Friday, September 26, 2014

City/ Not City

Previously, I briefly discussed Miami-Dade's Master Plan and what looked to me like double speak.  In particular, I concerned myself with the concept of urban expansion versus that of sprawl.  A brief look at the academic literature demonstrated that defining sprawl is difficult and no one accepted metric exists.  So, for Miami-Dade to determine they have urban expansion rather than sprawl is futile.  

The video above demonstrates that defining a city is no simple task, either.  The researcher in the video indicate that cities tend to share similar characteristics but on different scales.  Still the clear identification of city/not city is elusive.    

Thursday, September 25, 2014

Guest Post at Artemis

I have a guest post on the Artemis blog.  The blog and its associated website is a really amazing source for information on insurance linked securities, particularly cat bonds.  I've found it useful in my research and improving my understanding of the risk sharing and trading enterprise.  

The piece is about model risk. Despite grand efforts to help risk managers feel better about the uncertainty in their models, the risk that model is just wrong remains persistent.
In response to client demand, catastrophe modelers are offering improved access to model components and ease of model blending, morphing, fusing, etc. Most notable of efforts are those of RMS, Karen Clark and Company (KCC) and Lloyd’s. RMS(one) promises to provide users with access to over 300 probabilistic models, whereas KCC’s RiskInsight enables users access to internal assumptions. Lloyd’s Oasis offers users choice in “a set of plug-and-play components.”

These efforts are aimed at resolving concerns about model risk but do not actually help to reduce or control model risk. Improved ability to manipulate vendors’ models may buffer companies from volatility produced by model updates. But that volatility is produced by changes in the decision making by the model vendors and their judgments about how best to create a model.

The ability to create one’s own theory on how best to estimate a given risk does not make that theory an accurate representation of reality. 
The rest of the piece is here.

Tuesday, September 23, 2014

Consulting Services for FCHLPM: Sunshiny or Convoluted?
The state of modern science is such that one can legitimately piece it together in a myriad of ways to develop one's own unique perspective on a given issue.

This provides risk model vendors with with opportunity to develop their own secret sauce.  It  provides the vendor with their slice of the market and is therefore, fiercely protected.

Florida has "sunshine laws" which mandates that much of the government's going-ons, particularly meetings, becomes public record.   Florida's Sunshine Laws are in accordance with the Government in the Sunshine Act (1976) signed into law by President Ford.  It was introduced to the Senate- just after Nixon left office- by Florida's very own Lawton Chiles.  Presumably due to Nixon's legendary meeting secretiveness, the bill passed fairly quickly.

The Sunshine Act compliments the 10 years senior Freedom of Information Act (1966) which makes a bunch of government information public with some exceptions.  One exception is company trade secrets.  

So, there is a difficulty: Company's want to keep their information secret, FOIA allows them to, but once they have a "meeting" with public officials it becomes public information.  In order to resolve this difficulty in regards to catastrophe model vendors' secret science, the FCHLPM (those responsible for reviewing catastrophe model science) hold their meetings off public property at the vendors' office.

(Later today: It was brought to my attention that I may not be entirely clear on how FOIA and the Sunshine Law actually work.  However, I am still under the impression that the reason for site meetings [at the vendors' offices] is to avoid public disclosure of trade secrets.  As to how this legally works out, I'm not sure.  Some particulars on how and when FCHLPM things are exempt from public disclosure is here under section g.)   

However, models are becoming increasingly complex.  They have many more moving parts today then when first adopted by the industry in the early 1990s.   For example, under FCHLPM 2000 Standards, AIR submitted a report of 306 pages and under 2011 Standards the report was 404 pages.  

It takes a long time to review this amount of information perhaps longer than a site visit allows.  Besides, FCHLPM members have full time day jobs in addition to Commission responsibilities.  

To resolve this time consuming complexity problem (or so the story goes), the SBA has recently announced a request for consulting services
The SBA is seeking approximately fourteen (14) to sixteen (16) different vendors in seven areas of discipline (Meteorology, Structural Engineering, Coastal Engineering, Hydrology, Actuarial Science, Statistics, and Computer Science) to provide consulting services to the Commission. Respondents should be prepared to provide, at a minimum, the services described in the Report of Activities
The SBA financially administers the FCHLPM and the members of the commission are appointed by a mixture of statutory requirements and selection by the governor and state CFO.  The SBA is, ultimately, overseen by the Governor, the Chief Financial Officer and the Attorney General- all elected positions.  

