ABSTRACT
The environmental catastrophic accidents in China over the last three decades have triggered implementation of myriad policies by the government to help abate environmental pollution in the country. Consequently, research into environmental pollution liability insurance and how that can stimulate economic growth and the development of financial market in China is worthwhile. This study attempts to design a financial derivative for China's environmental pollution liability insurance to offer strong financial support for significant compensation towards potential catastrophic environmental loss exposures, especially losses from the chemical industry. Assuming the risk-free interest rate is 4%, the market portfolio expected return is 12%; the financial asset beta coefficient is 0.5, by using the capital asset pricing model (CAPM) and cash flow analysis; the principal risk bond yields 9.4%, single-period and two-period prices are 103.85 and 111.58, respectively; the principal partial-risk bond yields 10.09%, single-period and two-period prices are 103.85 and 111.58, respectively; and the principal risk-free bond yields 8.94%, single-period and two-period prices are 107.99 and 115.83, respectively. This loss exposure transfer framework transfers the catastrophic risks of environmental pollution from the traditional insurance and reinsurance markets to the capital market. This strengthens the underwriting capacity of environmental pollution liability insurance companies, mitigates the compensation risks of insurers and reinsurers, and provides a new channel to transfer the risks of environmental pollution.