For example if one pays 100 in premium to an insurer the insurer can pay out

For example if one pays 100 in premium to an insurer

This preview shows page 4 - 6 out of 16 pages.

For example, if one pays $100 in premium to an insurer, the insurer can pay out only about $65 in clams and still break even. That represents a loss of 35% in frictional costs without considering brokerage fees and soft costs. Imagine proposing such a financial instrument in the banking or equities arena. One of the most outspoken and long standing critics of the inefficiencies of the insurance market is Myron Picoult. He called me after RIMS to revisit this question. Given these inefficiencies, he
Image of page 4

Subscribe to view the full document.

poses the question, "Why doesn't the market step in and correct these?" Myron has a good point. Typically when there is inefficiency, some bright minds create a better product and make a killing in the market. There are certainly hints that capital market solutions are going to do just this. The appearance of hedge fund money funding sidecars in Bermuda is one sign of this. Cat bonds are another (and less promising) indication that there are market alternatives being developed. I had a conversation with the CEO of a very large insurer recently who indicated that there are many more capital market solutions to come. In Capital Ideas Evolving, I read with great interest the way that Myron Scholes looks at risk transfer. In his fund he does not measure alpha or beta. Instead he looks to take on the risk that other businesses wish to eschew. When his fund can take on those risks more efficiently than those wishing to get rid of them, he makes money. In a way, he is like the toxic waste clean-up guy. If someone has radioactive waste (risk) that they wish to be rid of, they call him and he takes it away. Because people are willing to pay a premium to dispose of the toxic waste, Mr. Scholes and company can make money by taking it away. One has to wonder, why can't his techniques be transferred across all forms of risk? For example, instead of buying property insurance for factories in New Orleans, why could one not simply buy options on businesses that make a ton of money after a hurricane hits? Or, better yet, why don't insurance companies buy these options to offset property loss claims so that they make money regardless of whether or not a loss occurs? As Picoult points out from his vantage point near Wall Street, many alternatives to insurance exist and could be implemented…if only the industry wanted to change. But change does not seem to be on the agenda. Myron sat on a panel at RIMS that included the heads of a few top insures and brokers. Many people attending this panel session reported that the panelists were not looking to move the business in any new directions. To the contrary, they seemed to wish for a return to the good old days of contingency commissions. The reticence of the insurance industry to beat the market through innovation is nonplussing. A few industry leaders have been clamoring for change for decades, with no discernable effect. I have to wonder whether we are on the cusp of change or are stuck in a vicious cycle.
Image of page 5
Image of page 6
  • Winter '14

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern

Ask Expert Tutors You can ask 0 bonus questions You can ask 0 questions (0 expire soon) You can ask 0 questions (will expire )
Answers in as fast as 15 minutes