The Business Ethics Forum is Nov. 3-5. Visit www.baylor.edu/businessethics for details.
I would like to encourage everyone to exercise their rights as U.S. citizens and vote in the upcoming November 2 election. As a technical detail, in order to vote in the upcoming November 2 election, you need to be a registered voter. The last day you can register for this election is Monday, October 4.
The Internet makes it that much easier to register. If you have established residency in Waco or some other community in the state of Texas, then you can register for the vote by visiting the Texas Secretary of State website. Once you get there ,you can print out a registration form and mail it to the voter registrar in your county of residence.
If you are not currently a registered voter, please take a few minutes to register so that you can exercise your right to vote on November 2!
Prudential Mortgage Capital Company is currently looking for an Analyst for its Securitization Group in Newark, New Jersey. Participating in a three-year Analyst program, incumbents will be involved in real estate and CMBS analysis and will interact with PMCC originators and underwriters, rating agencies, and investors.
Job Skills:
Job Function:
Prudential is an Equal Opportunity/Affirmative Action Employer and is committed to diversity in its workforce.
Please send all resumes and requests to:
Michael Barsky
100 Mulberry St. Gateway Center 4 , Fl 2
Newark, NJ 07102
E-mail: michael.barsky@prudential.com
Fax: 973-367-8155
Today's Gamma Iota Sigma meeting will be held at 4:00 p.m. in Cashion 406. Ms. Allison Keeton from St. Paul Travelers Insurance in Hartford, CT, will be speaking about her company as well as the property casualty industry in general. St. Paul Travelers is keenly interested in hiring graduating seniors into entry level underwriting positions in their field office in the Metroplex area, so graduating seniors in particular may benefit from making this connection.
The 3rd problem on problem set #3 is conceptually similar to the gambling problem presented on pages 38-41 of the lecture note entitled "Decision Making under Risk and Uncertainty, part 2. Here, instead of determining the optimal size of the bet (B*), you need to find that optimal allocation of your initial wealth W0 = $1000 to (risky) stock and (safe) bond investments; in other words, since you plan to invest $1,000a in the stock and $1,000(1-a) in the bond, you need to need to find the value for a which maximizes expected utility.
The problem is based on the following facts:
In order to compute expected utility of wealth, you must first determine state-contingent wealth (Ws). Since there is a 60% chance that the stock increases in value by 40%, a 40% chance that the stock decreases 40%, and a 100% chance that the bond increases in value by 6%, this implies the following:
Therefore, expected utility is:
E(U(W)) = .6 ln[1060 + 340a] + .4 ln[1060 - 460a].
It is up to you to solve for the optimal value of a. This requires solving the first order condition, which involves differentiating E(U(W)) with respect to a, setting the result equal to 0 and solving for a.
American Bank is currently seeking a qualified candidate to fill the position of full-time credit analyst. Please review the responsibilities and requirements listed below. If you should have any questions, contact information follows the description below:
POSITION: FULL TIME Credit Analyst
MAJOR RESPONSIBILITY: Monitor commercial lending relationships through financial statement analysis, site inspections, and other duties
PRIMARY DUTIES:
SPECIFIC REQUIREMENTS:
This position is now open.
To apply, please send a resume and cover letter to:
Human Resources
P.O. Box 154068
Waco, TX 76715-4068
hr@ambankwaco.com
(254) 867-7611
Here is a summary of the various articles I have written concerning public policy in the context of the disastrous hurricane season suffered by the state of Florida:
For people who are interested in reading more about public policy as it pertains to catastrophe risk, I highly recommend two books: 1) Catastrophe Insurance: Consumer Demand, Markets, and Regulation, and 2) When All Else Fails: Government As the Ultimate Risk Manager. Finally, I also highly recommend Martin Grace's weblog.
Ernst & Young will be making a presentation about their Investigative & Dispute Services and Transaction Advisory Services Practices. Ernst & Young primarily hires accounting and finance students for this aspect of their business. Furthermore, Ernst & Young also has an Insurance Claims Practice which is ideally suited for RMI students.
