I'm not aware that these currently exist but the concept of reinsurance on reinsurance is not new (it's called retrocession). I will do some digging and see what I can find - thanks for the suggestion.
While Covid 19 was certainly a "Catastrophe", the market for pandemic insurance in 2020 was minuscule and to my knowledge did not cause any insurer solvency issues. There were a few cases of insurers being instructed to pay out significant claims by the courts on Business Interruption losses which the insurers argued were not covered due to existing policy exclusion.
Product development is usually highly specialized as there are a lot of nuances and frictions within the insurance industry that outsiders may not fully understand. It helps also to be in the industry and have the network with insurers, reinsurers, brokers, etc. This is not at all to suggest there isn't room for clever people to bring innovation to the market though!
Book recs are hard to specify for CAT bonds but for insurance in general:
Against the Gods: The Remarkable Story of Risk - Peter L. Bernstein
The Black Swan - Nassim Nicholas Taleb
On the Brink: How a Crisis Transformed Lloyd's of London - Andrew Duguid
The lack of information was my inspiration for building Riskvest. I called my own broker and when I said catastrophic bonds they asked if I meant buying bonds already in default.
On the risk side - your comments here are part of the myth I’m trying to dispel and will have lots more to say in future posts.
Yes for a single CAT bond you are exposed to potential 100% principle losses. But if you buy a bundle of CAT bonds that focus on say California Earthquake, Florida Hurricane, Japanese Typhoon, and a Cyber Event, you can imagine the diversification benefit you get there.
I’ve already created a very very simple model for people to play around with and learn the intuition for CAT bond return patterns. A default means 100% loss and this is unique vs. other bonds. I plan in the future to build a much more robust model.
With the way things are going with climate change, I think that assuming “extreme climate events in different geographies are independent statistical events” is an extremely flawed assumption to make. You acknowledge that it is a simplified model, but that is not some minor oversight. Any model that does not account for this is deeply flawed, and I think no insurance company would choose to model extreme event risk like that. There are common factors (e.g. global average temperature) that can cause many of these events to be triggered in a correlated way.
A “2% risk of default” on an individual bond is something a retail investor might be able to understand, but no one should be buying a “diversified” bundle of these things if they cannot form a reasonable understanding of how correlated they are. Why should understanding the correlation risk be left up to individual investors building their own portfolios?
I also think forming an intuition for these more “all-or-nothing” type events is more difficult than e.g. understanding that if GOOG goes down 10% then AAPL might do too at the same time because they are both tech stocks.
> But if you buy a bundle of CAT bonds that focus on say California Earthquake, Florida Hurricane, Japanese Typhoon, and a Cyber Event, you can imagine the diversification benefit you get there.
Yeah, but imagine how bad a day you're having if all of those disasters happen at once, and then as a cherry on top you lose all your money.
Same principle as why many people prefer not to own shares in the company that employs them -- you're already heavily exposed to that specific risk and don't want to add more. If you live in Florida then a hurricane in Florida already might mean financial loss for you if it damages your house, so buying a CAT bond that covers a different thing is more diversified risk: you might get "house is trashed" or "bond is total loss" but at least you probably will not get both at once.
You're not incorrect, but this is the same sort of risk you take when buying an index fund, just that index funds have 100x more entries, so are much more diversified. Eg, we could rewrite this about an index fund like:
"Yeah, but imagine how bad a day you're having if all of those [stocks drop] at once, and then as a cherry on top you [enter a recession]."
I'm not saying this is exactly like buying an index fund. I'm very un-knowledgable about CAT bonds. I'm just saying that your criticism holds for _every_ diversified bundle of risks.
Correct on every point and great insight, hello fellow insurance person.
I will clarify that CAT bonds can have industry loss triggers OR actual indemnity triggers. If an indemnity trigger then the insurer has to prove the actual loss. But you’re right on ILWs (Industry Loss Warranty) in that there is additional model/basis risk considerations.
Insurance companies try to minimize this basis risk. Because while sure it’s great to be in the situation where your CAT bond recovers when you didn’t have large losses, it’s NOT good to be in the position where you had big losses and you don’t recover. Certainty of recover can affect things like how much regulatory credit you get for your reinsurance.
For the web designers here please let me know if you noticed anything amiss. Ive had particular issues getting captchas working so please comment if you run into that issue.
Thanks for sharing your insight. Wouldn't hurt from a proofread. There are some typos / wrong words, that detract from the sense of authority lent by the article. Eg:
"It's clear that we this structure" --> with
"with out those protections in place" --> without
"Investors would be best to limit their exposer to losses beyond their investment" --> exposure
There might have been others, I had to go back and skim to summarize for you.
The lack of quality is what gets to me. I've used AI tools in many aspects of my life to great benefit. Yet, nowadays scrolling through Reddit, X, or even video based platforms are a deluge of drivel. It was bad enough that I was spending too much time on my phone instead of interacting with other people but now even the content I'm interacting with isn't human!
More and more I find myself opening Youtube or Reddit and just closing because the information just seems low. It is either me or some sort of mass debasement of entropy is happening. Actually, good.
I thought Project Hail Mary by Andy Weir had a similar "feel", though it's more future-looking rather than past looking.
Daemon and Freedom(tm) by Daniel Suarez is another book (printed as two books, because reasons) that is ~1K pages but I've read 3 times (like Cryptonomicon).
Others in this thread have recommended The Baroque Cycle, but I just couldn't get into it. Ditto with Anathem. Maybe I should give them another try. However, I do love Diamond Age and Snowcrash.
Anthem is my favorite Stephenson book, by far. My copy is the only book I own with a broken binding because I've read it too many times. I don't think that one gets enough attention, especially from a world building and technical perspective.
yes, give it a try and try to get past the first few chapters. The first time I read it, the world building almost put me to sleep. Somehow I decided to give it another try on a long flight, and this time I grok'd the world building, and thoroughly enjoyed it all the way through to the end.
The Diamond Age: Or, A Young Lady's Illustrated Primer is the sequel to Snow Crash, and is excellent and in many ways more relevant and subversive now, given that more or less Snow Crash has passed into retrofuturism as all the things kind of happened, like Jules Verne.
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