Risk-based catastrophe bond design for a spatially distributed portfolio

Catastrophe bonds (CAT bonds) are risk-linked securities used by the insurance industry to transfer risks associated with the occurrence of natural disasters to the capital markets. Despite their growing importance, connected with the higher exposures to potential natural disasters, relatively few studies on CAT bond pricing, design and their application are available in the literature. In particular, the existing pricing formulations for pricing analysis do not account for uncertainties in model parameters and are not contextualized in a more general CAT bond coverage design procedure for an area of interest. For these reasons, this paper presents a general procedure for designing a CAT bond-based coverage for a spatially distributed portfolio against losses due to natural hazards, accounting also for model parameters uncertainties in CAT bond pricing process. The procedure is then applied to a case study represented by the residential building portfolio in Italy, proposing an ad-hoc CAT bond-based coverage against losses induced by earthquake occurrences, defined on the basis of the most recent version of the seismic risk map of Italy currently proposed in scientific literature.