One sure-fire way of selling insurance policies is to maximize your coverage while keeping premium rates reasonably low. Had we now got this down to a science?
By: Vanessa Uy
Back in the good old days – the previous 25 or more years to be exact – insurance company actuarial mathematicians used to statistically assess risk using a figure called the expected loss. They got it by multiplying the probability of an accident occurring times the damage done by the accident.
Henceforth, policymakers and statisticians of almost every insurance company around the world grown content in using the concept of expected loss as the sole measure of risk. But since insurance companies are always in a perpetual search of ways to “streamline” their economic “bottom line”, the quest is on to create policies that are more ambitious than the one that precedes it. An insurance policy that not only provides coverage for “catastrophes” other insurance providers won’t touch with the proverbial ten-foot pole but also can keep the client’s premium rates down to the absolute reasonable minimum (from the insurance providers perspective at least).
That fateful day came around in 1986, when a mathematician from the University of Virginia named Yacov Haimes and his team developed the partitioned multi-objective risk method or PMRM. Haimes and his team argue that insurance company actuarial mathematicians need to account for catastrophes separately from ordinary accidents in order to provide a better-structured insurance policy, one that maximizes coverage while minimizing premium rates. Rare but expensive (in monetary terms) accidents, the team pointed out could have a small-expected loss given their improbability of occurring.
In his book “Risk Modeling, Assessment and Management”, Yacov Haimes discusses the art of risk management after years of being acquainted and gaining expertise on the subject. Especially it’s important applications in such areas as engineering, science, and even the politically tinged vagaries of public policy. Haimes’ writing style equally covers the quantitative and qualitative aspects risk management by emphasizing how to quantify risk via construct probability together with real-world decision-making problems without ignoring the host of institutional, organizational, political and cultural considerations which these days often accompany such challenges.
Since developing his PMRM, Haimes has co-developed an even newer method of risk assessment called risk filtering, ranking and management or RFRM. The usefulness of RFRM in risk assessment is supported by several case studies cited in Haimes’ book. Given that Yacov Haimes has provided a new focus on minimizing the high cost associated with today’s more extensive risk management, how can all of this benefit us, the lowly policy holder, or for that matter, the whole global economy as a whole?
Ever since our on-going global economic downturn slowly – but inexorably – continues to drive all of us into an uncomfortable sense of fiscal austerity. Whoever can provide products that provide the maximum performance for the least amount of money will not only survive, but can even prosper during these times of economic hardship. If insurance companies can manage to provide us with insurance policies that offer more for less, then both – the insurance provider and the “mere” policy holder – can weather out the on-going global “financial storm” with a comfortable margin of confidence.
Monday, January 26, 2009
Monday, December 22, 2008
The Global Economic Downturn: Bad For Insurance Companies?
While major insurance companies – like AIG – have recently felt the pinch of the global economic downturn big time, is the current global economic crisis really that bad for all insurance companies?
By: Ringo Bones
Even though times of economic austerity usually spells reduced profits for all sorts business activity, many in the insurance underwriting sector are now hard at work devising various schemes. Schemes not only on how to stay afloat during our on-going global economic downturn, but also ways for their company to “make a killing” despite other financial institutions failing on the left and right.
From the perspective of risk assessors, insurance companies had become very indispensable part of our modern economy. Everyone now knows that every economic unit is subject to risk. Various organizations for economic activities and business organizations may have their goals and raison d’être completely destroyed if protection by insurance doesn’t exist. Paradoxically, insurance is even more important for the small business organization than for larger business organizations - which can meet small losses without difficulty.
Financial stability can also be maintained through credit insurance. A business concern that suffers losses through the insolvency of customers can normally meet these conditions by a reserve for bad debts. However – especially during times of widespread economic crisis - a severe amount of loss due to insolvency of various customers may cause serious financial difficulties. This adverse situation may be minimized by credit insurance.
Even though credit insurance had became indispensable due to the fact that credit is already a vital part of our economy, but during times of widespread economic crisis, the consequence of unexpected losses has been inevitably turned into a model that develops slower than previously intended. I mean an insurance company won’t last very long if the funds it set aside for pay outs must be injected with funds reserved for other things. Like funds set aside to keep up with the latest Basel Accord Compliance rules, cost of running the company, etc.
By no means utterly dire, insurance companies could manage to keep themselves afloat during times of economic crisis if it is skillfully managed. But given that the Bull Market is already for all intents and purposes an extinct species for the foreseeable future, it is highly unlikely that most insurance companies can “make a killing” during times of economic austerity.
By: Ringo Bones
Even though times of economic austerity usually spells reduced profits for all sorts business activity, many in the insurance underwriting sector are now hard at work devising various schemes. Schemes not only on how to stay afloat during our on-going global economic downturn, but also ways for their company to “make a killing” despite other financial institutions failing on the left and right.
