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Warren Buffett on Risk - Or Risky Ground?
May 15, 1998.

Mr. Buffett deserves the world’s accolades when it comes to investing.  He is the nonpareil equity investor.  When he speaks, the world, and I, properly pay attention.

Permit me, however, to take issue with several of his recent comments on bonds in general, and catastrophe bonds in particular, which appeared in Schiff’s and are excerpted alongside.

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Price, Risk and Ratings for Insurance-Linked Notes
May 5, 1998. Published in "Rethinking Insurance Regulation 1998" conference proceedings featured in Derivatives Quarterly.

Morton N. Lane, Ph.D.
President & CEO
Sedgwick Lane Financial, LLC

In the past two years, more than $1 billion of insurance risk has been transferred directly to the capital markets in the form of a dozen or more insurance-linked notes and catastrophe bonds.  This new form of risk transfer, bypassing the conventional reinsurance market, is expected to grow to an annual issuance of $5-$10 billion by the end of the decade, making insurance-linked notes a new and significant asset class.

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Is this an arbitrage I see before me?
April 30, 1998. Also published in The Risk Financier, June 1998.

Open interest at The Chicago Board of Trade (CBOT) jumped almost 20 percent during the month of April and now stands at 22,000 contracts.  Some half-dozen transactions have now been consummated at The Bermuda Commodities Exchange (BCE) and open interest has become visible.  At The Catastrophe Risk Exchange (CATEX), message activity (i.e., inquiries and responses) has jumped 32 percent since January.  Clearly, increasing numbers of people are beginning to pay attention to these new risk transfer markets.

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Arbitraging Insurance Risks v1
December 22, 1998 

On July 16, 1997, Swiss Re Financial Products, in cooperation with Credit Suisse First Boston completed a bond offering of $137 million in California Earthquake Bonds.  The total amount of insurance risk transferred in the bond was $112.2 million.  The size of the bond made it the second largest insurance securitization of the seven completed prior to that date.  Previous issues sponsored by Goldman Sachs, Credit Suisse, and Citibank, had been based on a book of underwritings of particular ceding insurers, namely St. Paul Re, USAA, Winterthur and Hannover Re.  The Swiss Re California Earthquake Bond in contrast was similar to the previous issues sponsored by both Sedgwick Lane Financial (for Reliance) and AIG, namely it was based on index of insured losses.  As such, it was the largest indexed insurance-linked note.

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Arbitraging Insurance Risk v2
July 18, 1997. Also published in Global Reinsurance, Vol. 6, Issue 4, Monte Carlo 1997.

Investors who intended to purchase the recently issued United Services Automobile Association (USAA) Insurance-Linked Note needed to satisfy themselves that the pricing of this novel security was appropriate.  The investment bankers involved in the transaction (Goldman Sachs, Merrill Lynch and Lehman Brothers) needed to assure investors that the price was fair, or even superior.  Among the reassurances given were that (a) USAA itself would share in at least 20 percent of the subject risk alongside the investor, (b) an independent auditor would assess the claims, (c) an independent index (a meteorological trigger of storm categories) would be required, (d) a third-party risk-assessment firm (Applied Insurance Research) would provide estimates of the probability of such storms and their likely effect on USAA’s book of business, (e) a note rating would be provided by the recognized independent rating agencies for certain of the securities, and (f) finally, and perhaps most comforting, that reinsurers themselves (experts on the pricing of such risks) were buying the notes for their own portfolio.  Evidently, all of these efforts worked.  The note (issued June 16) was the largest Insured-Linked Note issued to date and was oversubscribed by a factor of nearly 2.5:1.0.

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A New Wall and LaSalle Street Cocktail (With a Slice of Lime Street)
July 15, 1997. Also published in CFR Magazine, July-Aug. 1997 and The Risk Financier, November 1997

What a difference a year makes!  Last November CFO Magazine published a headline in its Newswatch column, “Disaster Bonds are a Catastrophe” (CFO November 1996).  The headline summed up a common sentiment at the time:  that the nascent effort to securitize insurance risk, once promised to be the next great wave of the future, was running out of gas.  It was indeed their winter of discontent.

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Trading Territories
June 30, 1997.

Insurance companies writing property covers in the US often find themselves with concentration of risks in catastrophe-prone areas.  They “hedge” such risks by buying reinsurance.  Even the reinsurers themselves “hedge” by buying retrocessional covers.  Now, with the PCS Option contract at the Chicago Board of Trade “synthetic” insurers (i.e., traders who write call options or call spreads) can protect against regional exposures by “hedging” or buying back regional contracts.

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A Year of Structuring Furiously
Promises, Promises, January 31, 1997. Also Published in Energy Insurance Review, Spring 1997.

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If it's good enough for Warren Buffett...
December 15, 1996.

On November 18, Chuck Quackenbush, the California Insurance Commissioner, announced that Berkshire Hathaway would underwrite an entire layer of the California Earthquake Authority (CEA).  This layer, $1.5 billion XS $7 billion, was originally intended to be the underpinning for the precedent setting California Earthquake Bond.  This bond was seen as a defining moment for the direct entry of capital markets into reinsurance and the subsequent securitization and derivatization of insurance.  It is obviously a great disappointment to Morgan Stanley, the bond underwriter.

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"Arbitraging"
November 26, 1996. Also published in The Risk Financier, May 1997.

Three times in the last ten years, annual aggregate catastrophic losses for the entire US, as measured by PCS, have exceeded $8 billion* (1994, $16 billion; 1992, $27 billion; and 1989, $14 billion).  Prior to 1989 no year’s aggregate exceeded that level.  In 1995, losses approached $7.8 billion. Losses for the first eleven months of 1996 are $6.8 billion.  Actual numbers are illustrated in the graph on the following page.

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