It's a Catastrophe!

How would you like to be a P/C actuary for one of the Bermuda Re-insurers these days? (In what follows, the discussion is around so called CAT bonds, which will be explained. While the events discussed were covered by regular liability insurance, such events should be covered privately, and CAT bonds are the logical vehicle. The difference isn't directly important to the argument.) Moving all that shale oil in antiquated railcars? No problem. Well, not so much it turns out. Although there hasn't been a post, that I've seen, come through R-bloggers on this specific genre, when Black Swan, outlier, events become part of the core distribution, life gets bitter.

Since March there have been no fewer than 10 large crude spills in the United States and Canada because of rail accidents. The number of gallons spilled in the United States last year, federal records show, far outpaced the total amount spilled by railroads from 1975 to 2012.

Again, just like "all those mortgages won't go underwater at once", "oil trains ran fine for all those years without a problem". Right.

... railroads and car owners can no longer ignore the liabilities associated with oil trains, which could reach $1 billion in the Quebec accident.

And, it turns out, not all the science and engineering were known beforehand (oops):

The accidents have brought another problem to light. Crude oil produced in the Bakken appears to be a lot more volatile than other grades of oil, something that could explain why the oil trains have had huge explosions.

Here too, the warnings came too late.

Federal regulators started analyzing samples from a few Bakken wells last year to test their flammability. In an alert issued on Jan. 2, P.H.M.S.A. said the crude posed a "significant fire risk" in an accident.

According to this Wall Street Journal report, the Canadian carrier had "normal" liability insurance and is already in bankruptcy. Gummint is paying for recovery. Damned socialists. Read this quote, closely:

They say initial data indicated the oil ranged from the most hazardous to some that wasn't classified at all. Truck shipping data, however, indicated all was the medium-hazardous type. In any case, when it reached the train, its classification changed to least hazardous - less prone to ignite - the Canadian investigators say in initial reports.

Sound a bit like the mortgage rating agency scam? "Do you feel lucky, punk? Well, do ya?"

One of these Bermuda companies, CatVest, according to this piece from a Bermuda industry organ indicates it is into such insuring. It's from two years ago, so might have somewhat different views today.

We analyse a whole suite of oil and gas risks, including physical damage to facilities, business interruption, third party liability and operators' extra expenses, which includes control and well issues and losses due to pollution damage. We've done hundreds of calculations over the years and act as both a calculation agent and a claims investigator for the energy and chemical sectors.

Hmm.

By the way, in this article you'll see a couple of acronyms that are likely foreign: ILS and ILW; insurance-linked securities and industry loss warranties. Again, they end up being open bets by third parties on events. Sound like a CDS to you? Does to me. As it happens, there are many esoteric swaps available. The Wiki lists, at least, some of them.

That is where the capital markets and insurance-linked securities meet, through derivative or securities markets. CAT [catastrophic event] bonds are grouped by their level of risk and sold in portfolios in security markets.

Sound even a bit familiar? The volume of ILS/ILW aren't at the level of MBSs or CDSs and the like in the run up to The Great Recession, but the quant folks involved in assessing risk must be experiencing ever tightening sphincters.

(Aside: if you follow no other link, you have to read this.

"from a legal perspective, all jolly interesting. As lawyers, we get to look at wording from ILS products, which are very often very novel, very inventive, very clever products."

)

If you want to pursue further, here's an industry newsletter. Better yet, perhaps, is this piece in 'The Economist'.

Pension funds and other institutional investors are on the hunt for assets generating decent yields, particularly if the returns are uncorrelated to stockmarkets. As recently as last year cat bonds paid up to 11 percentage points over Treasuries, for risks equivalent (at least according to the ratings agencies) to holding speculative-grade corporate debt.
...
Britain's financial regulator this week warned that the influx of new money into cat bonds could push insurers towards underwriting dicier business to keep profits up. Man-made disasters can be just as frightening as natural ones, after all.

Note the content of those parentheses. They're doing it again. By the way, if you don't read the whole thing, it was written in October, 2013, before Casselton happened. After Quebec, though.

Finally, this is an academic paper hot off the presses. Give it a scan. If nothing else, you'll see that this area of quant is ridiculously data poor.

To generate more interest in exchange-traded insurance-linked derivatives, we suggest that exchanges design their derivatives contracts in a simpler manner, by first selecting an index that is easy for market participants to grasp as a trigger for payoffs, and then settling the contracts very shortly after a catastrophe occurs...

If that doesn't sound a bit like a call for another Li's copula, you aren't paying attention. As ever, human events aren't like Brownian motion, and can be traced back to: incentive, incentive, incentive. The Times piece makes clear that those involved, oil companies, railroads, and car manufacturers, were intent (still are, I expect) in socializing cost (letting the Gummint pick up the tab) while privatizing profit. As they always do.