Futures Markets & Catastrophe Management Robert Eramo Vice President & Corporate Actuary, CNA Insurance 10/7/2002

Personal Experience At Broker Johnson & Higgins at the time On Task Force Recommending J&H Participation Futures Launched in Dec. 1992 10/7/2002

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 10/7/2002

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% 10/7/2002

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 10/7/2002

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 10/7/2002

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 10/7/2002

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? 10/7/2002

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 10/7/2002

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 10/7/2002

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! 10/7/2002

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 10/7/2002