Ernst & Young is looking for summer and winter 2005 interns, as well as a candidates for their YMP (Your Master Plan) program, a program that allows graduates to work for the firm and obtain a masters in accounting from Notre Dame or the University of Virginia.
If you are interested in attending this presentation, here is the information you need:
When: September 30, 2004, 6:30 PM
Where: Weithorn Visitors Center
Dress: Business Casual Attire
Food & Drinks Will Be Served.
Yesterday (Monday, September 20, 2004), E. S. Browning (Staff Reporter of the Wall Street Journal) wrote a very interesting article entitled "As Bush Goes, So Goes Market". He basically makes many of the same points which I made on Saturday, September 11 in my entry entitled "Update on the relationship between stock market returns and presidential futures returns"; i.e., that the presidential futures contracts appear to be pointing to a Bush victory this coming November, and that the stock market appears to be responding favorably. Or does the direction of causality move in the opposite direction?; i.e., as the stock market improves, this implies that investors are more confident about the economy's future prospects which which in turn improves the electoral prospects of the incumbent president (as reflected in futures prices). Professors Naveen Khanna and Jennifer Brooke Marietta-Westberg (both finance professors at Michigan State University) make the latter (rather compelling) argument in their paper entitled "Is it 'Kerry up, Market Down' or 'Market Down, Kerry up?' Correlation versus Causation".
Please note that the due date for Problem Set 2 is Tuesday, September 28, and that the due date for Problem Set 3 is Thursday, September 30.
Professor Martin Grace argues that the so-called "double deductible" problem in Florida is more of a problem of high deductibles, where doubling just worsens the problem. Why are deductibles high? Professor Grace notes that for some time now, insurers have not been allowed to charge adequate rates, so rate regulations have provided the incentive for the private insurance industry to reduce their Florida windstorm exposure. Since less risk is privately insured, more risk is borne by policyholders and government in various forms, including higher deductibles and state run risk pools.
Florida provides an interesting case study of dysfunctional regulatory policy. As Professor Grace so capably documents, the regulatory process has effectively undermined the viability of private insurance and substituted in its place an ad hoc set of risk sharing arrangements which no one particularly likes and very few people understand. Unfortunately, it appears that things may get worse before they get better. The New York Times published an article about the "double deductible" problem the other day which enumerates some of the short term measures and longer term reforms that are under consideration. One idea which has been floated is to provide a cash grant of $500 to everyone who has suffered unpaid insurance losses during the course of this hurricane season. While such a measure may alleviate some of the short term financial "pain" for affected consumers, from a longer term perspective this is not sound public policy, since policies like this undermine consumer incentives to make prudent risk management decisions (see "Catastrophes and Moral Hazard: The Case of Florida Windstorm Risk"). Actually, this is a classic case of a policy which may have favorable political implications but carries with it rather undesirable economic consequences. Furthermore, Mr. Tom Gallagher, who is the head of the state's Department of Financial Services, wants to get rid of multiple deductibles and substitute an alternative policy that would enable consumers to insure against aggregate losses and therefore only pay one deductible. There's nothing wrong with this idea so long as insurers are able to charge a premium which reflects the added risk and cost associated with such a policy. However, why stop there? Why not provide consumers with the option to choose between a policy based upon the current policy form, and the alternative policy proposed by Mr. Gallagher? This would encourage self selection, and therefore allow for more efficient and fair pricing. Besides offering consumers greater choice, such a policy reform would also promote market efficiency and enhance the insurability of Florida windstorm risk. In order to "fix" the Florida insurance market, regulatory reform needs to address pricing issues as well as policy forms. If not, then over time consumers and the state will continue to suffer from an insurability problem.
I have done some revision of this week's lecture notes, entitled "Decision Making under Risk and Uncertainty, part 2" (item 6 on the Lecture Notes webpage) and I recommend that you download and print these notes for the next lecture (Thursday, September 23). I do not plan to make any further changes.
We will begin next Thursday's lecture by covering pp. 29-41 from this week's notes. We will continue then with the lecture note entitled "Decision Making under Risk and Uncertainty, part 3".