From the perspective of risk assessors, insurance companies had become very indispensable part of our modern economy. Everyone now knows that every economic unit is subject to risk. Various organizations for economic activities and business organizations may have their goals and raison d’être completely destroyed if protection by insurance doesn’t exist. Paradoxically, insurance is even more important for the small business organization than for larger business organizations - which can meet small losses without difficulty.
Financial stability can also be maintained through credit insurance. A business concern that suffers losses through the insolvency of customers can normally meet these conditions by a reserve for bad debts. However – especially during times of widespread economic crisis - a severe amount of loss due to insolvency of various customers may cause serious financial difficulties. This adverse situation may be minimized by credit insurance.
Even though credit insurance had became indispensable due to the fact that credit is already a vital part of our economy, but during times of widespread economic crisis, the consequence of unexpected losses has been inevitably turned into a model that develops slower than previously intended. I mean an insurance company won’t last very long if the funds it set aside for pay outs must be injected with funds reserved for other things. Like funds set aside to keep up with the latest Basel Accord Compliance rules, cost of running the company, etc.
By no means utterly dire, insurance companies could manage to keep themselves afloat during times of economic crisis if it is skillfully managed. But given that the Bull Market is already for all intents and purposes an extinct species for the foreseeable future, it is highly unlikely that most insurance companies can “make a killing” during times of economic austerity.
Saturday, November 29, 2008
Private War Risk Insurance Providers: Bankrupted by Piracy?
Since the incidence of maritime piracy off the Horn of Africa is on the rise, will this endanger the economic viability of private companies underwriting war risk insurance contracts?
By: Ringo Bones
Ever since that brazen act of piracy by Somali pirates that allowed them to successfully hijack a full-sized Saudi-owned oil tanker then held her for a “King’s Ransom” became headline news, many of those in the insurance industry have switched into panic mode. After all, the International Community have not even yet reached a consensus whether to classify piracy as an act of war under the Geneva Convention, or just a civil criminal act. Given the current legal debacle of Guantánamo, are war risk insurance contracts still an economically viable part of the insurance industry?
War risk insurance is defined as a type of insurance that covers damages due to acts of war. This usually includes invasion, insurrection, rebellion, and hijacking. Some war risk insurance policies cover damage incurred when weapons of mass destruction – like nuclear devices – were used. This type of insurance is mostly issued in the shipping and the aviation industry.
War risk insurance generally has two parts: War Risk Liability, which covers personnel and items within the craft and is calculated based on the indemnity amount; and War Risk Hull, which covers the craft itself and is calculated based on the value of the craft. War risk insurance premiums are usually based on the expected stability of the countries and territories to which the vessel will travel.
Back in September 11, 2001, policies for private war risk insurance were temporarily canceled but later reinstated with substantially reduced indemnities. In response to this cancellation, the US federal government set up a terror insurance to cover commercial airlines. Because of this, the International Air Transport Association has argued that airline companies operating in the United States which do not provide war risk insurance find themselves at a competitive disadvantage. Because war risk insurance is very dependent on the prevailing geopolitical climate, some insurance companies – like Lloyds for example – have even made adverts highlighting that their companies are very mindful about the prevailing global trends concerning geopolitical security and stability.
For all intents and purposes, and their actions caught on the international news media’s cameras. Somali pirates in most people’s eyes falls under the purview of the Geneva Convention Section I on Belligerents, Article 1. Stating that countries where militia or volunteer corps constitute the army, or form a part of it, they are included under the denomination “army”. So like the al-Qaeda operatives, Somali pirates are by definition enemy combatants waging a war with the Western civilization through piracy.
Given that the maritime industry is the lifeblood of our current global economy, will the threat of piracy make the shipping of goods by sea become prohibitively expensive due to security and insurance mark-ups? Piracy, like the one existing in the Gulf of Aden and the Straits of Malacca only received scant Foreign Policy prosecution by various members of the International Community. With this conundrum, insurance companies and their clients – especially the clients – who are at the sharp end of uncertain losses that’s ever increasing can finally call themselves as the “social group” claiming to be unable to pay for protection. Thus causing widespread social jeopardy to the maritime industry workers and their families, the roots of which can be traced to various governments around the world and their inaction in ending the scourge of piracy.
By: Ringo Bones
Ever since that brazen act of piracy by Somali pirates that allowed them to successfully hijack a full-sized Saudi-owned oil tanker then held her for a “King’s Ransom” became headline news, many of those in the insurance industry have switched into panic mode. After all, the International Community have not even yet reached a consensus whether to classify piracy as an act of war under the Geneva Convention, or just a civil criminal act. Given the current legal debacle of Guantánamo, are war risk insurance contracts still an economically viable part of the insurance industry?
War risk insurance is defined as a type of insurance that covers damages due to acts of war. This usually includes invasion, insurrection, rebellion, and hijacking. Some war risk insurance policies cover damage incurred when weapons of mass destruction – like nuclear devices – were used. This type of insurance is mostly issued in the shipping and the aviation industry.
