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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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Strategy for the Grand National
November 12, 1996.

Introduction of the new National Annual PCS contract (October 7, 1996) makes for some interesting trading opportunities.

Consider the following trade:

Sell the 1997 National Annual 80/100 call spread at 9.0 points
Buy the 1997 Western Annual 80/100 call spread for 2.1 points
Buy the 1997 Eastern Third Quarter 80/100 for 2.5 points
    for a credit for the position of 4.4 points.

QUESTION:  Is a 22% RoL enough return for the non-western, non-hurricane quarter U.S. annual aggregate risk?

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Perfume of the Premium...
or Pricing Insurance Derivatives, recorded in the proceedings of the 1995 Bowles Symposium, Georgia State University, Atlanta, Georgia. (March 1995)

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