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.  To read the full version of this article with graphs: Download the PDF Here

 

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. To read the full version of this article with graphs: Download the PDF Here

 

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. To read the full version of this article with graphs: Download the PDF Here

 

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. To read the full version of this article with graphs: Download the PDF Here

 

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? To read the full version of this article with graphs: Download th PDF Here