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What the World Bank Should Do About Catastrophic Risk

What should The World Bank do about it?  A Personal View, January 15, 1999. Based on a presentation to The World Bank Disaster Funding Seminar, "Financial Management of High Severity Risk in Developing Countries", September 22, 1998, Washington D.C.

By Morton Lane

Today’s seminar has shown that “insurance risk management is not just your father’s homeowners policy” (to poorly paraphrase the Oldsmobile slogan of some years ago).  The preceding speakers have expertly demonstrated that: (a) traditional insurance and reinsurance against catastrophes has grown dramatically in the developed world; (b) that both risk-transfer and funded cover mechanisms are available for catastrophe protection; (c) that there has been a convergence between financial and insurance markets instruments; (d) that large institutions are protecting themselves against catastrophes by issuing catastrophe bonds and derivatives as well as buying traditional reinsurance; and (e) finally, that these new forms of protection use “index” or “parametric” measures as well as indemnity losses, thereby expanding their usefulness to developing areas.  All in all, some huge changes are rippling through the staid world of insurance, and the World Bank is to be congratulated for organizing so timely a seminar for its self-education.

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AQS
December 23, 1998

The basic idea is very simple:  Let the share for which the option (or under) writer is responsible increase as the penetration of the layer gets larger.

The purpose of this structure is to reduce the cost of traditional excess of loss (or pure option) coverage.  At the same time, the structure reduces volatility and provides for fuller coverage as losses increase.

First proposed in the context of a price guarantee program, the examples that follow are for Puts (or profit share) structures, but they work equally well for Calls (or loss-share) programs.

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Isolating the Effects of the Price Cycle on the Lloyd's Global Index
December 15, 1998. Also published in The Risk Financier, March 1999.
 
INSTRAT-UK recently proposed an index of underwriting results based upon the Lloyd’s Global result.  Since the index applies to a broad range of underwriting lines, it is a good gauge of the whole insurance market, and, perhaps, a good hedge of particular underwriting results.

Interest has begun to focus on the prices at which options on this index might trade.

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Flatlining
October 1, 1998. Also published in Insurance Finance & Investment, November 16, 1998.

What the heck is a zero beta asset?

Whaddaya mean new asset class?

Correlation coefficient?

You’ve got to be kidding me, adding earthquakes to my portfolio can actually reduce my risk!

Initial investor reaction to presentations about insurance-linked notes and their benefits in diversifying a portfolio often range from disbelief to scorn.  At best they are skeptical and we, like others, try to persuade them of our rationality with explanations about “efficient frontiers,” “diversification,” and “lower standard deviations”.  Pure as these theoretical arguments are, they are not always convincing.

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Echoes from the East
ECHOES FROM THE EAST
LESSONS FROM THE PAST
THOUGHTS FOR THE FUTURE

Lessons from the Past, Thoughts for the Future, September 1, 1998.

Some people think of 1992 as the year of Bill and Gennifer; others remember it as the year of Andrew and Inikki.

Current events have forced the former crowd to ruefully acknowledge that telltale events from the past have relevance for the present.

For the Andrew and Inikki crowd, however, current events have provided no such reminders.  Recent history in reinsurance terms has been benign.  Many of the lessons of 1992 have slipped off the radar screen.

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Warren Buffett on Risk - Or Risky Ground?
May 15, 1998.

Mr. Buffett deserves the world’s accolades when it comes to investing.  He is the nonpareil equity investor.  When he speaks, the world, and I, properly pay attention.

Permit me, however, to take issue with several of his recent comments on bonds in general, and catastrophe bonds in particular, which appeared in Schiff’s and are excerpted alongside.

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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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