War risk insurance generally has two parts: War Risk Liability, which covers personnel and items within the craft and is calculated based on the indemnity amount; and War Risk Hull, which covers the craft itself and is calculated based on the value of the craft. War risk insurance premiums are usually based on the expected stability of the countries and territories to which the vessel will travel.
Back in September 11, 2001, policies for private war risk insurance were temporarily canceled but later reinstated with substantially reduced indemnities. In response to this cancellation, the US federal government set up a terror insurance to cover commercial airlines. Because of this, the International Air Transport Association has argued that airline companies operating in the United States which do not provide war risk insurance find themselves at a competitive disadvantage. Because war risk insurance is very dependent on the prevailing geopolitical climate, some insurance companies – like Lloyds for example – have even made adverts highlighting that their companies are very mindful about the prevailing global trends concerning geopolitical security and stability.
For all intents and purposes, and their actions caught on the international news media’s cameras. Somali pirates in most people’s eyes falls under the purview of the Geneva Convention Section I on Belligerents, Article 1. Stating that countries where militia or volunteer corps constitute the army, or form a part of it, they are included under the denomination “army”. So like the al-Qaeda operatives, Somali pirates are by definition enemy combatants waging a war with the Western civilization through piracy.
Given that the maritime industry is the lifeblood of our current global economy, will the threat of piracy make the shipping of goods by sea become prohibitively expensive due to security and insurance mark-ups? Piracy, like the one existing in the Gulf of Aden and the Straits of Malacca only received scant Foreign Policy prosecution by various members of the International Community. With this conundrum, insurance companies and their clients – especially the clients – who are at the sharp end of uncertain losses that’s ever increasing can finally call themselves as the “social group” claiming to be unable to pay for protection. Thus causing widespread social jeopardy to the maritime industry workers and their families, the roots of which can be traced to various governments around the world and their inaction in ending the scourge of piracy.
Thursday, October 16, 2008
The American Taxpayer: Insurance Underwriters of Last Resort?
The Bush Administration’s 700 billion-dollar bailout package is supposedly for increasing banking liquidity – i.e. make banks more confident in providing credit. But is it wise to use the American taxpayer’s money?
By: Ringo Bones
As a way of mitigating the worst effects of the US Credit Crisis - which has now become global, the Bush Administration gave the green light on the implementation of their 700 billion-dollar bailout plan. An overwhelming majority of American taxpayers now question the wisdom of using public funds to bail out the follies that was caused by Wall Street’s “Quixotic Adventurism” in pursuit of easy money. While many Americans are now beginning to understand that when major financial institutions are allowed to fail – like Lehman Brothers – the negative repercussions will surely be felt around the world. And the question now is the decision to use the American taxpayer’s money a wise choice? Those in the know will inevitably be saying: “But isn’t this tantamount to a nationalization that would inevitably transform the US banking system from a free market economy to a command socialist economy?” After all, this inevitability will surely undermine the ideological underpinnings of Wall Street’s perception of what free market capitalism should be – a paragon of the American Protestant Work Ethic.
Central banks around the world are now coordinating to implement a plan modeled after the Bush Administration’s 700 billion dollar economic bailout scheme – albeit at a more modest scale. This is due to the fact that the International Monetary Fund’s top brass’ praise of the Bush Administration’s economic bail out scheme as “the most sensible so far” in solving our current global economic crisis. Thus the taxpayers disdain of using public funds to bail out the excesses and adventurism of the banking sector is no longer confined to the United States.
If the taxpayers’ money ever becomes the financial too of choice by governments to bail out their ailing economies, then the majority of us taxpayers will inevitably be harboring resentment. Plus that ever increasing consensus that insurance companies make so much because they charge clients / their customers high premiums and then underplay or deny claims altogether. Some have even said that insurance companies are just daring us to fight back. Will incidence of insurers bad faith rear its ugly head on every government around the world attempts’ in alleviating our global financial crisis?
By: Ringo Bones
As a way of mitigating the worst effects of the US Credit Crisis - which has now become global, the Bush Administration gave the green light on the implementation of their 700 billion-dollar bailout plan. An overwhelming majority of American taxpayers now question the wisdom of using public funds to bail out the follies that was caused by Wall Street’s “Quixotic Adventurism” in pursuit of easy money. While many Americans are now beginning to understand that when major financial institutions are allowed to fail – like Lehman Brothers – the negative repercussions will surely be felt around the world. And the question now is the decision to use the American taxpayer’s money a wise choice? Those in the know will inevitably be saying: “But isn’t this tantamount to a nationalization that would inevitably transform the US banking system from a free market economy to a command socialist economy?” After all, this inevitability will surely undermine the ideological underpinnings of Wall Street’s perception of what free market capitalism should be – a paragon of the American Protestant Work Ethic.
