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Current Market Conditions
 The reinsurance market provides about $19 Billion in property and WC catastrophe limits per zone today
The CBOT did about $19 Million in 1995.
Act-of-God bonds have done about 19 press releases.
Buyers must consider the proven breadth and depth of the markets when considering practical alternatives to reinsurance.
Consideration for Buyers
Exposures Covered
Basis Risk
On-Exchange vs. OTC
Tax and Accounting Issues
Transformers, Loss Warranty Reinsurance
Exposures Covered
Three major products have been sold in the U.S., either on the CBOT or off-exchange:
Eastern, Third Quarter, to address hurricane
Western or National, Annual, to address earthquake
Event-in-Progress, e.g., Opal, Fran during landfall
Basis Risk
When using a derivative to hedge an existing business exposure, "basis risk" is the residual risk that results from different, and unpredictable, price movements between the hedger's inherent exposure and the derivative instrument.
In insurance examples,
The risk that when the ceding company had a loss of the size anticipated by the hedge, the industry loss will not be proportionately as large, and so the hedge doesn't pay off.
And vice-versa,
The cost of unneeded coverage, when the ceding company doesn't sustain the targeted loss, but the industry loss is disproportionately high and the hedge pays off anyway.
Over-The-Counter Trading
Until recently, market activity was mostly over-the-counter
OTC derivatives are subject to specific requirements in the Commodity Futures Trading Act. For insurance options:
- Both parties must be large, knowledgeable
- Transaction must hedge existing exposures in the original business of one party
- Hedger must be the offeree
CFTC has the power to fine and enjoin violators and disallow inappropriate contracts
Things You Don't Do When Buying a Used Car
Trust the wrong people for objective advice
Lack of public price data
Lack of internal controls
Change strategy in mid-course
Misdirected incentives
Misunderstand leverage
Regulatory violations
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