3. RISK TRANSFER
The Louisiana Coastal Protection and Restoration Authority (LACPRA) seeks to protect the State from excessive losses in responding to possible storm events in the Louisiana Delta. To do so, the Authority has negotiated re-insurance and ILS risk transfers according to the following schedule:
LACPR Retention — 200m Company A 30% Quota-Share limited to 200m loss — 200m LACPR 40% Retention 200m 400m Company B First 60% Surplus-Share 200m 400m Company C First Excess of Loss 400m 600m Company B 100m Indemnifying CAT Bond for losses over 600m Company D 100m Excess of Loss 600m 800m Company E Stop Loss 800m 1000m
The probability distribution of losses in a catastrophic storm, expressed as a probability density function (PDF) is,
1 f (x) = —ae-(x I a)
in which x is the dollar loss and a = 109 is a constant. The expected value of this distribu-tion of losses is E[x] = a = $109.
a) Draw the risk-transfer layer diagram for this schedulej b) If a $700m storm loss occurs, who pays how much to cover the claim? c) What is LACRA’s expected loss from a catastrophic storm?