Insurance option refers to an option whose strike price is the loss of a certain underwriting risk. When an insurance company buys an insurance option, when the specific underwriting loss exceeds the option exercise price, the value of the option increases with the increase in the amount of the specific underwriting loss. At this time, if the insurance company exercises the option, the option income it obtains can just offset the loss over the limit, thus protecting the solvency of the insurance company.
Features of insurance options
As a financial innovation, insurance options have the following basic characteristics:
(1) Compared with catastrophe risk bonds, insurance options, especially over-the-counter insurance options, have lower costs for transferring underwriting risks. Insurance is essentially an option or a combination of options. Using option features to control the operating risks of insurance companies is in line with insurance companies’ demand for dynamic solvency.
(2) When the specific underwriting loss exceeds the exercise price of the option, the loss of the seller of the insurance option increases with the increase in the amount of underwriting loss. The premium of the insurance option that the seller collects in advance is the risk compensation for the seller to bear the risk of such insurance loss.
(3) For the seller of insurance options, there is no upper limit to the loss risk of a single insurance option. In practice, it is difficult to find a seller of a single insurance option, and it is often necessary to combine two insurance options with the same contract period but different exercise prices to reduce the risk borne by the option seller.
(4) Insurance options have two forms: on-exchange trading and over-the-counter trading. Over-the-counter transactions can easily arrange insurance option contracts suitable for insurance companies’ underwriting risk conditions based on the risks transferred by insurance companies, but such exchanges bear a greater risk of default by the counterparty; and on-exchange transactions must comply with the exchange’s According to the standard conditions, the risk contained in the option contract is a certain underwriting risk of the entire insurance industry, which is not necessarily suitable for the individual needs of individual insurance companies to diversify underwriting risks.