On September 30, 2004, from 12:00-5:00 pm, Baylor Career Services will present their Fall 2004 Career Fair at the Ferrell Center. If you are interested in finding out more about the firms which will be recruiting at this job fair, go to https://baylor-cfm.symplicity.com/events/students.php?cf=fall2004. Currently, there are 95 companies signed up to participate, and it is possible that the number will exceed 100!
I have decided to cancel class on Tuesday, September 21, 2004 due to a personal scheduling conflict. I have readjusted the lecture schedule accordingly, along with dates for quizzes and problem sets. This will not have any effect with respect to the dates for the two midterms; specifically, the first midterm will still be given in class on Tuesday, October 5, and the second will be administered on Tuesday, November 9.
In the highly unlikely case that you are not aware of the CBS document scandal (which may be the most highly reported and blogged bit of news in the history of Western thought and culture), James Taranto's OpinionJournal entry from this past Monday is definitely worth a read, particularly so that you can watch the animated GIF file, which compares the CBS document with the same words typed using Microsoft Word (12 point Times New Roman font, default tab-stop and margin settings).
Solutions for Problem Set #1 are now available for downloading from the class website.
According to an article appearing in today's Wall Street Journal, Insurers note that the industry's losses from Hurricane Ivan, the latest of three major storms to hit the Southeastern U.S. in the last month, could be higher than for the other two huge storms, since Ivan will make landfall west of Florida. Alabama and the neighboring Gulf Coast states do not have a state-sponsored reinsurance program like Florida so that insurers will have to cover more of the losses from the latest hurricane. Alfa Insurance Group, a small insurer, has a 20 percent market share of Alabama's homeowners and auto insurance markets, more than twice the share of Allstate Corp and only a little less than that of State Farm. Alfa could have to pay a large percentage of the initially estimated insured losses of $4 billion to $10 billion from Hurricane Ivan.
Today's Wall Street Journal features an article by John Kerry entitled "My Economic Policy". After spending a fair amount of time during yesterday's lecture analyzing financial market and futures market reactions to the Bush and Kerry political campaigns, I highly recommend reading this article. Now that Senator Kerry has laid his cards out on the table, it will be interesting to see whether President Bush follows up with his own article in the Journal.
A new study has found that if the Terrorism Risk Insurance Act (TRIA) is allowed to expire as scheduled at the end of 2005, it will have negative consequences on the U.S. economy. Glenn Hubbard, former chairman of the White House Council of Economic Advisors, urged Congress to extend the Act, arguing that without the federal terrorism insurance backstop the potential drag on the gross domestic product (GDP) could be $53 billion, 0.4 percent of the GDP. The study also found that failure to extend TRIA could reduce job growth by 326,000 and household net worth by $512 billion. The study was funded by the American Insurance Association, The Financial Services Roundtable, the National Association of Mutual Insurance Companies, the National Council on Compensation insurance, the Property Casualty Insurers Association of America and the Reinsurance Association of America.
According to an article appearing in today's Wall Street Journal, hedge funds are making increasing use of privately negotiated transactions allowing reinsurance companies to manage their exposure to such natural catastrophes as Hurricane Ivan, which is now moving toward the U.S. Gulf Coast. The leading hedge funds in this market include Citadel Investment Group LLC of Chicago; Nephila Capital Ltd. of Hamilton, Bermuda, and CooperNeff Advisors Inc., a unit of the French bank BNP Paribas. Greg Hagood, a Nephila Capital partner, says that the fund has focused on reinsurance catastrophe coverage since he cofounded the firm, part of insurance broker Willis Group Holdings Ltd., with Frank Majors in 1997. Hagood says that the market, which can produce large returns for hedge funds, is attracting many investors. A hedge fund typically offers to pay $10 million to a reinsurer when it faces a particular level of catastrophic losses, charging as much as $3 million for a one-year contract or less for a single threat such as Hurricane Ivan.