Central banks around the world are now coordinating to implement a plan modeled after the Bush Administration’s 700 billion dollar economic bailout scheme – albeit at a more modest scale. This is due to the fact that the International Monetary Fund’s top brass’ praise of the Bush Administration’s economic bail out scheme as “the most sensible so far” in solving our current global economic crisis. Thus the taxpayers disdain of using public funds to bail out the excesses and adventurism of the banking sector is no longer confined to the United States.
If the taxpayers’ money ever becomes the financial too of choice by governments to bail out their ailing economies, then the majority of us taxpayers will inevitably be harboring resentment. Plus that ever increasing consensus that insurance companies make so much because they charge clients / their customers high premiums and then underplay or deny claims altogether. Some have even said that insurance companies are just daring us to fight back. Will incidence of insurers bad faith rear its ugly head on every government around the world attempts’ in alleviating our global financial crisis?
Wednesday, September 10, 2008
Tattoo and Piercing Insurance
Even though this form of insurance has been regularly available across the United States for more than a decade, tattoo and piercing insurance is still an esoteric idea to some bemoaning how tattooing became popular. Is this insurance really useful?
By: Vanessa Uy
Toward the end of the 1980’s, when the rise of the Los Angeles Hair Metal Scene epitomized by bands like Mötley Crüe, Guns N’ Roses, LA Guns, and Poison started to made tattoos – even body piercings - a part of Madison Avenue’s “Fashion Ethic”. Tattoo insurance was virtually nonexistent. A few years later with the rise of the Seattle Grunge scene, the concept of a “Tattoo Insurance” began to take shape.
Many in the tattoo art world credit insurance agents Ray Pearson and Susan Preston for making tattoo insurance an economically viable product. Ray Pearson is the self-proclaimed “short, hairy, fat guy in a suit that you see at the conventions behind the Alliance of Professional Tattooists or APT booth” of O.S. Bruner. While Susan Preston of Professional Program Insurance Brokerage for their hard work during the mid-1990’s to make tattoo insurance a reality. Both Ray and Susan have tattoos themselves, which make them in a privileged position understand their respective clients’ point of view. At the time, Ray Pearson and Susan Preston were very busy in providing tattoo shops with coverage at a minimum cost. The coverage also includes piercing, since this body-modification artform has risen in popularity when the 1990’s began.
Tattoo insurance starts with two basic types of coverage. The first is general liability, which provides coverage similar to that of a standard homeowner’s policy – i.e. coverage against fire, flooding etc. General liability coverage is available to professional tattoo and piercing studios that meet the eligibility requirements.
Next is professional liability, which protects an individual tattooist or piercer much like the malpractice insurance that covers physicians. Professional liability has been proved very important in most cases since judging “artistic merit” is largely a matter of taste. This coverage mainly provides legal defense costs (which can be substantial) especially in cases when a client is not satisfied with his or her tattoo. Professional liability also covers various “mistake” claims, like the perennially publicized “Fighting Irish” debacle.
Insurance companies basically judge professional liability eligibility on the normal, commercial underwriting standards. Like the cleanliness of the shop? The type of neighborhood is the shop in since geographic profiling / gentrification / red lining can be an issue (Have you observed the 2008 US presidential hopeful Barack Obama’s Chicago South Side neighborhood’s “arrested development” via Machiavellian-style political machinations?). Are there any immediate hazardous exposures next door? (Like Monsanto’s undocumented PCB dump sites). Insurance companies also look for legitimate, professional, permanently located tattoo / piercing studios as opposed to an artist working out of his or her own basement.
Some insurance companies require a tattoo shop to routinely register their clients in a log to prove that the specific person were tattooed by them on a specific date. This is distinct from the paperwork of liability waivers most tattooists and piercers require their customers to sign. Courts have been recognizing the validity of these waivers and had been enforcing them for over a decade now. When an adult enters into another contract with another adult, signed with a full understanding and approval, the artist is free of responsibility. The cost to the tattooist is then limited to legal fees, which the insurance company pays for.
As the cornerstone of a good “beauty business” has always been repeat customers and referrals. Tattooists and piercers can be considered an excellent example of a beauty business for reasons previously described, but they also did a good job of policing themselves over the years by consistently and universally operating on a safe and professional level that there haven’t been many claims. This resulted in a business that operates on minimal loss and high profit margins that insurance costs by way of premiums can be considered minimal.
Professional Program Insurance Brokerage offer insurance premiums that start as low as $615 to insure a tattoo shop or individual artist. They usually charge 10% more if a shop does facial or cosmetic tattooing – like permanent eyebrows and lipcolor - which is considered riskier than regular body tattooing.
Some insurance companies offer group policies. O.S. Bruner offers such a policy to eligible Alliance of Professional Tattooists or APT members, which significantly lower the costs of availing one. Ray Pearson says O.S. Bruner’s average shop policy with $30,000 of contents coverage, a $500,000 limit of general liability, and special perils coverage - which is “all risk”, including theft - costs around $1,175, inclusive of taxes and other fees.
