Category Archives: Catastrophes

Terrorism risk insurance

Clearly insurance is an enabling technology; without insurance many if not most large-scale commercial activities would grind to a halt. In a Business Week article entitled “The Unexpected Threat to Super Bowl XLIX“, Wharton professors Howard Kunreuther and Erwann Michel-Kerjan point out that that if Congress decides not to renew the Terrorism Risk Insurance Act (TRIA) (set to expire on Dec. 31), there is a chance that the Super Bowl might not be played. Will Warren Buffet step in as an insurer of last resort if TRIA is not reauthorized?  Also, Gordon Woo raises some excellent points about possible private sector alternatives to TRIA in his blog posting entitled “RMS and the FIFA World Cup: Insuring Against Terrorism“.

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Assorted Links (6/14/2010)

Here’s a list of articles that I have been reading lately:

Stephen A. Blumenthal: It’s Time to Nationalize Fannie and Freddie – WSJ.com

online.wsj.com

“In The Wall Street Journal, Stephen A. Blumenthal writes that any solution that allows private companies to have a special relationship to government is destined to fail.”

Think Smarter About Risk – WSJ.com

online.wsj.com

“Moshe A. Milevsky says in The Wall Street Journal that when gauging risk, too many investors don’t consider the most important asset: their human capital.”

Opening weekend – 2010 World Cup – The Big Picture – Boston.com

boston.com

“The 2010 FIFA World Cup opened last Friday in South Africa, after years of preparation, with an Opening Ceremony at Soccer City Stadium – the first matches taking place over the weekend.”

Foreign Tax Bill Likely, But ‘A Bad Idea,’ Validus CEO Says

highlinedata.com

“NEW YORK-Proposed legislation denying tax deductions for reinsurance premiums paid to offshore affiliates will likely pass through Congress, a Bermuda executive predicted here yesterday, but he criticized the measure as a restriction of free trade.”

The Dark Side of Stimulus

“‘Regulating Wall Street’ Co-Editor and NYU economics professor Thomas Cooley breaks down the pros and cons of stimulus spending…”

Gerald O’Driscoll: The Gulf Spill, the Financial Crisis and the Failure of Big Government – WSJ.com

online.wsj.com

“In The Wall Street Journal, Gerald P. O’Driscoll notes that Republicans and Democrats fail to see the limits of centralized regulation in a modern market economy.”

Dynamic Dr. Krugman|KeithHennessey.com

KeithHennessey.com

“In his column today Dr. Paul Krugman argues that the deficit impact of a large ($1 trillion) stimulus would be mitigated by the effects of higher GDP growth.”

Women Prefer Men Holding State Bonds, Japan Ad Says (Update1) – Bloomberg.co.jp

Bloomberg.co.jp

“June 9 (Bloomberg) — Japanese women are seeking men who invest in government bonds, according to an advertisement being run by the Ministry of Finance.”

The Road to Price Controls — The American, A Magazine of Ideas

www.american.com

“Conventional wisdom is that U.S. pharmaceutical companies made out well under the Obama health plan by bargaining with the White House. That wisdom is wrong.”

Just How Risky Are Nuclear Industry, NASA Missions? – The Numbers Guy – WSJ

online.wsj.com

“Scientists in some risky pursuits attempt to quantify risks, which helps identify trouble spots. That might be in the future of the deep-sea oil-drilling business.”

Scenes from the Gulf of Mexico – The Big Picture – Boston.com

boston.com

“Based on recently revised estimates, BP’s ruptured oil well at the bottom of the Gulf of Mexico continues to leak 25,000 to 30,000 barrels of oil a day. The new figures suggest that an amount of oil equivalent to the Exxon Valdez disaster could still be flowing into the Gulf of Mexico every 8 to 10 days.”

Lawrence M. Krauss: Science and the Gulf Spill – WSJ.com

online.wsj.com

“In The Wall Street Journal, scientist Lawrence M. Krauss says that TV has fueled unrealistic expectations of a quick fix to the oil spill.”

Fouad Ajami: Iran and the ‘Freedom Recession’ – WSJ.com

online.wsj.com

“Fouad Ajami writes in The Wall Street Journal about the anniversary of the Iranian crackdown on pro-democracy protests that Facebook had no answer to the pro-regime vigilantes who ruled the streets. And the U.S. president, who might have helped, stood aside.”

Andy Kessler: The iPhone, Net Neutrality and the FCC – WSJ.com

online.wsj.com

“Andy Kessler writes in The Wall Street Journal that the FCC should make it easier for more companies to enter wireless data and cable broadband markets.”

