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

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Recognizing the Costs of Options and Disguising the Cost of Insurance
August 2, 2002

By Morton N. Lane, Ph.D.

In one of those delicious ironies that occur from time to time, the August 1st edition of The Wall Street Journal contained two  excellent articles−one about options, the other about insurance−which when juxtaposed, show the ever-present nature of contradictions between finance theory and current corporate practice.  The contradictions exist side by side even in the full glare of the current soul searching environment. 

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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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