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Optimal Insurance and Reinsurance Portfolios...
Sept. 24, 2007

By: Morton N. Lane, President; Jerome Kreuser

Some reinsurers use optimization procedures to generate underwriting portfolios, maximizing expected returns which are perfectly aligned with their stated risk preferences. Similar objectives apply to those who use simulation or DFA techniques. However, beyond the optimal portfolio itself, optimizers as part of their output also generate marginal economic signals, such as “implied” or “risk adjusted” probabilities which are important but underused and often misunderstood management tools. The purpose of this paper is to further illustrate the power of those economic signals.

In an earlier paper4 we illustrated how implied or risk-adjusted probabilities from optimal solutions may be derived and used in a simple single risk zone example. In this paper we continue the same simplifying universe but with multiple risk zones. We then use the marginal outputs to illustrate how to price indifference points for traditional retrocession purchases, which complement the optimum portfolio. In addition, we show how the implied probabilities may be used to allocate retrocession costs to the respective zones. Of course, allocating retrocession costs is an important sub-species of allocating capital costs in general. Actually we also believe the marginal outputs are the key to unlocking general capital allocation decisions.

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Developing LFC Return Indices
August 14, 2007

By: Morton N. Lane, President; Roger G. Beckwith, Vice President; Jason Overbey

It is a non-trivial exercise to construct a set of indices representing the world of Insurance Linked Securities (ILS).  And, at the end of the exercise, there is neither a unique nor a precise formula for the perfect index.

In case this observation causes undue distress, it is well to be reminded of the variety of indices used to represent the US stock market. The Dow Jones Index is a price-weighted index of 30 stocks. At the other end of the spectrum, the Wilshire 5000 index offers market capitalization-weighted indices related to both total capitalization and float weighted capitalization. The S&P 500 index is float-weighted and the NASDAQ 100 is a “modified” market weighted index.  Each captures different aspects of the market and over time consumers have found utility in each of them.

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That was the Year that was!
April 20, 2007
The 2007 Review of the Insurance Securitization Market

By: Morton N. Lane, President and Roger G. Beckwith, Vice President

The past 18 months of frenetic activity in the Insurance-Linked Securities (ILS) market seems to have come to an end. One is tempted to ask, is that all there is?

Is this a halt, or a pause that refreshes? The precipitating causes of the 2006 rush of activity were the losses from Katrina, Wilma and Rita. The end seems to have been precipitated by a) the absence of significant 2006 losses, b) the restoration of capital1 equilibrium and finally, c) the actions of the state of Florida to abandon private markets and to nationalize (is that the correct word for state level application?) catastrophe risk. The first two of these reasons are to be expected, the last is a bit of a shock to the reinsurance body politic. And, worse, it may have been entirely unnecessary. Politicians were stampeded to action by high insurance prices within the state during 2006. However, a look at the chart reproduced here as Figure 1 shows quite clearly that prices peaked in July last year and have been declining ever since. With another loss free year they show every prospect of a return to pre-Katrina levels. But if there is another violent year, why should they? It will reflect a new reality, as subsidizing Florida taxpayers will no doubt learn to their cost. 

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Recapitalizing Reinsurers - A Never Ending Story?
January 31, 2007

By: Morton N. Lane, President

The early weeks of 2007 present a study in contrasts for both the property catastrophe reinsurance and insurance industries. The reinsurance industry has experienced a flood of new capital (of which more below) and has seen premiums turn lower from their June 2006 peak. In contrast, the insurance industry is galvanized by the actions of regulators, particularly in Florida, who have essentially mandated lower premiums for their citizen home-owners and decided to provide reinsurance capital via the enforced subsidy of their taxpayers. The reinsurance industry is largely unregulated, largely off-shore and driven by competitive market forces; the insurance industry is heavily regulated (by States) and appears to be largely driven by domestic State politics. In Florida the regulators want to extend the reinsurance that is provided at fixed prices from Citizens (their assessment and public backed insurer of last resort). Question is, which solution is likely to lead to lower prices over time (if they indeed should be lower) and which provides the healthier source of reinsurance capital? The answer seems self evident to us, and part of the reason for that is the track record of the reinsurance industry during the last 15 months. The amount of capital raised and the innovation that has been displayed is impressive. The purpose of this paper1 is to review and record that story. 

