User:Pranavtaneja

What are INSURANCE DERIVATIVES?
Insurance derivatives is a financial derivative whose value is derived from an underlying asset or assets.The underlying asset in this is a non-financial asset which are the losses adhered to the catastophes like earthquakes,cyclones etc.This type of derivative is mainly ment for insurance companies to hedge their exposure to insurance losses.Apart from hedging insurance derivatives are also used for speculative purpose and diversification of portfolios.

Need of Insurance Derivatives
The first need for Insurance Derivatives came into existence in the 1990s when the insurance industry was hit hard by a number of catastrophes like earthquakes,storms and hurricanes.It was noticed that the potential losses associated with these natural disasters was far more than the available capacity of the insurance and reinsurance markets.Even the recent study by an institution revealed that in 2006 the total insured losses incurred due to natural catastrophes was worth USD 11.8 bn and the man made disasters brought in about USD 4.0bn worth losses.Now in order to mitigate the burden of sudden

The First Insurance Derivative
The first Insurance derivative came into existence around a quarter century back by CBOT((Chicago Board of Trade).But due to small trading volumes associated to it CBOT stopped its trading.The resurgence of insurance came into being when the insurance industries were badly hurt in the 20th century due to some of the deadliest earthquakes and hurricanes. Due to small volumes of trades related to the insurance derivatives there came a solution of switching this category of derivatives into the capital market as it used to trade in huge volumes and a well established market as well.

How does Insurance Derivative work?
Catering to hedging the risks of insurance industries due to the unexpectedly disastrous natural and human generated catastrophic events gave a strong impetus to the inception of Insurance derivatives.An insurance derivative can be something of the sought of an option that gives its buyer the right to a cash payment if a specific index of insured earthquake losses reaches a specified level .This level could be the strike price.Alternatively, the index might be based not on the level of losses, but on the severity of the catastrophic event.Since there are no underlying assets linked to the insurance derivatives so the payment triggers in this can be the losses as incurred by the insurer or the insurance company or on a an index which decides the intensity of the occuring catastrophic event.Mainly the insurance companies refers to the parammetric index or industry loss indexes as benchmarks to these derivatives.Many times there can be a combination of both of them to diversify the risk portfolio.This is mainly ment to mitigate the basis risk Under Construction