Typology and Design of Parametric Cat-in-a-Box and Cat-in-a-Grid Triggers for Tropical Cyclone Risk Transfer

Abstract

The insurance industry has used parametric solutions to transfer catastrophe risks since the 1990s. Instead of relying on a lengthy process to assess a claim, these products pay the insured a pre-agreed amount if the physical characteristics of the event fulfill pre-defined conditions. Cat-in-a-box or cat-in-a-circle triggers, commonly used tools for tropical cyclone risk transfer, provide a payout to the insured if the track of a hurricane crosses the perimeter of a geographic area defined by a polygon or a circle with a certain intensity. Cat-in-a-grid solutions are novel and more sophisticated. They rely on a set of multiple cat-in-a-box triggers arranged on an orthogonal grid. The consideration of multiple geographic domains instead of a single box or circle is helpful to reduce basis risk, i.e., the difference between the parametric loss estimate and the target loss. In the case study for Miami presented here, for instance, a cat-in-a-grid solution showed 18.5% less basis risk than a typical cat-in-a-box alternative. To organize the different types of triggers within a common framework, we classify the existing alternatives based on whether they use a single geographic domain (like a box or a circle) or multiple domains (like a grid). We discuss their advantages and disadvantages and describe the process required to calibrate any one solution with the help of a catastrophe-risk model. We focus, in particular, on the analysis and construction of cat-in-a-grid triggers, the alternative that we believe offers the greatest potential for global standardization and adoption.