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

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

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
10/7/2002

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%
10/7/2002

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
10/7/2002

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
10/7/2002

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
10/7/2002

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?
10/7/2002

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
10/7/2002

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
10/7/2002

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!
10/7/2002

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
10/7/2002