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Archive for March, 2009

Emancipation!

Emancipation!

These kinds of articles always make me laugh (h/t Guru):

“London is in danger of falling even further out of favour as a place to do business for the insurance industry. This week, after announcing its annual results, Brit Insurance said it is moving headquarters to the Netherlands.

I don’t know how much tax revenue the holdco generates, but I know that governments don’t like this kind of behaviour.

The real question is whether this kind of tax bickering is really going to cause a large-scale shift in talent away from centres like London towards places like Dublin or the Netherlands. I would argue no, and not just because I think these kinds of redomiciling are probably just temporary noise. There’s real economic theory behind concentrations of expertise; in fact, some guy won the nobel for that very insight this year (though he undermined his own conclusions a bit in his acceptance speech).

The point is that moving the financial operations away from the centre of the market doesn’t kill the local market in the short run. And in the long run, they’re not going to wind up staying put in one new domicile long enough to get critical mass, anyway.

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The Image of Discipline

Mob Discipline?

There’s an interesting article by the CUO of IronHealth on Syndication (H/T Specialty Insurance Blog). SIB’s takeaway:

Insurers want more premium and tend to increase their risk tolerance in a soft insurance market, which leads to larger lines and less risk sharing.  As the article suggests, insureds might want to consider increasing the number of insurers on their programs.  Two ways to accomplish this are subscription policies, frequently used by Lloyds, and layered programs.  While this can be more work for the broker, it can also reduce carrier risk.

The idea of a subscription market intrigues me. Taken on an aggregate level, the insurance industry is a very large pool of captial that attempts the dual task of mitigating and paying for risk in the economy. If rates become too high, new capital enters the pool; or, more specifically, grows and migrates through new channels to different parts of the pool, but the result is the same.

Now, I get why, as a capital provider, you’d want a manager that you believe can beat the market. But, realistically, all those great managers are probably already employed and you can only get to them by paying them more money, thereby reducing their net value. So, here are the different ways an investor can delpoy capital into the (re)insurance industry:

1. buy stock in an existing company;

2. start a new company, poach managers and duplicate overhead;

3. start a new company, minimize admin and have them follow a “leader”.

To me, #3 is by far the least appealing. By far. Profitability in insurance is about striking a very careful balance to get and keep good business. Why would you hire a manager that isn’t good enough to stand on his/her own? I don’t understand why this manager is supposedly able to mitigate systematic risk. To me, they’re incredibly pro-systematic simply because they’re clones of the existing players.

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Our Oracle Sucks

imagesmatrix-oracle-small

Oracle: I’d ask you to sit down, but, you’re not going to anyway. And don’t worry about the vase.
Neo: What vase?
[Neo turns to look for a vase, and as he does, he knocks over a vase of flowers, which shatters on the floor]
Neo: How did you know?
Oracle: What’s really going to bake your noodle later on is, would you still have broken it if I hadn’t said anything?

 

 

Everyone hates the rating agencies and I completely with the scepticism. What are we going to do?

Well, don’t bother asking the Oracle of Omaha, even though he knows they’re not going anywhere.

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682din_buffet

Reinsurance Guru links to an article at the Motley Fool, concluding, in the quote, with this sentence:

So is it time to conclude that Buffett’s investing legend has been nothing more than extreme luck and excessive risk-taking — the ultimate bubble waiting to pop?

I don’t understand why RG picked out only the really nasty setup of the article and totally missed the knockdown. For instance, the conclusion from Motley Fool:

There is plenty of risk in Berkshire shares, but at current prices, I believe that Berkshire Hathaway is worth the risk.

One thing that the Motley Fool article does alight on is something that I mentioned in an earlier post, namely that the risk in BRK isn’t the stock investments (can only go to zero in the worst case scenario) and it isn’t the prospect of a debt default (see here for an interesting discussion on why CDS spreads can expand). It’s the reinsurance risk.

And reinsurance risk is extremely poorly disclosed to investors, which continues to baffle me. We don’t have an idea for RDS values or what risk management steps Buffett undertakes (which would give us a clue as to what kind of risks really lurk in this smorgasbord).

