2006 Hurricane Risk Case Study

1. What is the main source of income for U.S. property-casualty insurance companies during 2001-2005? Justify your answer. (Hint: You may use Exhibit 7.)

2. Assuming Category 1-3 hurricanes will cause damage of 5% of the value of the home structure, and Category 4-5 hurricanes will cause damage of 50% of the value of the home structure, what is the expected amount of damage to Joe Martinez?s home structure if a hurricane hit?s Joe?s home in 2006? (Hint: use Exhibit 1.) What is Joe?s expected loss of hurricane damage in 2006 if the probability of the hurricane hits Joe?s home is estimated to be 20%, and how does that compare to the wind coverage premium?

3. Should Joe continue to purchase the wind coverage in 2006 when the premium doubled as compared to year 2005?

4. What are Suzanne Feller?s payout scenarios if she purchases the catastrophe (?cat?) note? What is the expected annual return of this investment?

5. What is Susan?s required rate of return for this ?cat? note investment based on the one-factor CAPM model? Do you think she should invest in ?cat? note?


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