ABSTRACT
Risk hedging strategies are at the heart of prudent risk management. Individuals often hedge risks to their property, particularly from infrequent but expensive events such as fires, floods, and robberies, by entering into risk transfer contracts with insurance companies. Insurance companies collect premiums from those individuals with the expectation that at the end of the year they will have taken in more money than they have had to pay out in losses and overhead, and therefore remain profitable or at least solvent. Perhaps not surprisingly, insurance companies themselves try to hedge their risks, particularly from the potentially enormous losses often associated with natural catastrophes such as earthquakes, hurricanes, and floods. Much of this hedging is facilitated by the global “property cat” reinsurance market [1], where reinsurance companies insure primary insurance companies against the massive claims that can occur due to natural catastrophes. Figure 12.1 illustrates how this flow works.
