Risk transfer tools in the Italian financial market: catastrophe bonds

Abstract

This thesis is an analysis of a particular risk transfer tool such as catastrophe bonds, one of the main financial tools for the securitization of insurance risks; in particular for what concerns earthquakes in Italy.

Firstly there will be an introduction of financial risk trasfer with Credit Default Swaps and Collateralized Debt Obligations, which are two of the most widespread financial hedging instruments, then the focus will move to catastrophe bonds.

In the first chapter financial hedging tools such as Collateralized Debt Obligations (CDOs) and Credit Default Swaps (CDSs) are presented, with a brief explanation of their structure and how they work in the financial market. These two financial derivatives were chosen to introduce catastrophe bonds because of their wide spread and heavy use since their development and because, as catastrophe bonds do in occurrence of a catastrophic natural event, CDSs and CDOs provide a sort of protection against negative financial events.

In the second chapter, which is divided in four main parts, catastrophe bonds are introduced:

• The first part explains the development, the mechanics and the behaviour of this instrument;

• The second part studies the valuation and the rating of cat bonds;

• The third part of the chapter deepens the main variables taken into consideration for the choice of the jurisdiction where to establish the special purpose vehicle needed for the issuance of a catastrophe bond.

• The last part analyses pros and cons of this particular risk transfer instrument.

In the third chapter only cat bond covering earthquakes in Italy is studied, which was issued by UnipolSai Assicurazioni in 2015 and whose name is Azzurro RE I Limited catastrophe bond.

Firstly an analysis of UnipolSai's portfolio in Italy is provided to better understand how an earthquake could affect the catastrophe bond.

Secondly, an analysis of Azzurro RE I Ltd. catastrophe bond itself will be provided, in particular of all the features of the coverage of the cat bond and the results of the risk analysis made by the experts through a specific model, which is presented as well in this section. The latter is even applied to earthquakes occurred in Italian history to study the impact they would have had on this catastrophe bond.

The third part of the chapter studies why the impact on Azzurro RE I Limited catastrophe bond of the earthquakes occurred in central Italy in August 2016 and in the following months was nothing, both from the point of view of the insurance company and the one of the investors.

Finally, future developments of cat bond in Italy are presented, with a reflection of the social value provided by this financial tool to the community.