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Futures Markets & Catastrophe Management

Futures Markets & Catastrophe Management. Robert Eramo Vice President & Corporate Actuary, CNA Insurance. Personal Experience. At Broker Johnson & Higgins at the time On Task Force Recommending J&H Participation Futures Launched in Dec. 1992. CAT Futures.

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Futures Markets & Catastrophe Management

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  1. Futures Markets & Catastrophe Management Robert Eramo Vice President & Corporate Actuary, CNA Insurance

  2. Personal Experience • At Broker Johnson & Higgins at the time • On Task Force Recommending J&H Participation • Futures Launched in Dec. 1992

  3. CAT Futures • Created by Richard Sandor, original creator of the Treasury Futures in 1975 • Traded on Chicago Board of Trade (CBOT); Dream of Liquid Insurance Market • Based on an ISO Loss Ratio • Property Losses (Non-Fire) to Property Premiums

  4. Call Option Characteristics • A typical experience quarter may have an expected 10% loss ratio • Contract Quarters had several strike prices • A 10% Strike Contract reimbursed a buyer 15% if loss ratio were 25%

  5. Similar to Aggregate Excess Contract • However Aggregate Excess Pays Specific Losses to Insured • CAT Future Pays Based on Industry Experience • Thus Basis Risk Relative to Actual Experience • More Like Loss Warranty Writings Tied to an Index

  6. Basics Of Viable Futures • Primary Participants Hedge • Secondary Participants Trade/Speculate • Primary Buyer, Cereal Manufacturer Hedges Price of Corn • Primary Seller, Farmer ADM Hedges Price of Corn

  7. Buyer’s Hedging Interest Lacking • Primary Insured and Primary Insurers Want Indemnification for Losses • Original Cat Futures Rarely Provide Indemnification • Selling Interest Sufficient - Similar to Other Insurance Writing

  8. Consequences Part I • Few Contracts Written • Consequent Lack of Liquidity Provided Nil Opportunity for Traders or Speculators • Floor Operations a Money Loser • Contracts Quoted at Prices Often Higher than Aggregate Excess Contracts. Why buy when you were assuming Basis Risk?

  9. Consequences Part II • Actual Buyers Often Marginal Risks Hard Pressed to Find Any Cover • Could Have Appeal to More Insureds in Tight Market • Appeal Would Disappear Under Normal Market Conditions

  10. New Contract Born I • Based on Actual Evaluation of Catastrophic Event as Assessed by Property Claim Services Office • Premium No Longer in Experience • Some Contracts Specifically Concentrated on One Peril • Countywide and Regional Contracts

  11. New Contract Born II • Contract Bought for Loss Amounts XS of an Index. • Index of one was a $10 Billion event. • Contract, however, still has basis risk!

  12. Where From Here? • Is dream of Liquid Insurance Market Gone? • Will Internet Eventually Be Provide the Machinery for the Quick Transfer of Risk? • CATEX May Be Starting Point • Liquid Market May be Limited to Profession Reinsurance Market • Probably Always Limited to Property

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