Dr. John Seo, a Harvard PhD in biophysics who became the CEO of a multi-billion dollar insurance linked securities firm (primarily with what is known as catastrophe bonds) began his presentation with some background on how he came to be here and what brought him into his finance industry niche. He explained that both his parents are mathematicians who immigrated to this country from Korea because of the intellectual opportunity it offered. Although Dr. Seo was initially considered a slow learner he later graduated from MIT and then went on to Harvard for his graduate work.
While engaged in post-doctoral work and with a teaching offer in hand, Dr. Seo’s wife was pregnant with their second child. The Seos had little money and no insurance to cover the considerable expenses that would be associated with her pregnancy and giving birth. To remedy the monetary shortfall, Dr. Seo took what he considered a short time position with a financial institution that offered him health insurance that covered the pregnancy. At the financial company Dr. Seo managed to solve a persistent problem that the company had been facing that allowed it to make a considerable amount of money. Based on this success and other solutions to problems by Dr. Seo, the company made him a permanent offer at a salary approximately forty times the amount he would make teaching. While not particularly motivated by money, Dr. Seo had found his experience at the company had presented interesting problems, which he could use his skills to solve. Consequently, he eventually accepted the offer.
In the following years, he built up a reputation as a go-to person to solve complex pricing and risk assessment problems and kept getting offers from various financial firms. As he got additional exposure to difficult risk assessment problems, Dr Seo became aware of so called Tail Risks, which are major catastrophic events such as hurricanes or earthquakes and the struggles the insurance industry had in trying to assess such risks and how to price coverage when they even provided it. Such Tail Risks when they occurred had a crippling effect on the affected area. Insurance companies left the areas, or raised their rates to a prohibitive level. This devastated property values as no mortgage company would grant a property mortgage unless there was insurance backing up their exposure. Consequently, a ripple effect could crash the entire economic system in an affected area. Dr. Seo developed a method of handling such risks through taking the risk to the capital system by way of investors in catastrophe bonds as well as the way to price such risks. His company is now the largest dealer in catastrophe bonds in the world.
Questions and Answers
Q. Mechanically how do you make this work?
A. The trick is to keep the investor’s money out of the hands of insurance companies. To do this it is placed with charitable trusts.
Q. How do you protect yourself against disaster?
A. I don’t. The investors have to be very rich and the investments have to be diversified to spread out the risks.
Q. Don’t you need very complex mathematical models to evaluate the risks?
A. Yes and my company spends a fortune on the research to develop those models.
Q. Insurance companies assess risk for pricing. How do you do it?
A. Very differently than insurance companies. Insurance companies are like gambling casinos. Their models work on principles of having relatively lots of small bets. If the bets are too big it crashes their working models and they can’t accept that. Tail Risks place too much potential loss for the insurance models to handle. We handle it by taking it to capital markets, which is a totally different approach from the insurance model.
Q. After Sandy, did insurance companies pull back and how did they price their products?
A. Insurance companies pulled back quite a bit. Before Sandy, these companies would only offer catastrophe insurance to their very best customers. They never offered it as a stand-alone product. After Sandy, they were reluctant to offer it even to those platinum edged customers and then at considerably higher prices.
Q. What does the investor receive?
A. Investors receive 5% over the amount presently offered on short-term Treasury notes. Nobody gets to invest unless they have in excess of 100 million dollars in personal wealth and they have to invest in increments no smaller than $250,000.
Q. What are the going rates?
A. As previously stated they are 5% over short-term Treasury note rates. Right now they are about the same as re-insurance rates, but they are getting cheaper and cheaper. In effect, we have sounded the death knell on re-insurance because we have shown the way to get the same effect for less cost.
Q. How would you describe the social benefit of what you do?
A. A major benefit is the property value stabilization that occurs and this has the ripple effect of saving all the businesses and savings that are dependent on those values.
Q. How do investors know what they are insuring?
A. They know because of the extreme transparency we use in our investor relations. We provide them with constantly updated breakdowns of risks and costs involved. This is very proprietary information, but it has never leaked because of its worth to our investors.
Q. Is the government your prime competition?
A. Yes, but less and less so because the government says it will not be the solution. Basically the inland states don’t want to bail out the coastal states and the coastal states are where most of the risk is located.
Q. What won’t you insure?
A. We won’t insure anything that has a whiff of corruption and there are lots of things that are corrupted when you are talking about the amount of money at stake in the insurance industry.