Though the consulting services hired will provide their scientific evaluation to the FCHLPM who remain the decision makers, the consulting services, it seems, could be answering to the SBA.  

This adds a layer of non-transparency to the expert advising system.  In addition, it is unclear how much freedom of evaluation and access to information will be maintained by the FCHLPM.  Will the FCHLPM still be able to evaluate as they see fit or will their responsibilities be limited to decision making based only on the consulting services information? 

It is certainly not uncommon for a government agency to contract private expertise, demonstrated by by the colloquially termed Beltway Bandits.  But it is also not uncommon is for governmentally hired private expertise to produce information selectively favorable for their client.  

Clarification of who is the client helps improve transparency of potential incentives- particularly in situations of modeling science which is easily pieced together in different ways and really more theory than accepted knowledge, anyway.   

Improved transparency about how this new expert advice system will work is important for democracy and the continued integrity of the FCHLPM.  

Friday, September 19, 2014

How Different Insurance Actors Handle Recent Changes in Market Judgment of Risk

A dominant characteristic of the insurance market right now is that it does not have enough large loss to maintain pricing stability.  On Monday, the Insurance Journal ran three different stories that demonstrate several types of institutional behavioral responses to changes in the market judgement of risk.

The first article covered the recent Reinsurance Rendezvous, an annual event in Monte Carlo where the world's reinsurers get together and do whatever it is that they do behind closed doors such as, throw lavish parties.  The article reported that reinsurers are very much disgruntled with market pressure to bring their pricing down.   According to the article, originally from Reuters, Nikolaus von Bomhard, chief executive of Munich Re  claimed, “I am disappointed, exasperated, and even rather appalled by what is happening in the market."

Reinsurance shareholders are expected to benefit from the market dynamic.  The article reports, “Returning capital to shareholders reduces the pressure to do something that has higher risk,” said Moody’s analyst Stan Rouyer.  Earlier this year year, Swiss Re was reported to have done this in the form of a special dividend.

In the second article, the Insurance Journal reported that the Louisiana Citizens Property Insurance Corporation seeks to lower rates for a handful of residential policyholders and, overall, for some commercial policyholders.  The reason for the change is reported as the cost of reinsurance.   Here, the ability to offload more risk onto reinsurers for cheap has led to lower overall pricing for the public.

In the third article, the Insurance Journal reported that primary insurers (i.e. State Farm, Farmers and Allstate) in Texas are increasing homeowners rates.

The article reports the primary insurers are claiming that increased risk warrant raising rates,
Luis Sahagun, a spokesman for Farmers, said the insurer needed to adjust its rates to account for the “increasing costs associated with covering the risks faced by customers” in Texas. That includes tornadoes and hailstorms. 
“The costs associated with paying for losses resulting from fires and water damage have also kept growing,” he said.
Deeia Beck, the Texas Public Insurance Counsel reportedly argued that the raising rates are driven by profit margins,    
She said State Farm’s new rates were excessive and based on projections that “exaggerate future expected losses.” Further, the company is citing unreasonably high expenses to justify its new rates, she said.
Farmers, meanwhile, is trying to reap a “greatly excessive” profit in Texas, she said. That includes substantial profit generated from management contracts between Farmers’ holding company and its subsidiaries. 
To the extent primary insurers are able to pass perceived increases in risk onto reinsurers at a low cost, charging the policyholder for the cost of additional risk while the actual cost of managing the risk may not have changed because of the substantial decrease in reinsurance pricing would seem like a means of creating additional profit as Beck suggests.  

Here, the advantage of low reinsurance pricing is had by the primary insurer.

Though, the geophysical risk hasn't changed, pricing of the risk has changed quite a bit due to reinsurers market conditions.  Which again highlights that pricing catastrophic weather risk likely has more to do with market perceptions than scientific measures of the hazard.

