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Essays and Commentaries
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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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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Responding to Katrina
September 16, 2005

By: Morton N. Lane, President

As of this writing it has been two and one half weeks since Katrina first made landfall (in Florida) and two weeks since Louisiana and New Orleans suffered their landfall and subsequent devastation.  And, as of yet, no one has a definitive estimate of the insured losses that will be suffered by the insurance and reinsurance industry as a result of Katrina.  The now most widely quoted estimate is by Risk Management Services (RMS) who released an estimate to their clients on Friday, September 9th that the total industry losses would be between $40 billion and $60 billion.  Shockingly high, but it is not exactly precise.

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Arbor I-Xth Series - Still a Win-Win?
September 1, 2005

By: Morton Lane, PhD

On Aug. 19, Swiss Re announced the tenth issue in its Arbor I series. Interest is currently being solicited and the contract will settle on Sept. 15, 2005.  Strictly, “being solicited” is inaccurate.  Technically, and more accurately, the window is open for investors to express any interest they have at the offered price.  Swiss Re is agnostic about whether they would want more or less at that price.  It has happened before that Swiss Re has announced a price and received no bids (Sakura in its sixth take down in September 2004).  It may happen again given that hurricane Katrina may spook investors.  However, one question we raise here is whether Arbor I is a fair deal at the current price.  Given the time of writing it is reasonable to ask the question in two parts.  First was the pre-Katrina price reasonable?  Second, how does Katrina affect the evaluation now (Sept 1)?

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A Look at Avalon Re and ILS Pricing at Mid-Year
September 1, 2005

By: Morton N. Lane, PhD

In Arthurian legend Avalon was the island paradise in the western seas to which King Arthur went at his death.  In naming its inaugural insurance linked security (ILS) Avalon, Oil Casualty Insurance Ltd. (OCIL) may have been trying to invoke the calming effect of a (risk-free?) paradise reached with this instrument, or it may have been alluding to (shareholders in) western seas.  Then again it may have just been a colorful first letter of the alphabet for what will be a series of such ILS.  Whatever its descriptive intention, however, Avalon has transported the world of ILS to a new insurance arena, namely the securitization of liability risk.  Heretofore, ILS have been dominated by catastrophe bonds, or at the very least short-tailed risk. Avalon has changed that.  It has opened the door to a wider class of securitization of insurance risk – general liability.

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Pricing Limit
August 15, 2004

By: Morton Lane, Ph.D.

Aviation insurers are often asked to provide limits of liability to insureds (a) that are  large and (b) whose exposures are difficult to assess.  This is particularly true of providers of coverage for product manufacturers and other products liability.  The question arises, for several insureds with little or no loss experience, how should such coverage be priced? In particular, is there some minimum price of limit?

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The Viability and Likely Pricing of "Cat Bonds" for Developing Countries
February 14, 2004 (Revised March 31, 2004)

Excerpt from Catastrophe Risk and Reinsurance: A Country Risk Management Perspective, Eugene N. Gurenko (ed.) 2004 (London: Risk Books)

By Morton N. Lane, Ph.D.

An inordinately large number of natural catastrophes occur in the developing world.  That is, they occur in those areas least likely to be able to handle the disaster’s human and economic consequences and quickly return to functioning societies.  In the developed world, when disasters hit, governments respond with aid but a large measure of restitution is provided by private insurance markets.  In the developing world, the usual sources of help are international reconstruction agencies like the World Bank and IMF, donor governments and charities.  The insurance markets provide very little help.

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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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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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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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