Hedging strategies using catastrophe insurance options

For several years there has been discussion in the insurance industry of the need for additional capital sources to participate in insuring the financial risk posed by natural catastrophes. A number of methods for accessing the capital markets have been introduced and some insurers are using these to hedge exposure to catastrophe loss. We will summarize some of the discussion and describe some of the methods proposed. We will then focus on one of these methods, the use of catastrophe insurance options. We will give the results of simulations which may serve as a guide to insurers interested in using these options as part of their risk management strategy and also as an indication to investors of the value of these instruments as a new component of an investment portfolio.