Although catastrophe bonds are continuing to gain importance in today's risk transfer and capital markets, little is known about the decision-making processes that drive the demand for this aspiring asset class. In the paper at hand, we focus on one segment of the investing community. Our main research goal is to identify major determinants of the cat bond investment decision of insurance and reinsurance companies. For this purpose, we have conducted a comprehensive survey among senior executives in the European insurance industry. Evaluating the resulting data set by means of exploratory factor analysis and logistic regression methodology, we are able to show that the expertise and experience with regard to cat bonds, the perceived fit of the instrument with the prevailing asset and liability management strategy, as well as the applicable regulatory regime are significant drivers of an insurer's propensity to invest. These statistical findings are supported by further qualitative survey results and additional information from structured interviews with the investment managers
of four large dedicated cat bond funds.
Under Expected Utility Theory (EUT) and its behavioural counterpart Cumulative Prospect Theory (CPT), the demand for interest rate guarantees of cliquet style cannot be explained. The reason is that both theories solely focus on the terminal payoff a contract offers and hence completely ignore the stabilizing effect of interest rate guarantees throughout the course of the investment. Recognizing this, recent research has proposed Multi Cumulative Prospect Theory (MCPT) as an approach that extends regular CPT to also include interim value changes of a contract in the policyholder's valuation. We find that under CPT investor preferences, the direct investment yields the highest utility as compared to simple and complex guarantee forms. In contrast to previous findings under MCPT, we show that cliquet style guarantees can only outperform simpler guarantee forms or a direct investment when the investor puts his main emphasis on the subjective utility of the interim changes. As soon as the influence of the terminal value on the subjective utility increases to a certain level, the cliquet style guarantee will be dominated by other products.
Participating life insurance contracts are common products in Europe. Their savings component typically exhibits an interest rate guarantee in combination with a surplus participation mechanism. Together, these two features constitute an embedded option. The purpose of this article is to show how an insurance company can maximize policyholder utility by setting the level of the interest rate guarantee in line with his preferences. We develop a general model of life insurance, taking stochastic interest rates, early default and regular premium payments into account. Furthermore, we assume that equity holders receive risk adequate returns on their initial equity contribution. Our findings show that the optimal level for the interest rate guarantee is far below the maximum value typically set by the supervisory authorities.
