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.