Evaluation of portfolio of financial and insurance instruments: Simulation of uncertainty

The increasing number of natural catastrophes leads to severe losses for production, in infrastructure and individual property. Classical insurance mechanisms may not be sufficient in dealing with such losses because of dependencies among sources of losses, huge values of damages, problems with adverse selection and moral hazard. To cope with dramatic consequences of such extreme events integrated policy is required. In this paper we discuss the model of portfolio which consists of a few layers of insurance and financial instruments, like catastrophe fund, catastrophe bonds, governmental help, etc. We use approach based on neutral martingale method and simulations. We price the catastrophe bond applying Vasicek model used for zero-coupon bond under assumption of independence between catastrophe occurrence and behavior of financial market. We discuss the effects of uncertainties which arise from estimation of rare events with serious, catastrophic consequences like natural catastrophes.

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