Most companies offer tattoo liability limits available from $100,000 to a million dollars. And property coverage can be scaled-up for basically whatever the client needs. Premiums can be paid in a lumped sum – i.e. all at once - or through a more manageable monthly financing. Looks like the tattoo and piercing insurance providers are really looking out for both the shops and their customers, how’s that for corporate social responsibility.
The short but crowded history of tattoo and piercing artform’s assault on the money driven media mainstream – from the late 1980’s Hair Metal scene to the mid 1990’s Riot Grrrl movement epitomized by Theo Kogan and the rest of Lunachicks. With anything that had gone before, between, or after has really popularized both tattoos and body piercings. Some might be jaded, but for better or for worse (I say better) tattooing might outlast anything – the US Navy, Bike Gangs / Enthusiasts, etc - that had helped it become popular in the first place.
By: Vanessa Uy
Toward the end of the 1980’s, when the rise of the Los Angeles Hair Metal Scene epitomized by bands like Mötley Crüe, Guns N’ Roses, LA Guns, and Poison started to made tattoos – even body piercings - a part of Madison Avenue’s “Fashion Ethic”. Tattoo insurance was virtually nonexistent. A few years later with the rise of the Seattle Grunge scene, the concept of a “Tattoo Insurance” began to take shape.
Many in the tattoo art world credit insurance agents Ray Pearson and Susan Preston for making tattoo insurance an economically viable product. Ray Pearson is the self-proclaimed “short, hairy, fat guy in a suit that you see at the conventions behind the Alliance of Professional Tattooists or APT booth” of O.S. Bruner. While Susan Preston of Professional Program Insurance Brokerage for their hard work during the mid-1990’s to make tattoo insurance a reality. Both Ray and Susan have tattoos themselves, which make them in a privileged position understand their respective clients’ point of view. At the time, Ray Pearson and Susan Preston were very busy in providing tattoo shops with coverage at a minimum cost. The coverage also includes piercing, since this body-modification artform has risen in popularity when the 1990’s began.
Tattoo insurance starts with two basic types of coverage. The first is general liability, which provides coverage similar to that of a standard homeowner’s policy – i.e. coverage against fire, flooding etc. General liability coverage is available to professional tattoo and piercing studios that meet the eligibility requirements.
Next is professional liability, which protects an individual tattooist or piercer much like the malpractice insurance that covers physicians. Professional liability has been proved very important in most cases since judging “artistic merit” is largely a matter of taste. This coverage mainly provides legal defense costs (which can be substantial) especially in cases when a client is not satisfied with his or her tattoo. Professional liability also covers various “mistake” claims, like the perennially publicized “Fighting Irish” debacle.
Insurance companies basically judge professional liability eligibility on the normal, commercial underwriting standards. Like the cleanliness of the shop? The type of neighborhood is the shop in since geographic profiling / gentrification / red lining can be an issue (Have you observed the 2008 US presidential hopeful Barack Obama’s Chicago South Side neighborhood’s “arrested development” via Machiavellian-style political machinations?). Are there any immediate hazardous exposures next door? (Like Monsanto’s undocumented PCB dump sites). Insurance companies also look for legitimate, professional, permanently located tattoo / piercing studios as opposed to an artist working out of his or her own basement.
Some insurance companies require a tattoo shop to routinely register their clients in a log to prove that the specific person were tattooed by them on a specific date. This is distinct from the paperwork of liability waivers most tattooists and piercers require their customers to sign. Courts have been recognizing the validity of these waivers and had been enforcing them for over a decade now. When an adult enters into another contract with another adult, signed with a full understanding and approval, the artist is free of responsibility. The cost to the tattooist is then limited to legal fees, which the insurance company pays for.
As the cornerstone of a good “beauty business” has always been repeat customers and referrals. Tattooists and piercers can be considered an excellent example of a beauty business for reasons previously described, but they also did a good job of policing themselves over the years by consistently and universally operating on a safe and professional level that there haven’t been many claims. This resulted in a business that operates on minimal loss and high profit margins that insurance costs by way of premiums can be considered minimal.
Professional Program Insurance Brokerage offer insurance premiums that start as low as $615 to insure a tattoo shop or individual artist. They usually charge 10% more if a shop does facial or cosmetic tattooing – like permanent eyebrows and lipcolor - which is considered riskier than regular body tattooing.
Some insurance companies offer group policies. O.S. Bruner offers such a policy to eligible Alliance of Professional Tattooists or APT members, which significantly lower the costs of availing one. Ray Pearson says O.S. Bruner’s average shop policy with $30,000 of contents coverage, a $500,000 limit of general liability, and special perils coverage - which is “all risk”, including theft - costs around $1,175, inclusive of taxes and other fees.
Most companies offer tattoo liability limits available from $100,000 to a million dollars. And property coverage can be scaled-up for basically whatever the client needs. Premiums can be paid in a lumped sum – i.e. all at once - or through a more manageable monthly financing. Looks like the tattoo and piercing insurance providers are really looking out for both the shops and their customers, how’s that for corporate social responsibility.
