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Rationale and Results with the LFC CAT Bond Pricing Model
December 31, 2003

Published in Insurance and the State of the ART in Cat Bond Pricing, Etudes et Dossiers No. 278, Working Paper Series of The Geneva Association, January 2004

By Morton N. Lane, Ph.D.

Cat bond pricing presents theorists with both an opportunity and a challenge.  The opportunity is that for the first time ever, investors have been presented with explicit probability statistics about the likelihood of full repayment at maturity.  They receive these probability estimates at the time of issue.  Other fixed income securities may allude to likely default statistics, via a letter rating, but none, prior to the advent of cat bonds, did this with precision. Indeed, the rating agencies themselves used different metrics to arrive at their letter ratings, therefore representing different things.  In spite of this, the traded market often uses the letter ratings interchangeably as surrogate ranges of default probability.  The opportunity then is to observe transaction prices and examine them relative to precise statistics provided at issue. 

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USAA and the Magnificent Seven
August 31,2003.

By Morton N. Lane, Ph.D.

In 1997 USAA – assisted by its investment bankers, Goldman Sachs, Merrill Lynch and Lehman Bros - stunned the nascent world of insurance securitization with it’s sponsorship of Residential Re and a near-$500 million securities issue. Since that date USAA has sponsored a new security every year, including this year’s Residential Re 2003 Ltd [Res Re 2003] bringing its total issues to seven – the magnificent seven.

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Arbitrage Algebra and the Price of Multi-Peril ILS
July 4, 2003.

By Morton N. Lane, Ph.D.

INTRODUCTION

At this year’s third annual  Bond Market Association Risk-Linked Securities Conference, John Seo gave an excellent address entitled “Risk Management Tools for Investors.”  The more colorful subtitle was along the lines of ‘evaluating multi-peril bonds and avoiding the Bermuda rectangle.’  Yes, rectangle.  We will leave the Bermuda angle (rect- or tri-) for John to explain and he can be found (together with his brother Nelson) at Fermat Capital Manage¬ment LLC managing a fund specializing in investing in cat bonds and other exotica.  However, this paper takes advantage of his basic plea (simplification) to further explore a favorite topic of ours – how should Cat bonds be priced. In particular, to explore the vexing question of multi-peril bonds compared to single peril bonds. Our approach is to explore “arbitrage-equivalent”  pricing in which covers can be either bought or sold. We do not yet know how to determine how the absolute level of cat bond prices should be set – although we expect it must be driven by two old friends (a.k.a. supply and demand) but the Seo simplification allows greater insights into relative prices of single vs. multi-peril bonds even in our arbitrage context. We begin with a reprise of John’s examples.

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Review of Trends in Insurance Securitization
April 25, 2003

By Morton N. Lane, Ph.D. and Roger G. Beckwith

INTRODUCTION
The year, 2002, was a record for insur¬ance securitization.  It’s official.  According to Marsh and McLennan  $1.22 billion bonds were issued in 2002 versus $1.136 billion in 2000.  Our own readings of history are slightly off calendar, usually measuring the twelve months in between 1st Quarter ends.  Never¬theless, like Marsh we believe that the most recent twelve months repre¬sent something of an up-tick in activity.  Like the margin by which the Marsh record was set, the magnitude of the up-tick is small, tiny in fact, but potentially a significant harbinger of directional change.  In truth, these are crumbs of comfort for those toiling in the vineyards of insurance securitization.  The harvest from a great deal of intellectual and financial investment still eludes us.
Notwithstanding, this paper records the trends that have occurred during our last twelve months and the messages they contain for that brighter securitization future that surely lies ahead.
Two significant events occurred during 2002/3.  Vivendi issued a cat bond protecting their own (insurable) exposure to earthquake, by bypassing the insurance market.  This disintermediation of the insurance market is only the second issuance directly by an insured.  The second significant event was the introduction by Swiss Re of a shelf registration that allows open ended issuance of insurance linked securities up to a fixed amount for a fixed period of time.  The essential feature of this arrangement is that it saves on issuance costs, which have been one of the bad raps on securitization.

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Pricing Issues in Aviation Insurance and Reinsurance
April 16, 2003.

By Morton N. Lane, Ph.D.

INTRODUCTION

Airlines are in the business of transporting passengers or freight from origin to destination as efficiently as possible.  They do this with mixed financial success.  However, they do it with remarkable physical success.  The accident rate for airline travel is lower than for any other mode of transportation, and it continues to decline.  Nevertheless, when accidents do happen they can cause considerable financial, as well as emotional, distress.  Airlines choose to avoid the financial distress by purchasing insurance against loss-through-accident.  Aviation insurers accommodate the desire of airlines to get rid of loss-due-to-accident by assuming all such losses.  The remarkable thing is that the insurers have provided this cover on a ground-up basis for each and every loss, i.e., on an unlimited basis.  The question such large and unlimited cover provokes is, how should it be priced?

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Alternative Risk Strategies
Edited by Morton Lane, Risk Books, London 2002.

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Alternative Capital Sources
December 15, 2002,

Excerpt from Rational Reinsurance Buying, Nick Golden, ed. Risk Books 2002

By Morton N. Lane, Ph.D.

INTRODUCTION
The above definition of “capital” captures two things; first, the essential meaning of capital as the resource necessary for production of wealth and, second, the fact that capital can mean many things to many people.  On the other hand, one thing that may be missing is any reference to the relation between risk and capital.  The definition was written before the modern capital market theories were expounded, yet it does capture the essentials —present value of income, etc.—before the significant contributions of Black, Scholes, Merton and other modern finance theorists formalized the concepts.  The theories contributed by these Nobel Laureates added to our general understanding of capital markets, and the insights allowed a proliferation of new, innovative instruments by which capital can be accessed and managed. Swaps, options, futures, collateralized debt obligations (CDOs), converts, caps, floors, collars, Remics, collateralized mortgage obligations (CMOs) and derivatives of all kinds are all aids in the use of capital to produce wealth.

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An Analyst's View of the Aviation Insurance Industry
September 1, 2002

By Morton N. Lane, Ph.D.
 
INTRODUCTION
The events of September 11, 2001 generated devastating monetary losses for the aviation insurance industry.  Figure 1 shows the true extent of that loss. Minor as these monetary losses are com¬pared the personal trauma suffered by individuals, families and America as a whole, they have produced their own trauma-induced monetary responses.  Future aviation insurance prices have risen dramatically, easily doubling and in some cases quintupling. Exclu¬sions have been added to policies and certain cover¬ages have been specifically withdrawn from the market.  More interestingly, having survived and put in place temporary solutions to enable the market to move forward, the industry through this conference and numerous internal reviews has begun to ask itself how it should charge for its services, whether it has sufficient capital and if past pricing practices should be perpetuated.

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Review of Trends in Insurance Securitization
August 23, 2002

By Morton N. Lane, Ph.D. and Roger G. Beckwith

INTRODUCTION
The past year was dramatic in terms of capital-raising and new issuance for the reinsurance industry.  As Figure 1 shows, at least 41 companies raised equity and/or debt between September 2001 and January 2002.  Unfortunately, not enough of the drama that occurred there was reflected on the securitization stage.  During the 12 months April 2001 to March 2002, only $860 million of insurance securitizations were issued, representing a little over 4% of the traditional market’s capital-raising effort.  While events of the magnitude of 9/11 were expected to give spur to the still-developing securitization market, the concerns of the traditional market were too consuming to even think about cat bonds for very long.  New funds flowed all too easily to the traditional market; there was little need for new types of capital.

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Meanwhile, Back at the Price Drawing Board
August 23, 2002

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