Thursday, September 4, 2014

Rating Agency Outlook Performance

My understanding of a rating agencies outlook is that it is a generalized prediction about more specific predictions to be made sometime over ~2 years.  A rating is itself a prediction about a company's credit worthiness- will they or will they not pay someone.

Interestingly then, what you have with outlooks are predictions about future predictions.

How do outlooks perform?

(unless otherwise noted, a year's outlook was published the previous September.  So, the 2013 outlook was published in September 2012)

2013 Outlook

Fitch: Stable outlook over the next 12-24 months
Moody's: Stable outlook over the next 12-18 months

2014 Outlook

Fitch: Stable over the next 12-24 months; moved to NEgative outlook in January 2014
Moody's: Stable for next 12-18 months

2015 Outlook
Fitch: Negative over next 12-24 months
Moody's: In June- Negative outlook over the next 12-18 months; Can't find September report

It looks like outlook predictions don't perform all that well.  Consider Fitch's:

  1. In September 2012, they guessed stable over 12-24 months.  
  2. Twelve month's later they guessed stable again.  
  3. Three months later this became negative. 
  4. Nine months later (ie. this month) they guess negative for the next two years.  

This means that the original outlook was only good out to 15 months.  The second outlook did not hold true very long at all.  We will have to wait to see how the negative outlook of January and September 2014 will perform.

In their 2014 outlook, Fitch argued that would could trigger a downgrade in their outlook is, "Catastrophic Loss with Interest Spike,"
A sizeable catastrophic loss in conjunction with significant unrealised investment losses from an abrupt jump in interest rates is viewed as the greatest threat to the sector’s stable outlook at this time.  
I don't monitor interest rates but a sizeable catastrophic loss has not occurred (2013, 2014).  So something other than a 'catastrophic loss with interest spike' encouraged a downgrade.

This means that not only are the outlooks not so great but the reasoning behind them may not be so wholly transparent.

Tuesday, September 2, 2014

Financial Morality

In the academic world there is a group of social scientists who discuss the use of "risk" as a modern form of moral regulation: Alan Hunt, Tom Baker, Richard Ericson, etc.  That risk has moral connotation seems intuitive.  The idea of doing something that has the potential for harm or loss inherently conjures feelings of goodness and badness.

From this, Hunt Baker and Ericson, have argued, modern institutions of risk such as, insurance, act as morally governing.  They define good and bad risks and to the extent that this aligns with certain portions of the population, the result is good and bad people or populations.  

In my experience, the idea that financial decision making has moral implications and/or depends on moral judgements meets a great deal of push back by those that see financial decisions (and the decisions behind those decisions) made by a group of "rational agents."  From this perspective, judgements are not really value based on considerations of good ideas and bad ideas but simply on what is economically advantageous.

The circular argument in this perspective is that to prize economic theory or economic advantage over other considerations IS a value judgement.  And to consider some judgements better than others to achieve profit or financial sustainability IS a moral judgement: Profit is Good/ Financial ruin is Bad.

A good example showed up in the comments section to a recent FT article foreshadowing a financial crisis even more dire than the last.  Bagehot by-the-Bay wrote, 
In some industries — high tech and the airlines, for example — bankruptcy is not a sin, it’s part of the natural order of things. I suppose one either believes this, or not.  ...
Mr or Mrs Bagehot identifies bankruptcy as a moral bad (i.e sin) for some but a virtue for others- much like taking multiple wives is morally good for some and morally bad for others.  It depends on what flavor of marriage industry to which one subscribes.  It depends, according to Bagehot, on what one "believes" about the meaning of bankruptcy beyond the identification of its occurrence.

There is nothing about the fact of bankruptcy that is inherently value laden but it is how one responds to the risk or realization of bankruptcy that gives it significance.  At times, bankruptcy has the potential to impact,  directly or indirectly,  a broad range of people with different value sets.  For example, bankruptcy may cause loss of employment, economic volatility, "bad credit," etc.  Different groups may approach the bankruptcy event differently much like "high tech" may approach it differently from some other industry.

Making decisions about risk including financial risk, necessitates consideration of outcomes to be sought after or avoided, values to be upheld or neglected.  In short, consideration of what is morally good and bad.