For years, doctors have been able to rest easier at night knowing that, thanks to malpractice insurance, the smallest mistake won’t bring about their financial ruin. Now hedge fund managers, no strangers to the specter of financial ruin after the events of last fall, can buy a little piece of mind as well, in the form of professional liability insurance geared specifically toward hedge funds.

Last December, Simsbury, Conn.-based Executive Risk issued the first known hedge fund insurance policy, and has written more than 20 policies since. It has turned heads in the insurance world. “Historically, hedge funds and other private investment funds have been lumped into an ‘undesirable’ class of exposure by the insurance industry,” says Anthony Giacco, vice president of underwriting in Executive Risk’s financial services division. “Currently, many brokers will not send in submissions for this business, because they fear they will be declined simply based on the class of business.”

So what exactly is Executive Risk doing for the lepers of the financial world? It offers what it calls a “comprehensive portfolio of tailored coverages,” which breaks down into four main groups of insurance coverage. Entity coverage protects hedge funds and private investment funds for claims arising from the operation and management of the funds—typically brought by limited partners, creditors, competitors, regulators and the companies in which the funds invest. General partners liability coverage protects the general partner and fund managers in their “professional or fiduciary capacities” against claims brought by any of the aforementioned potential litigants. Directors and officers liability coverage protects all directors, officers, trustees and members of the fund’s management board for claims arising out of the performance of their duties. Professional liability coverage is the broadest category, covering the fund’s general partner, directors, officers, trustees, board members and employees; it also includes “vicarious liability coverage” for “actual or alleged wrongful acts of outside contracted service providers.” The hedge fund policy protects managers against litigation-related losses up to $25 million.

In the fourth quarter of 1998, the over-the-counter derivatives markets were boosted temporarily by the global financial crisis before a general downturn in business, says the Bank for International Settlements in its latest report.

Hedge funds and proprietary traders, faced with heavy losses, unwound many of their positions and tried to shift their exposures via structured products. But this boom in business proved short-lived, as the Russian default and several corporate and sovereign downgrades led risk-averse lenders to cut back sharply on credit lines to nonbank intermediaries. Many market participants reassessed their use of value-at-risk measures, placing more emphasis on future liquidity and exposure risk factors.

In the interest rate swaps market, spreads over major benchmarks in October reached an eight-year high, as a result of mounting concerns over credit risk. In addition, with the introduction of the euro, many firms cut back on market activity to focus on the accounting and strategic aspects of a single European currency. These combined to slow business overall. But a drop in long-term British interest rates led to an increase in relative-value and convergence trades against German swap rates, and boosted activity in asset swaps as well. One important development during the quarter, says the report, was the “unusual evolution of interest rates in the Japanese interbank market.” Banks based in the West “began offering negative rates on yen-denominated deposits, while Japanese banks faced new upward cost pressures on their interbank liabilities. These developments prompted Western banks to reverse outstanding yen-denominated interest rate swaps and led some intermediaries to offer yen interest rate floors.”

In the realm of cross-currency products, says the report, market volatility reached “unprecedented highs.” The marked appreciation of the yen led to record volatility in yen-related options and spooked equity markets. An unexpected easing of European interest rates led to bursts of increased volatility. Meanwhile, euro-zone volatility remained “subdued.”

For a copy of the report, see www.bis.org.

By Nina Mehta

Wall Street denizens who assume that Monte Carlo analysis is something associated exclusively with saving financial portfolios might be surprised to learn it can also be used to save lives.

“Monte Carlo simulation is used in a phenomenal range of areas and disciplines,” says Brian Cooke, a managing director at NumeriX, a New York-based risk management systems vendor that is expanding its offerings into cancer radiation therapy. “It’s used in areas as diverse as pharmaceutical drug design, aeronautical design, aerospace, mining research and computer animation.” Yet in many areas, Monte Carlo simulation exists more in the realm of potential than reality.

The problem is time. “You literally have to run hundreds of thousands of computations, and in many cases hundreds of millions, before you get an accurate picture of the thing you’re trying to simulate,” he says. What’s simulated could be an option price, a cartoon character running or the paths that irradiated cells are likely to take through the body. But since the process involves complex computations, speed is of the essence.

That’s where NumeriX enters the picture. It has developed proprietary algorithms that get to the right answer faster.

Radiation therapy treatment for cancer currently involves sending radiation beams into a body to destroy the tumor without further damaging the person. Because care needs to be taken around critical organs such as the spinal cord and liver, it’s crucial to have an accurate dose-calculation process to “determine how strong the radiation beams should be, what surface area the beams should have and at what angles they should be targeted,” says Cooke. An accurate process also cuts down on “overflow radiation.”

Monte Carlo simulation is generally considered the most accurate way to determine the correct dose, but other dose calculations are more popular since they’re quicker and less costly. “The time needed to calculate a dose that will actually be implemented—and typically the physician might review half a dozen plans before approving one—takes around 12 hours right now using Monte Carlo simulation research software,” notes Cooke. “And that process is simply too long to be commercially viable.”

NumeriX says it can bring the process down to a matter of minutes. The firm is coupling its expertise honed in speeding up financial models with Stanford University’s radiation and oncology department’s experience in using Monte Carlo simulation to determine correct dose calculations. The end result: software that can be sold and delivered to the universe of 2,000 cancer centers and clinics around the world to improve radiation therapy—particularly in aggressive radiation treatments.

The collaboration began in September 1998, and a software product is due out later this year. Intellectual property rights will belong to NumeriX, and the product will be distributed by Computerized Medical Systems, a major provider of cancer radiation therapy software.

In the early 1980s, when Standard & Poor’s and the Chicago Mercantile Exchange reached an agreement that allowed the Merc to list futures on the S&P 500, both groups thought they were on the verge of something big. They were right—the S&P 500 quickly became the established benchmark in U.S. equity derivatives, and the S&P futures contract grew into a giant, fueling the derivatives boom of the 1980s and 1990s.

Now, nearly two decades later, Standard & Poor’s thinks it’s developed another groundbreaking product to tap into a growing market—indices that measure credit spreads in the U.S. bond market. While the credit derivatives business is certainly more developed than the equity derivatives market was during the Carter administration, it still lacks a definitive benchmark. S&P thinks it can fit the bill. “We’ve always received a lot of calls from people looking for spread information,” says Andrew Pedvis, a director at Standard & Poor’s. “The events last year certainly heightened interest in a benchmark that tracks daily movements in credit spreads, but we had actually been planning to do this for some time.”

	“The events last year heightened interest in a benchmark that tracks daily movements in credit spreads. The applications of the indices are enormous.” —Andrew Pedvis

The indices will be calculated based on the average of the bonds’ spread over U.S. Treasuries. Initially, S&P will offer two indices: the U.S. Industrial Investment Grade Index, and the U.S. Industrial Speculative grade index. The investment-grade index will include 99 credits with ratings between AAA and BBB-, while the speculative-grade index will include 99 credits ranging from BB+ to CCC-. The indices will be calculated using the average of each credit’s option-adjusted basis point spread over U.S. Treasuries. Most corporate bonds are issued with embedded optionality such as call and put provisions and other covenants. The option-adjusted approach neutralizes the optionality and gives a truer representation of a bond’s real credit spread.

The applications of the indices are enormous, says Pedvis. In addition to myriad over-the-counter uses, which he expects will begin to emerge immediately after launch, the indices are expected to be licensed to unnamed Chicago exchanges for futures and options contracts—creating the highest-profile publicly traded corporate credit derivatives in the world. Whether the indices catch on, of course, is another story. But S&P is optimistic. “We’re providing the market what it asked for,” says Pedvis.

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