The short but crowded history of tattoo and piercing artform’s assault on the money driven media mainstream – from the late 1980’s Hair Metal scene to the mid 1990’s Riot Grrrl movement epitomized by Theo Kogan and the rest of Lunachicks. With anything that had gone before, between, or after has really popularized both tattoos and body piercings. Some might be jaded, but for better or for worse (I say better) tattooing might outlast anything – the US Navy, Bike Gangs / Enthusiasts, etc - that had helped it become popular in the first place.
Friday, August 29, 2008
Collaterized Debt Obligations: Instigating the Global Credit Crunch?
Somewhat unfairly blamed as the instigating agent of the 2007 Global Credit Crunch, are collaterized debt obligations or CDO, really deserving of such infamy?
By: Ringo Bones
After reading the latest book by the billionaire investor guru George Soros titled “The New Paradigm for Financial Markets”, I recently had an epiphany that stability and equilibrium are not our Wall Street controlled global economy’s natural state of being. Instead, the quixotic adventurism in search of quick and easy profits undertaken under unacceptable levels of risk is the rule, rather than the exception. Thus explaining the inevitability of the global credit crunch and the current yo-yoing price of crude oil pegged against the US dollar. Even the rise of asset backed security based on synthetic constructs marketed as investments to anyone who likes to experience first-hand what it's like to be financially devastated by an Enron-type scheme.
Often referred to by everyone’s friendly neighborhood financial advisor as an asset backed security product that works just like a home insurance against losses from fire and theft. Except that it applies to big corporation’s credit insurance which you – a mere civilian – can easily get rich of off. By the start of the 21st Century, CDO s was being sold-off to with alarming frequency to financially ignorant civilians – i.e. people like you and me. Your friendly neighborhood financial advisor might – and it’s very likely – to have made ungodly amounts of money relatively easily. Surprisingly to you – the financially ignorant - through the sheer inherent complexity of structured financial transactions of CDO s that he or she –your financial advisor – might seem like a saint for helping you, the financially ignorant retail chump, to experience your friendly neighborhood financial advisors new found get-rich-quick scheme. Except your financial advisor forgot to mention one tiny but very important detail. You must sell – i.e. pass on / dump them – your CDO s once the financial markets turns into a “Bear”. But most of all, are collaterized debt obligations or CDO deserving of their infamy? But first, let us first explain what is a CDO.
Collaterized Debt Obligations or CDO s are often described by financial academics as a type of asset-backed security and structured credit product. CDO ’s are constructed from a portfolio of fixed-income assets. The assets are divided into different credit rating tranches: senior tranches which are rated AAA or “triple a”, mezzanine tranches which are lower on the credit rating “food chain” are rated AA to BB, and the equity tranches, which are unrated. The first CDO were issued back in 1987 by bankers of the now defunct Drexel Burnham Lambert Inc. for the Imperial Savings Association. A decade later, CDO s became the fastest growing sector of the asset-backed “synthetic” securities market.
A major factor for the further growth of CDO s at the start of the 21st Century was the 2001 introduction of Gaussian Copula Models by David X. Li. Which allowed the rapid pricing of CDO s. Because of this, Collaterized Debt Obligations became a major force in the so-called derivatives market were the value of the derivative is derived from the value of other assets. But unlike some fairly straightforward – i.e. “real” derivatives – such as stock options, calls and even the much-maligned Credit Default Swap, CDO s were nearly impossible for the average person to understand. To me at least, the higher mathematics used in creating synthetic securities constructs like Collaterized Debt Obligations and its related variants like Collaterized Insurance Obligations are better to be used in designing weapons systems that will allow a 250-gram projectile to be thrown at 2,700 feet per second. Most of all if anything goes terribly wrong, asset-backed synthetic securities are really worth less than the paper they are printed on, or the bits – one’s and zeroes – they are encoded on.
The complexity of CDO products – which the investor savvy swears by for making him or her earn easy money – is the reason why CDO s are often blamed by the mainstream news media for the 2007 credit crunch. This inherent complexity is often blamed for the failure of risk and recovery models used by credit rating agencies to value these products. Worst of all, CDO s and their ilk are just mere “financial constructs” – as opposed to concrete assets like gold or land. Complicating matters even more was that there was no market on which to sell the CDO s – i.e. CDO s aren’t traded on exchanges. Causing many CDO customers to be mauled by the impending Bear Market. Which is no Bull by the way.
Given that the math used for credit rating various CDO products is about as complex as the higher mathematics used to quantify the dynamics of certain complex sociological phenomena, its best to be pragmatic. It might lead some to some desperation in embracing Sharia Banking Laws in order to retain a semblance of financial stability in our post global credit crunch environment. Were the sobering fact fiscal austerity are forcing credit and bond insurance underwriters to finally remember what it means to be prudent in doing business.
