lending institutions consider innovations for subsidizing these payments 2