Question

Suppose an insurer writes policies in an area likely to experience hurricanes. To reduce the amount of potential losses, the firm may securitize the risk by:

Answer 1

Answer -

If an insurer writes policies in an area likely to experience hurricanes then to reduce the amount of potential losses, the firm may securitize the risk by issuing Catastrophe Bond to transfer risk to investors in the event of a natural disaster. A catastrophe bond is a debt instrument with very high yield that is designed to raise money by insurers only in the event of natural disaster like, earthquake, tornado or hurricane etc. These bonds gives a payout at the time of these events to the insurance companies.The insurer is not obligated to pay interest and principal of the bond. The investors in these bonds are institutional investors, hedge funds and pension funds.