PBS has produced a superb 4-hour television documentary based upon Armand Nicholi's stimulating course at Harvard, and it is to be aired on Sept. 15th and 22nd in two 2-hour segments. The inspiration for the PBS series of the same name, The Question of God does not presuppose which man -- Freud, the devout atheist, or Lewis the atheist-turned-believer -- is correct in his views. Rather, viewers are invited to join Nicholi and his students in their inquiry and decide for themselves. For details on the coming production, see http://www.pbs.org/previews/questionofgod/
Armand Nicholi is Clinical Professor of Psychiatry at Harvard University. For more than thirty years, Professor Nicholi has taught a very popular upper division undergraduate course at Harvard comparing the philosophical arguments of C. S. Lewis with those of Sigmund Freud. In April 2002, Nicholi's book, based on the course, was published and has sold quite well. Entitled The Question of God: C. S. Lewis and Sigmund Freud Debate God, Love, Sex and the Meaning of Life, Dr. Nicholi presents the writings and letters of Lewis and Freud, allowing them to "speak" for themselves on the subject of belief and disbelief. Both men considered the problem of pain and suffering, the nature of love and sex, and the ultimate meaning of life and death -and each of them thought carefully about the alternatives to their positions. The 20th century produced, a generation apart, these two brilliant men with two diametrically opposed views about the question of God. While they never actually met, Nicholi has done a great service in offering us their arguments in one volume, placed side by side and contrasted, for the very first time.
It is important that as a consumer, one be aware of the various scams that are being perpetrated on the Internet. The latest scam which is genuinely harming consumers is a practice known as "phishing". Quoting from the official website of the Anti-Phishing Working Group, "Phishing attacks use 'spoofed' e-mails and fraudulent websites designed to fool recipients into divulging personal financial data such as credit card numbers, account usernames and passwords, social security numbers, etc. By hijacking the trusted brands of well-known banks, online retailers and credit card companies, phishers are able to convince up to 5% of recipients to respond to them."
From today's Wall Street Journal, be sure to check out the article entitled "Investors Who Bet On Storms, Disasters Gauge Trade Winds". This article provides a very interesting discussion of an important form of "alternative risk transfer" known as catastrophe, or "cat," bonds. This is considered alternative risk transfer because the more traditional way to finance the cost of catastrophes has been to rely upon insurance and reinsurance markets. In a nutshell, by purchasing cat bonds, investors receive a relatively high interest rate (usually at a substantial premium above the London Interbank Offer Rate (LIBOR) in exchange for assuming some of the risk of paying claims in the event of catastrophic losses. Depending upon the severity of the catastrophe, it is possible for investors to lose their principal and/or interest payments if a storm triggers losses at and exceeding an amount set when the bonds are sold. The investors' money is then used to help pay for insurance claims.
According to Moody's, roughly $1 billion in cat bonds were issued per year for several years leading up to 2003, typically involving 4-6 separate bond issues. During 2003, a total of $1.5 billion was raised involving 13 separate bond issues. Cat bond issuers typically include insurance companies who are seeking alternatives to traditional reinsurance, as well as nonfinancial corporations whose capital assets are significantly exposed to risks of natural and man-made (i.e., terrorism) risks. USAA (insurer based in San Antonio) is one of the important innovators in the cat bond market, as is Disney.
According to a newly published study commissioned by the Knight Foundation Commission on Intercollegiate Athletics, success in big-time athletics has little if any effect on a college's alumni donations or on the academic quality of its applicants. You can read about this study in a September 8, 2004 Austin American Statesman article entitled "New Knight Commission study says athletic success has little to do with alumni contributions". The study, entitled "Challenging the Myth: A Review of the Links Among College Athletic Success, Student Quality, and Donations", was written by Robert H. Frank, who is the Henrietta Johnson Louis Professor of Management and Professor of Economics at Cornell University's Johnson Graduate School of Management.