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Bigger, Better?

giant

It’s a narrow focus, I know, but it still struck me that the biggest companies in this list had the smallest impact on shareholders’ funds from Ike (below). I think that, generally, diversification IS possible; it’s gotten quite a bad rap over the last year or so as correlations have shot up and what was once considered diversified has now been found to be aggregating.

 

 

hurricane-exposures-08-funds

 

I think the errors have been of improperly identifying assets that do and don’t diversify. For instance, anything that can provide short-term liquidity does just that in a crisis by being (over) sold. Combine this with mark-to-market rules and, bingo, you have losses on your books from a risky asset that has not had any kind of adverse event.

Insurance, in particular, takes quite well to diversification. You have non-tradable risky liabilities (claims) that have unrelated triggers (Japanese Earthquake and UK Medical Malpractice, for example). This diversifies. This reduces the liklihood that any single disaster can take down the whole ship (Swiss Re vs Advent above).

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Cash and Glroy are Substitutes

Cash and Glroy are Substitutes

I don’t think that people only want to make money; I think that they also want prestige and status. Status achieved, for example, by working for a company that has a AAA and putting together big headline-smashing deals that everyone reads about and marvels over.

With ratings, in particular, I’m with Felix Salmon’s view that in these times, their departure is welcome. Ratings are not how money is made; in fact, as soon as you need your rating for its particular advantages in order to stay in business, you must lose your rating. It is a label, not a lever. I think rating agencies are shielded from competition, which would do a much better job of monitoring their work than the SEC (ha!) and, because of this, their edicts should be viewed only as a poorly informed opinion of a company’s ongoing stability, not the foundation of a business strategy.

Another way to soak in your own ego is to do a Big Deal that everyone can marvel at in the papers. The reason why (re)insurance and investment banking feeds egos is that employees are empowered to toss around millions of dollars every day. Some have the temperament to walk away from such a Big Deal but some do not. And these Big Deals are so carefully negotiated that it is almost guaranteed that “If you sit down at the table and can’t see the sucker…”

This, however, isn’t glorious stuff, but it’s how profits are made:

Aon Benfield has today confirmed that it will transfer further operational work to Xchanging, the global business processor, as predicted earlier in the week.

You can only make more money than the guy next door if you can do what he does more cheaply. Any other application of intelligence is likely to result in ruin.

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Stick ’em Up

Go Ahead, Make My Day

I'm gonna blow the hair off your head

I’ve been wanting to do an AIG roundup, so here it is.

AIG has released a supposedly confidential document (H/T CalculatedRisk) that lists out all the things that AIG does and tries to give a flavour for all the various exposures different companies have to it.

It looks like it’s supposed to work like a mob boss asking a reluctant extorion victim, “So, how’s your wife and kids?”, the implication being that he has the guy by the balls.

AIG is trying to make the case that it is some kind of near-monopoly and its failure is armageddon. But it is not; at least, in insurance it is not. The insurance industry is going to be fine and every executive worth worth a damn is itching to write the bejesus out of the market as soon as AIG gets ITS balls clipped by unkie Sam.

Speaking of those executives, they’re coming out and slamming AIG publicly.

First, there’s Brit (HT: ReinsuranceGuru)

He added that AIG – which has a large UK presence – was “haemorrhaging teams of people” but still winning business. “In order to win business they are offering premiums so low they are unsustainable,” he said.

And Liberty Mutual‘s Ted Kelly

In a conference call to address Liberty Mutual’s fourth-quarter earnings, Kelly said the federal money given to American International Group Inc. gave it an unfair advantage, allowing the struggling enterprise to be “overly aggressive.”

I think that one or two of these guys are going to really start cranking out the public statements because AIG is very sensitive to publicity and they’re possibly more ready to swipe AIG’s lunch than they were 9 months ago. Shareholders of insurers are going to make a killing at some point because of this.

Lastly, for the geeks out there, there’s a great post at a new blog on credit trading that goes through AIG’s strategy, describing it as being a nice combination of arrogance and regulatory mismanagement. 

My big question after this whole mess subsides is: what’s going to happen with the rating agencies?

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