By: Ringo Bones
After reading the latest book by the billionaire investor guru George Soros titled “The New Paradigm for Financial Markets”, I recently had an epiphany that stability and equilibrium are not our Wall Street controlled global economy’s natural state of being. Instead, the quixotic adventurism in search of quick and easy profits undertaken under unacceptable levels of risk is the rule, rather than the exception. Thus explaining the inevitability of the global credit crunch and the current yo-yoing price of crude oil pegged against the US dollar. Even the rise of asset backed security based on synthetic constructs marketed as investments to anyone who likes to experience first-hand what it's like to be financially devastated by an Enron-type scheme.
Often referred to by everyone’s friendly neighborhood financial advisor as an asset backed security product that works just like a home insurance against losses from fire and theft. Except that it applies to big corporation’s credit insurance which you – a mere civilian – can easily get rich of off. By the start of the 21st Century, CDO s was being sold-off to with alarming frequency to financially ignorant civilians – i.e. people like you and me. Your friendly neighborhood financial advisor might – and it’s very likely – to have made ungodly amounts of money relatively easily. Surprisingly to you – the financially ignorant - through the sheer inherent complexity of structured financial transactions of CDO s that he or she –your financial advisor – might seem like a saint for helping you, the financially ignorant retail chump, to experience your friendly neighborhood financial advisors new found get-rich-quick scheme. Except your financial advisor forgot to mention one tiny but very important detail. You must sell – i.e. pass on / dump them – your CDO s once the financial markets turns into a “Bear”. But most of all, are collaterized debt obligations or CDO deserving of their infamy? But first, let us first explain what is a CDO.
Collaterized Debt Obligations or CDO s are often described by financial academics as a type of asset-backed security and structured credit product. CDO ’s are constructed from a portfolio of fixed-income assets. The assets are divided into different credit rating tranches: senior tranches which are rated AAA or “triple a”, mezzanine tranches which are lower on the credit rating “food chain” are rated AA to BB, and the equity tranches, which are unrated. The first CDO were issued back in 1987 by bankers of the now defunct Drexel Burnham Lambert Inc. for the Imperial Savings Association. A decade later, CDO s became the fastest growing sector of the asset-backed “synthetic” securities market.
A major factor for the further growth of CDO s at the start of the 21st Century was the 2001 introduction of Gaussian Copula Models by David X. Li. Which allowed the rapid pricing of CDO s. Because of this, Collaterized Debt Obligations became a major force in the so-called derivatives market were the value of the derivative is derived from the value of other assets. But unlike some fairly straightforward – i.e. “real” derivatives – such as stock options, calls and even the much-maligned Credit Default Swap, CDO s were nearly impossible for the average person to understand. To me at least, the higher mathematics used in creating synthetic securities constructs like Collaterized Debt Obligations and its related variants like Collaterized Insurance Obligations are better to be used in designing weapons systems that will allow a 250-gram projectile to be thrown at 2,700 feet per second. Most of all if anything goes terribly wrong, asset-backed synthetic securities are really worth less than the paper they are printed on, or the bits – one’s and zeroes – they are encoded on.
The complexity of CDO products – which the investor savvy swears by for making him or her earn easy money – is the reason why CDO s are often blamed by the mainstream news media for the 2007 credit crunch. This inherent complexity is often blamed for the failure of risk and recovery models used by credit rating agencies to value these products. Worst of all, CDO s and their ilk are just mere “financial constructs” – as opposed to concrete assets like gold or land. Complicating matters even more was that there was no market on which to sell the CDO s – i.e. CDO s aren’t traded on exchanges. Causing many CDO customers to be mauled by the impending Bear Market. Which is no Bull by the way.
Given that the math used for credit rating various CDO products is about as complex as the higher mathematics used to quantify the dynamics of certain complex sociological phenomena, its best to be pragmatic. It might lead some to some desperation in embracing Sharia Banking Laws in order to retain a semblance of financial stability in our post global credit crunch environment. Were the sobering fact fiscal austerity are forcing credit and bond insurance underwriters to finally remember what it means to be prudent in doing business.
Thursday, July 31, 2008
Credit Default Swaps: Easy Money through Complexity?
Often referred to as a sophisticated form of credit insurance that’s an easy source of big money for the financially savvy, that is until greedy speculators used them to cash in on the US subprime mortgage crisis. Green backs from Red Tape?
By: Vanessa Uy
Financial regulators now bemoan the existence of Credit Default Swaps or CDS. Some even say that trading in Credit Default Swaps ought to be crime because of the way it siphons the hard-earned money of less investment savvy folks into the coffers of greedy speculators. This almost criminal practice of earning big money easily was recently highlighted by the financially savvy purchasers of homeowners insurance who opted for Credit Default Swaps to hedge their risks, which unfortunately created a “domino-effect” that led into the US credit crunch and the subprime mortgage crisis. Because of this, majority of US banks and other financial institutions no longer trust the credit worthiness of their fellow “financial institutions” due to the effects of the unregulated trade in Credit Default Swaps. But in order for us to form a sound judgment over Credit Default Swaps, let us first define what it is.