In an earlier post entitled "Kerry Up, Markets Down? A Regression Analysis", I reported the results of the following regression equation:
(1) rS&P500,t =
where r
Kerry Regression Statistics R2 0.0508 Observations 69 Coefficients Standard Error t Stat P-value a 0.00081 0.0099 0.9921 b -0.03789 0.02001 -1.8938 0.0626
Bush Regression Statistics | | | | |
R2 | 0.1007 | | | |
Observations | 69 | | | |
| | | | |
| Coefficients | Standard Error | t Stat | P-value |
a | 0.00079 | -0.0598 | 0.9525 | |
b | 0.06997 | 0.0255 | 2.7390 | 0.0079 |
As promised, here is today's Austin American Statesman article entitled "Baylor football a bear market".
With the entire furor over the so-called "double deductible" problem in Florida, a contractual issue is looming in the market for catastrophe reinsurance which may be much more significant economically. Insurers writing property insurance routinely purchase reinsurance coverage for the purpose of limiting their catastrophe exposures. When insurers purchase reinsurance, they must decide whether to pay extra for an option which automatically reinstates coverage after an insured event occurs. The default reinsurance contract pays for one insured event, and then the coverage disappears unless the insurer has purchased the option to reinstate. Insurers can select how many reinstatements they wish to have. Typically, the cost to reinstate coverage is roughly half the cost of the original reinsurance premium. For example, suppose a reinsurer quotes $100 for the default reinsurance contract which does not reinstate. Then the reinsurer might quote a price of $110 for a contract which reinstates once, $120 for a contract which reinstates twice, etc. Whenever reinstatement occurs, the reinsurer would charge the insurer an additional $50 premium.
Since it is rare that multiple hurricanes strike the same properties, many insurers will prefer to purchase the default reinsurance contract and retain the risk of a subsequent catastrophe. Unfortunately, this is likely to be the most popular strategy for the smaller, less solvent companies for two reasons: 1) since the "option to default" conveyed by the legal rule of limited liability is more valuable for such firms, smaller, less solvent insurers are likely to reinsure less than larger, moresolvent insurers by not purchasing the reinstatement option, and 2) by foregoing the purchase of the reinstatement option,this results in significant reinsurance premium savings. Furthermore, given the dynamics of the Florida insurance market (where, for a variety of reasons, many of the worst risks are covered by such companies), we may be looking at a much worse insolvency scenario for the Florida insurance industry than we might have otherwise expected.
I wish to thank my good friend and colleague, Dr. Richard Derrig, for pointing this problem out to me.
In a statistical sense, the probability that the same property is damaged by multiple hurricanes is surely a rare event. However, this is a situation which many property owners in Florida now face. The print media is filled these days with examples of policyholders whose properties have sustained separate damages from Hurricanes Charlie and Frances who will likely have to pay two deductibles. Hopefully this won't become an n deductible problem; obviously whether n will be greater than or equal to two will depend upon how the rest of the hurricane season plays out.
While one cannot help but be sympathetic toward people who face such financial hardships, it is also important to think through this issue in a logical fashion. Under most property insurance contracts, claims and deductible payments are related to a specific insured event. The insurance policy promises to make the property owner whole after an insured event occurs (where being made whole is defined as paying the difference between the property damage related to the insured event and the deductible). Even if a policyholder suffers the misfortune of multiple (e.g., 2, 3, ..., n) different hurricanes affecting the same property, contractually these represent multiple insured events, not one. Consequently, n deductibles apply. Similarly, a person who has the misfortune of being involved in multiple car accidents is not afforded the option of treating multiple accidents as one event; in fact, these are multiple events and each event has its own claim settlement process.
A useful way to think about the double deductible problem is to relate it conceptually to the World Trade Center controversy. In that case, there was one insured event; specifically, a coordinated strike by terrorists on the two buildings. Although it could be (and certainly was) argued that were two insured events, the court's decision to treat it as one event appropriately came down to a question of policy language, which is why the "one event" position eventually prevailed in that case. In the case of Florida homeowners insurance, multiple deductibles follow as a logical consequence of (state regulated) homeowners insurance policy forms which require separate claims and deductibles for damage on separately named storms. From a contractual standpoint, Hurricanes Charles and Frances were clearly two different insured events, so two deductibles (or three if Ivan also ends up hitting the same property) would seem appropriate and consistent with standard policy form contract language and legal principles of insurance.
