Fundamental Aspects of Operational Risk and Insurance Analytics: A Handbook of Operational Risk

Chapter Eighteen Insurance and Risk Transfer: Pricing Insurance-Linked Derivatives, Reinsurance, and CAT Bonds for OpRisk

This chapter deals with more advanced aspects of OpRisk insurance mitigation and covers three main topics: catastrophe bonds (CAT bonds) and insurance-linked derivatives for extreme loss (low frequency, high consequence) risk transfer, insurance portfolio selection, and purchase strategies for OpRisk insurance products (including optimal decision rules for when to purchase insurance under a multiple stopping time framework).

In this chapter, we address the following components of OpRisk insurance modeling.

1. How does one manage the transfer of risk with regard to issues such as adverse selection, moral hazard, counterparty risk and withdrawal, payment uncertainty (in amount and time), and systemic risk?

   We particularly address this question in reference to more advanced risk transfer mechanisms such as insurance-linked derivatives like CAT bonds.

2. What are CAT bonds, how are they structured and priced, and how are they relevant to OpRisk?
3. How can one optimize a coverage of Basel III allowable insurance mitigations using linear portfolio of CAT bonds and insurance products via optimal portfolio theory based on tail functional risk measures for generic OpRisk loss processes that do not have a direct insurance product available?
4. What are the optimal multiple times to purchase or construct such insurance mitigation portfolios given an LDA model structure ...