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Of Sidecars and Such
January 31, 2007

By: Morton N. Lane, President

Sometimesit happens that one word so captures the zeitgeist that it isimmediately adopted into the language as if it were always present. Soit was with the word “sidecar” at the beginning of 2006 in the languageof the reinsurance world. In the scramble to replace capital lost inthe Katrina, Rita and Wilma (KRW) hurricanes of 2005 a variety of newmechanisms was being utilized; sidecars was one of them. It was notexactly a new mechanism; by our count in the preceding ten yearsbetween $2 and $3 billion of capital had been raised by a mechanismthat would now be called a sidecar. Those forerunners were called by avariety of names, but generically could be called capped quota shares.Since re-branding, the same vehicles have raised some $6.5 billion innew capital in a period of 15 months, see Figure 1. The purpose of thisnote is to record that dramatic development and to lay out an “issuesset” for issuers and investors in these vehicles.

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Over the Top, But Not Off the Boil
November 20, 2006

By: Morton N. Lane, President 

Inour April 2006 review of insurance securitization “How High is Up?” weoffered a view of an index of reinsurance price shifts over time. Thatperspective allowed us to observe that premiums were at historic highsand close to their tops. If anything, we were premature in thatassessment. The months immediately after our paper saw a frenzy ofpre-storm season activity which resulted in peak prices in June andJuly of this year.

The question now at hand, however, is what prices to expect in the January 2007 renewals?
Theindustry traditionally gauges renewal prices at its annual gatheringsin Monte Carlo, Baden Baden and the PCI Conference, and this year’sverdict seems to be that this will be a “hard” renewal, i.e., priceswill remain high. However, that has to be qualified. It certainly willbe hard compared to last January, but how hard will it be compared tothe mid-year activity? There the answer is more vague. Consensusappears to be that prices will not be quite as high as mid-year butwill remain strong – over the top, but not off the boil, so to speak.

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How High is Up?
April 21, 2006

By: Morton N. Lane, President and Roger Beckwith, Vice President

As this is written, there is a constellation ofhighs in the financial markets. The stockmarket is near a 5year high, gold is at a 25year high, US government bond yields are ata 4 year high, oil is at all time highs andreinsurance costs are at a 12 year high. Wecould have thrown in housing andcommodities for good measure, but whateveris in this constellation, we make the confidentprediction that it will not last. That isespecially true of the current high level ofreinsurance prices, especially if the upcomingstorm season is benign. Absent a quiet seasonall bets are off. As it is, however, the currenthuge increases in insurance rates is a signal toreluctant capital to “come on in, the water isfine”. As we reported in What Katrina hathWrought, Jan. 2006, capital markets haveresponded to the tune of some $20 billion bythe end of 2005. It was not enough, becauseperhaps of the attractions of other markets,and the welcome flags of high premiumshave been hoisted even higher.

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What Katrina hath Wrought
January 6, 2006

By: Morton N. Lane, President

Itis now more than four months since those three wicked witches of thewest, Katrina, Rita, and Wilma, devastated the Gulf of Mexico and itssurrounding coast line.  Collectively, according to Property ClaimsService (Nov. 28), these storms caused over $50 billion dollars worthof insured loss and multiples of that in non-insured losses.  And, justas the physical landscape has changed but is slowly recovering, thefinancial landscape in the world of insurance has shifted and is beingrepaired.  Insured losses have rippled and are rippling through theprimary insurance market, the reinsurance market, the retrocessionalmarket and the hybrid market (i.e., cat bonds, insurance-linkedsecurities, industry loss warranties and the like).  Keeping track ofthese changes is not easy, but it is important.  Predicting the shapeof things to come as a result of change is, hopefully, easier thanforecasting a storm track, but the consequences for participants in anyof these markets can be just as severe.

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An Introduction to the Benefits…
June 2, 2006

By: Morton N. Lane, President; Jerome Kreuser

The use of optimizing models for portfolio selection and construction in the context of insurance is relatively new. Investment portfolio managers regularly rely on optimization, but underwriters are much more likely to use good old fashion trial and error, with some admittedly quite sophisticated, simulation techniques to developing underwriting portfolio strategies. The unique characteristics of insurance risk, e.g. long tails, one sided correlations etc, did not lend themselves to early optimization models but, certain technical breakthroughs have advanced optimization modeling and insurance risk is now a potentially important application. Moreover, once adopted, optimization techniques have considerable informational benefits over simulation.

The purpose of this paper is to illustrate these benefits. We do this in two ways. First by tracing out the numerical implications with a simple practical application; second, by introducing some of the algebra4 necessary to extract the benefits in more general and complicated cases. The techniques have been successfully applied in several large scale real situations and further technical details will be forthcoming in subsequent papers

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Unlovely Rita's Market Meter
September 24, 2005

By: Morton N. Lane, President

Thefollowing tables update the exhibits from last week’s note “Respondingto Katrina” in light of the potential impact of hurricane Rita on theTexas – Louisiana coast.  The message of the markets as of Fridayevening, when exact landfall and strength was unknown, is contained inthese updated tables.

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