In all likelihood, the state of Florida will end up considering various regulatory reforms once this hurricane season is over. Even Florida governor Jeb Bush has weighed in on this issue, suggesting that the double deductible is something that might need to be changed because of the financial hardship that this creates for many property owners. In my view, a constructive approach would involve giving consumers the option to choose between a policy based upon the current policy form, and an alternative policy that would enable consumers to insure against aggregate losses. Contractually, the latter policy type would closely resemble a typical health insurance contract which has a "stop loss" provision built in for aggregate losses. Since the alternative policy would provide consumers with the opportunity of insuring against paying multiple deductibles, consumers could expect to pay more for the alternative policy than for the current policy. Besides offering consumers greater choice, such a policy reform would improve market efficiency. So long as these contracts are fairly priced, chances are that the worse-than-average risks would tend to gravitate toward the stop loss policy, whereas the better-than-average risks would tend to gravitate toward the current policy form.
For your information, I have changed the due date for problem set 1 from Thursday, September 9 to Tuesday, September 14. On Thursday, I plan to cover the lecture note which was originally intended for today.
Regarding problem sets - there are two ways to submit them to me: 1) electronically (via email sent to problemsets@rmi.baylor.edu) or 2) hard copy (at the beginning of the class period when the problem set is due). If you opt for the electronic alternative, please use your Baylor email address and not a Yahoo, AOL, MSN, or Hotmail address. Email which comes from a Baylor email address is always delivered, whereas email coming from Yahoo, AOL, MSN, and Hotmail is often (falsely) identified as spam by the anti-spam filtering software which I use. Whenever this occurs, the email is automatically deleted; consequently, email sent to me from these types of accounts will often never be delivered. For that matter, if you ever send me email, try to use your baylor email address so as to avoid this problem.
An important public policy aspect of catastrophes such as hurricanes, floods, earthquakes and terrorist actions is the effect of public disaster relief on the incentives of private firms and individuals to make prudent risk management decisions. Typically, economists are most worried by the possibility that public disaster relief, however well intentioned, may make matters worse in the long term by undermining incentives for firms and individuals to select economically efficient levels of private insurance and loss mitigation.
A useful way to think about this problem is to consider what optimal risk management and insurance decisions might look like in a world without public disaster relief, and compare these decisions with the decisions that are likely to be made in a world with public disaster relief. Since consumers fully internalize the costs and benefits of risk management and insurance decisions in the former case, but do not in the latter, the prospect of public disaster relief reduces consumers' demand for private insurance and incentivizes consumers to underinvest in loss mitigation. This is a classic example of the so-called "moral hazard" problem. Moral hazard refers to the tendency for insured consumers to change their behavior in ways that increase the probability and/or size of claims. It is an important issue whenever risk sharing occurs and the price at which risk is transferred is distorted in some fashion; e.g., in the form of subsidized insurance provided after the fact by public entities such as FEMA.
Jon Meacham, best-selling author of Franklin and Winston: An Intimate Portrait of an Epic Friendship, will present the third Ferguson-Clark Author Lecture benefiting the Baylor University Libraries.
Meacham will speak on "Franklin and Winston: Leadership Issues for Today" at 7:30 p.m. Oct. 26 in the Mayborn Museum Complex. Baylor alumnus Collen A. Clark established the lecture series endowment in honor of his mother, Carla Sue Ferguson Garrett, a Baylor alumna and member of the libraries' Board of Advisors. Ernest Gaines and David McCullough presented the first two lectures.
Managing Editor of Newsweek
Born and raised in Chattanooga, Tenn., Meacham graduated cum laude from the University of the South and went to work as a reporter for The Chattanooga Times. He soon became an editor of The Washington Monthly and two years later was hired by Newsweek as a national affairs writer. As managing editor at 34, he oversees Newsweek's coverage of politics, international affairs and breaking news. The New York Times has called him "one of the most influential editors in the news magazine business."