Peggy Noonan: ‘We Are Totally Unprepared’ – WSJ.com

online.wsj.com

“Peggy Noonan writes in The Wall Street Journal that nine years after 9/11, there is a chilling complacency about WMD attacks.”

Charles Krauthammer – The myth of Iran’s ‘isolation’

washingtonpost.com

“Obama’s strategy against Tehran hasn’t worked.”

Don’t Believe the Double-Dippers

online.wsj.com

“Alan Reynolds writes in The Wall Street Journal that while liberals issue dire warnings to argue for more stimulus spending, Republicans embrace gloom as evidence stimulus hasn’t worked. Truth is the economy isn’t that bad.”

Obama Meets Toto

online.wsj.com

“In The Wall Street Journal, Dan Henninger writes that with the Gulf oil spill, faith in the omnipotence of government has put us in the land of Oz.”

Europe’s Determination to Decline

www.project-syndicate.org

“At a time when their economies are sputtering, European leaders have embraced the bizarre idea of further reductions in greenhouse-gas emissions. There is a strong correlation between carbon emissions and GDP growth, so, in the absence of alternatives to fossil fuels, Europeans are, in effect, calling for an even deeper recession.”

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Assorted Links (5/29/2010)

Here’s a list of articles that I have been reading lately: 
 
“Obama is as responsible for the Gulf as Bush was for New Orleans.”
 
“The Financial Crisis Inquiry Commission on Friday and Saturday heard several academic economists’ take on what led to a near-meltdown of the global economy.”
 
“Why a long-term study couldn’t reach conclusive results.”
 
Mark Helprin: On Memorial Day – WSJ.com

“In The Wall Street Journal, Mark Helprin writes about what we owe to the fallen, and to those now serving.”

 
Calling a State Sponsor a State Sponsor

“A growing body of evidence points to Venezuelan dictator Hugo Chavez’s singular role in supporting terrorism and related criminality.”

 
“Waves & Beyond and The Gift by Jan Florence Garven: Jan Florence Garven is an artist who specializes in mixed media. She combines paper, metal, wax, textiles and found objects to convey conceptual images.”
 
“Fill a lightweight material with hot air, helium or hydrogen, and you have a vessel that floats in the air. People around the world use balloons, blimps and airships for transportation, to conduct research, to deliver messages, to protest, and – mostly – for having fun.”
 
“The spill is a disaster for the president and his political philosophy, Peggy Noonan argues in The Wall Street Journal.”
 
“The Wall Street Journal that Interior Secretary Ken Salazar had a reform plan to prevent blowouts like the one at the Deepwater Horizon oil rig in the Gulf of Mexico.”
 
“Governments were the solution to the economic crisis. Now they are the problem.”
 
“After a yearlong effort to get it right, the U.S. Senate passed a financial overhaul bill last week that actually weakens the government’s ability to manage the next financial crisis. The House version passed last December is better, but not much.”
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Assorted Links (5/29/2010)

Here’s a list of articles that I have been reading lately: 
 
“Obama is as responsible for the Gulf as Bush was for New Orleans.”
 
“The Financial Crisis Inquiry Commission on Friday and Saturday heard several academic economists’ take on what led to a near-meltdown of the global economy.”
 
“Why a long-term study couldn’t reach conclusive results.”
 
Mark Helprin: On Memorial Day – WSJ.com

“In The Wall Street Journal, Mark Helprin writes about what we owe to the fallen, and to those now serving.”

 
Calling a State Sponsor a State Sponsor

“A growing body of evidence points to Venezuelan dictator Hugo Chavez’s singular role in supporting terrorism and related criminality.”

 
“Waves & Beyond and The Gift by Jan Florence Garven: Jan Florence Garven is an artist who specializes in mixed media. She combines paper, metal, wax, textiles and found objects to convey conceptual images.”
 
“Fill a lightweight material with hot air, helium or hydrogen, and you have a vessel that floats in the air. People around the world use balloons, blimps and airships for transportation, to conduct research, to deliver messages, to protest, and – mostly – for having fun.”
 
“The spill is a disaster for the president and his political philosophy, Peggy Noonan argues in The Wall Street Journal.”
 
“The Wall Street Journal that Interior Secretary Ken Salazar had a reform plan to prevent blowouts like the one at the Deepwater Horizon oil rig in the Gulf of Mexico.”
 