A Credit Default Swap or CDS is a credit derivative – i.e. financial instruments of special nature – dealt between two counterparties. One party makes periodic payments – usually in the form of insurance premiums – to the other and receives the promise of a payoff if a third party defaults. The former party receives credit protection via credit insurance and is said to be the “purchaser”. The other party provides credit protection and is said to be the "seller”, while the third party is known as the “reference entity”. For all intents and purposes, Credit Default Swaps are nothing more than privately traded insurance contracts that let people bet on a certain company’s financial health.
When it comes to credit derivative products, Credit Default Swaps are the most widely traded. The usual term of maturity of a CDS contract is five years. But because it is a derivative that’s dealt over-the-counter, Credit Default Swaps of almost any maturity can be traded.
As credit derivatives go, Credit Default Swaps are a relatively recent development. Back in 1995, Blythe Masters of JP Morgan developed the first Credit Default Swap and Collaterized Debt Obligations even though other bond insurance products are already available since the 1970’s. When Blythe Masters was heading the Global Credit Derivatives group of JP Morgan, he introduced Credit Watch in April 2, 2007 as a regulatory measure and also to help evaluate credit swaps among other financial instruments. By the end of 2007, there is an estimated 45 trillion US dollars worth of Credit Default Swap contracts. But if the inherent regulatory measures are well established, then what’s the problem?
The problem with Credit Default Swaps occurs when they hit the market. Everyone knows that banks and insurance companies are regulated, while the credit swaps market is not. Because of this, contracts can be traded – or swapped – from investor to investor without any regulatory body overseeing the trades to ensure the buyer has the resources to cover the losses if the security defaults. The instruments can be bought and sold from both ends – the insured and the insurer – with nary an oversight. Thus your typical greedy speculator has now been granted “free reign” to prey upon the financially ignorant and those with gullibility for get rich quick schemes. For all intents and purposes, the current market in credit derivatives has now become Mephistopheles’ playground due to lack of regulation and oversight. Thus perpetuating our current financial crisis in which these forms of credit insurance were built to prevent in the first place.
By: Vanessa Uy
Financial regulators now bemoan the existence of Credit Default Swaps or CDS. Some even say that trading in Credit Default Swaps ought to be crime because of the way it siphons the hard-earned money of less investment savvy folks into the coffers of greedy speculators. This almost criminal practice of earning big money easily was recently highlighted by the financially savvy purchasers of homeowners insurance who opted for Credit Default Swaps to hedge their risks, which unfortunately created a “domino-effect” that led into the US credit crunch and the subprime mortgage crisis. Because of this, majority of US banks and other financial institutions no longer trust the credit worthiness of their fellow “financial institutions” due to the effects of the unregulated trade in Credit Default Swaps. But in order for us to form a sound judgment over Credit Default Swaps, let us first define what it is.
A Credit Default Swap or CDS is a credit derivative – i.e. financial instruments of special nature – dealt between two counterparties. One party makes periodic payments – usually in the form of insurance premiums – to the other and receives the promise of a payoff if a third party defaults. The former party receives credit protection via credit insurance and is said to be the “purchaser”. The other party provides credit protection and is said to be the "seller”, while the third party is known as the “reference entity”. For all intents and purposes, Credit Default Swaps are nothing more than privately traded insurance contracts that let people bet on a certain company’s financial health.
When it comes to credit derivative products, Credit Default Swaps are the most widely traded. The usual term of maturity of a CDS contract is five years. But because it is a derivative that’s dealt over-the-counter, Credit Default Swaps of almost any maturity can be traded.
As credit derivatives go, Credit Default Swaps are a relatively recent development. Back in 1995, Blythe Masters of JP Morgan developed the first Credit Default Swap and Collaterized Debt Obligations even though other bond insurance products are already available since the 1970’s. When Blythe Masters was heading the Global Credit Derivatives group of JP Morgan, he introduced Credit Watch in April 2, 2007 as a regulatory measure and also to help evaluate credit swaps among other financial instruments. By the end of 2007, there is an estimated 45 trillion US dollars worth of Credit Default Swap contracts. But if the inherent regulatory measures are well established, then what’s the problem?
The problem with Credit Default Swaps occurs when they hit the market. Everyone knows that banks and insurance companies are regulated, while the credit swaps market is not. Because of this, contracts can be traded – or swapped – from investor to investor without any regulatory body overseeing the trades to ensure the buyer has the resources to cover the losses if the security defaults. The instruments can be bought and sold from both ends – the insured and the insurer – with nary an oversight. Thus your typical greedy speculator has now been granted “free reign” to prey upon the financially ignorant and those with gullibility for get rich quick schemes. For all intents and purposes, the current market in credit derivatives has now become Mephistopheles’ playground due to lack of regulation and oversight. Thus perpetuating our current financial crisis in which these forms of credit insurance were built to prevent in the first place.
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