Important, Insightful Book
Tom Brokaw, author of The Greatest Generation wrote: "This is at once an important, insightful, and highly entertaining portrait of two men at the peak of their powers who, through their genius, common will, and uncommon friendship, saved the world. Jon Meaham's Franklin and Winston takes its place in the front ranks of all that has been written about these two great men."
Meacham's new sources - including unpublished letters of FDR's secret love, the papers of Pamela Churchill Harriman, and interviews with the few surviving people who were in FDR and Churchill's joint company - shed new light on the characters of both men. Meacham calls the book "a portrait of what I believe to be the "most fascinating friendship of modern times."
An eloquent speaker and a skilled raconteur, Meacham understands important issues and events in all of their complexity and how they impact our lives.
More information on the event may be obtained by calling Mary Goolsby, 254-710-6735.
Today's Wall Street Journal features a page 1 story entitled, "After Storms, Florida Wakes Up to a New Insurance Reality". This article provides a very compelling analysis of the economics of catastrophe risk, focusing specifically upon the "special case" of Florida windstorms since Hurricane Andrew in 1992.
After blogging earlier this evening about the financial implications of hurricanes, I was blown away by the National Hurricane Center's forecasted paths for Frances and Ivan. Also, it is hard to beat NASA's picture of Frances, circa September 5, 2004.
Fortunately, the severity of damage from Hurricane Frances will likely be much less severe than what was anticipated in the later part of last week. Then, forecasters were bandying about Andrew/911 level estimates; e.g., $20-$50 billion. The three most prominent insurance risk management companies, AIR Worldwide, Risk Management Solutions and EQECAT, now estimate that insured losses from the storm will likely range from $2 billion to $10 billion, which still aren't exactly "chump change". Combined with Charley's insured losses of $7 billion, this is turning out to be a rather expensive hurricane season for the insurance industry.
The worst hurricane (in terms of total property damage and insured losses) was Hurricane Andrew, a Category 4 hurricane which hit Florida in August 1992. Andrew caused $20.3 billion in losses for insurers (in today's dollars) and caused a dozen insurance carriers to go bankrupt. Andrew set in motion fundamental changes in the way that the insurance business is conducted in Florida. Consider the following examples of private sector innovation:
Furthermore, other mechanisms have been put in place which causes consumers and the state government to share more of the catastrophe risk. Consider the following:
It will be interesting to see how this hurricane season plays out. To date, the damages have been very manageable for the insurance industry. However, if we have many more storms like Charley and Frances, this may have significant pricing and coverage implications for property insurance markets throughout the United States. Historically, the capital shocks from major catastrophes such as Andrew and 911 caused insurance rates and reinsurance rates to rise and coverage levels to fall. This is to be expected, since capital shocks result in capacity constraints in these markets, which in turn result in higher rates and lower coverage.
Tomorrow (on Tuesday, 9/7) we will be completing the Statistics Tutorial and moving on to the lecture note entitled Decision Making under Risk and Uncertainty, part 1. You'll probably want to download and print these lecture notes because I made a few minor changes (corrections and improvements) to them today. While you're at it, you might also want to download and print the lecture note for Thursday's class, entitled Decision Making under Risk and Uncertainty, part 2, since I also made some minor modifications that that document as well and I expect this to be the "final" version for the time being. Also, Thursday, 9/9 is the due date for the first problem set for this course.
Besides reading the book chapter entitled Risk and Utility: Economic Concepts and Decision Rules, you should also read Supply of Insurance and Measuring Morals: Researchers ask if Americans are cheating more often -- and what can be done about it for tomorrow, and Avoiding Decision Traps for Thursday.
The Wall Street Journal asks a series of questions to a number of Nobel Laureates in economics. On one question, whether the global income distribution will be more equal 50 years from now, several of them say "yes," because they are optimistic about China and India. This article is definitely worth reading!
In case if you missed its airing on Saturday Night Live, I highly recommend the video entitled "Straight Talk about Today's Markets"!