“Governments were the solution to the economic crisis. Now they are the problem.”
 
“After a yearlong effort to get it right, the U.S. Senate passed a financial overhaul bill last week that actually weakens the government’s ability to manage the next financial crisis. The House version passed last December is better, but not much.”
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Finance to the Rescue

For what it’s worth, I am one of four people (along with Jeff Holland, Liongate Capital Management founder, John W. Howton Rockbrook Capital founder, and John C. Bogle, founder and former CEO of the Vanguard) interviewed in “Finance to the Rescue”, an article that appears in the Fall 2005 issue of Baylor Business Review.  My interview is on the topic of cat bonds, which is a topic that I have previously blogged about.

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Bush’s avian flu initiative (AKA the International Partnership on Avian and Pandemic Influenza)

The White House posted the transcript of President Bush’s speech today to the United Nations.  Of particular significance is the President’s announcement concerning the International Partnership on Avian and Pandemic Influenza (see http://www.whitehouse.gov/news/releases/2005/09/20050914.html for the complete transcript):

“As we strengthen our commitments to fighting malaria and AIDS, we must also remain on the offensive against new threats to public health such as the Avian Influenza. If left unchallenged, this virus could become the first pandemic of the 21st century. We must not allow that to happen. Today I am announcing a new International Partnership on Avian and Pandemic Influenza. The Partnership requires countries that face an outbreak to immediately share information and provide samples to the World Health Organization. By requiring transparency, we can respond more rapidly to dangerous outbreaks and stop them on time. Many nations have already joined this partnership; we invite all nations to participate. It’s essential we work together, and as we do so, we will fulfill a moral duty to protect our citizens, and heal the sick, and comfort the afflicted.”

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Hurricane Katrina and the Great New Orleans Flood

Here is a collection of readings that I have been wading through (pardon the pun) in order to try to gain some perspectives on the tragedy that we see unfolding in the Gulf Coast generally and in New Orleans in particular:

1. Katrina, Cost-Benefit Analysis, and Terrorism, by Richard Posner, Senior Lecturer in Law, University of Chicago.
2. Major Disasters and the Good Samaritan Problem, by Gary Becker, 1992 Nobel Laureate in Economics, Professor of Economics at the University of Chicago and Senior Fellow at the Hoover Institution, Stanford University.
3. Rebuilding New Orleans — and America, by Thomas Sowell, Rose and Milton Friedman Senior Fellow, The Hoover Institution, Stanford University.
4. A Fuller Picture: Beginning to understand what we are seeing in New Orleans, by Michael Novak, George Frederick Jewett Scholar in Religion, Philosophy, and Public Policy at the American Enterprise Institute.

In retrospect, it would appear that the man-made aspects of the disaster are by far and away much worse than the storm itself.  The initial damage report from risk modeling firm Risk Management Solutions (RMS) was $20–$35 billion.  Later that same day (September 2), the levees failed in New Orleans and RMS immediately revised its estimate to $100 billion.  On September 7, the Wall Street Journal published a page 1 article entitled “First Estimates on Katrina Costs For Washington Hit $200 Billion”.  The biggest long term problem (at least from a loss prevention standpoint) has been a chronic underinvestment in levee protection for most of the history of the city of New Orleans.  Interestingly (as noted in John Berlau’s piece entitled Greens vs. Levees), the Army Corps of Engineers was sued sometime back in the mid-90’s in order to prevent them from raising and fortifying Mississippi River levees.  The Corps’ rationale for this project at the time was that it was needed “…because a failure could wreak catastrophic consequences on Louisiana and Mississippi which the states would be decades in overcoming, if they overcame them at all.”

Late today (September 8), Congress approved $51.8 billion in emergency spending to pay for Hurricane Katrina recovery efforts, and thankfully this will be directed through channels other than Louisiana public officials (see Congressman Tom Tancredo (R-CO)’s letter to Speaker Dennis Hastert (R-IL) on the problem of public corruption in Louisiana).

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Cat bonds

The very concept of insurance is based on risk. So it’s no surprise that important innovations in risk management and finance often come from the insurance industry. One such innovation that is growing in popularity is the so-called catastrophe bond, or “cat bond.”

