Catastrophe equity put options

An option purchased by an insurer that allows it to sell its own stock at a certain price in the case that its insurance losses pass a specific threshold. Catastrophe equity puts, or CatEPuts, are used to ensure that insurance companies remain solvent if a catastrophe drastically increases the number of claims that it must cover.

Insurance companies examine the likelihood that a claim will be filed and the severity of that claim when determining whether to underwrite a new insurance policy. The actuarial models that they use take into account historical claims based on demographics , geography, and a number of other factors, and help the insurer set the policy premium. The models also aid the insurer in deciding whether to underwrite a policy.

Insurers plan on a certain number of claims to be made over the course of the year, and set aside money to ensure that they are able to pay those claims. State insurance regulators may also require that the insurer set a particular percentage of premiums aside. The rest of the premiums can be used to pay for business operations, as well as pay investors.

In some cases, however, so many claims are filed that the insurer may not have enough funds to pay what it is obligated to pay. Catastrophe equity puts are designed to provide insurers with additional liquidity in the case that a catastrophe occurs. They are triggered by policy losses stemming from the catastrophe passing a specific threshold.

Reinsurance | III

The insurer does face the risk that the investors who sold it the put will be unable to pay for their obligations; a situation referred to as counter-party risk.

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Derivatives | Catastrophe Equity Put Option

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The Pricing of Catastrophe Equity Put Options with Default Risk - Wang - - International Review of Finance - Wiley Online Library

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