Common sense as well as theory suggests that proper diversification of any risk involving a remote possibility of enormous loss (such as a natural or man-made catastrophe) makes such a risk more manageable. Traditionally, catastrophe, or “cat” risk was transferred and shared through the insurance and reinsurance markets. However, in spite of the dramatic growth in the magnitude of human and economic losses from natural and man-made catastrophes in recent years, it is surprising how little cat risk transfer actually occurs. Property owners fail to adequately insure catastrophe risk, and even when they purchase insurance, their insurers tend to retain most (as much as 70 percent) of this risk rather than distribute it more broadly through the reinsurance market. The reason why cat reinsurance is so limited is due to inadequate global capacity and correspondingly high reinsurance premiums.

Cat bonds came into existence due to this lack of capacity in the reinsurance market. Although they have been used primarily as an alternative to cat reinsurance, there are examples of corporations and other non-insurance entities issuing cat bonds. For example, during the summer of 1999, Tokyo Disneyland issued cat bonds because management found at the time that it was cheaper to have the capital markets insure its earthquake exposure than the insurance markets. More recently, the Fédération Internationale de Football Association (FIFA) issued a $260 million cat bond to protect itself against (a terrorism-related) cancellation of the 2006 World Cup in Germany.

Cat bonds represent a form of insurance securitization in which risk is transferred to investors rather than insurers or reinsurers. Typically, an insurer or reinsurer will issue a cat bond to investors such as life insurers, hedge funds and pension funds. The bonds are structured similarly to traditional bonds, with an important exception: if a pre-specified event such as a terrorist attack or hurricane occurs prior to the maturity of the bonds, then investors risk losing accrued interest and/or the principal value of the bonds.

Although the cat bond market is still relatively small compared with the traditional insurance and reinsurance markets, it is already having a particularly important effect on reinsurers. Since the cat bond market provides insureds with a credible alternative to traditional reinsurance, the cat bond market has forced reinsurers in particular to become more competitive in their pricing and underwriting practices. Furthermore, investors value cat bonds in part because returns on these securities tend not to be very highly correlated with returns on other asset classes such as stocks, conventional bonds, commodities and real estate.

Given the benefits that cat bonds offer both insureds and investors, the market for cat bonds is expected to continue to grow and exert an important check and balance upon pricing and underwriting practices in conventional insurance and reinsurance markets. Ironically, as documented by a recent Wall Street Journal article, the growth of the cat bond market is in turn fueling the growth prospects of the reinsurance industry, as a number of hedge funds that were early cat bond investors are now starting to launch their own reinsurance firms.

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Catastrophe risk summary and recommended reading

Here is a summary of the various articles I have written concerning public policy in the context of the disastrous hurricane season suffered by the state of Florida:

  • 09.07.04: Financial Implications of Hurricanes – This article provides some insight concerning the evolution of public policy in the post-Andrew world. Because of persistent regulatory suppression of insurance rates, economic theory suggests that over time, product quality will likely deteriorate and insurers can be expected to exit the market. For all practical purposes, this is what has occurred in the Florida homeowners insurance market. Clearly, there has been a shifting of risk away from private insurers and toward government and policyholders. What has resulted is a rather ad hoc set of risk sharing arrangements which no one particularly likes and very few people understand.
  • 09.08.04: Catastrophes and Moral Hazard: The Case of Florida Windstorm Risk – This article explains why public disaster relief, however well intentioned, may make matters worse in the long term by undermining incentives for firms and individuals to select “economically efficient” levels of private insurance and loss mitigation.
  • 09.09.04: The double deductible problem in Florida – Here, you will find my “proposal” concerning policy regulation reform; i.e., why not offer consumers a choice between the status quo policy form and an alternative policy form that enables consumers to insure against aggregate losses? This is a workable reform, assuming that the rate suppression problem can also be properly addressed.
  • 09.10.04: Reinsurance reinstatement option – This article discusses an important contractual issue that is looming in the market for catastrophe reinsurance which may end up being considerably more significant economically than the “double deductible” problem (i.e., given the amount of catastrophe exposure this season, this important aspect of “fine print” may result in quite a few insolvencies).
  • 09.17.04: More on double deductibles – This article argues that in order to “fix” the Florida insurance market, regulatory reform needs to address pricing issues as well as policy forms. Specifically, 1) the rate suppression problem needs to be properly addressed so that rates accurately reflect the expected cost of risk, and 2) consumers ought to have a broader set of choices concerning policy forms.

For people who are interested in reading more about public policy as it pertains to catastrophe risk, I highly recommend two books: 1) Catastrophe Insurance: Consumer Demand, Markets, and Regulation, and 2) When All Else Fails: Government As the Ultimate Risk Manager. Finally, I also highly recommend Martin Grace’s weblog.

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