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Archive for July, 2009

Good One

Good One

So there are a pile of earnings releases coming out now and there’s an interesting common theme: even though rate increases aren’t here yet, they’re just around the corner.

Yeah, right.

The only way rates go up in the P&C market is if something goes horribly wrong and capacity leaves the market. If you talk about hardening rates, you need to have a reason why they’re going to harden. What happens to make people suddenly actually NEED to charge more?

Something nasty has to happen out there. AIG going down would have done it. Didn’t happen. That’s the scale we’re talking about, though.

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So Moody’s downgraded Berkshire a while back, which prompted this misunderstanding from Felix Salmon:

Reinsurers used to feel that they needed a triple-A rating because that connoted utter safety: you could reinsure your catastrophe risk with Berkshire safe in the knowledge that the risk of Berkshire being unable to meet its obligations was significantly lower than the risk of, say, a hurricane hitting New York.

Felix went on to add this bit:

Update: My commenters are saying that insurers don’t hedge their counterparty risk to reinsurers. Either you trust a reinsurer or you don’t; if you do, you don’t hedge counterparty risk, and if you don’t, you don’t do any business with them at all. Maybe insurance regulators should be looking into this.

Felix’s commenters are correct in that the rating is a difference of type rather than one of degree. Felix doesn’t like this for some reason, which is beyond me. The issue is twofold: first, policyholder claims are senior to credit claims (this is why insurer ratings are higher than debt ratings) and, two, insurers go into ‘runoff’, not insolvency, and start negotiating with the holders of their liabilities (policyholders, not bondholders). Policyholder obligations are immense compared with bondholder obligations and the consequences of negotiating down bondholders are probably far worse. Why bother when you have a bigger, easier target? Especially for reinsurance companies.

One of Felix’s commenters directs us to the awkwardly named BRAVE Partners, LLP, who have written a paper on protecting reinsurers credit risks with some product they claim gets arond the CDS issue.  They have two key terms in the agreement, it seems: 1. pre-agreed IBNR calculation methods; and, 2. claim triggered only if the name is “unable to pay”.

I’ll leave #1 alone, even though it’s basically a promise to go to arbitration, and skip to #2. How do you define “unable to pay”?  Obviously a company has enough cash in the bank to pay one counterparty’s claims. What about the IBNR on all the other counterparties? Do you apply your magic formula from #1 to all of the company’s liabilities? Will they let you audit their entire portfolio to make sure they can’t pay? Sorry, guys. Nice try, at least.

Back to Berkshire, who has now sold part of its stake in Moody’s. I wonder what the temporal ordering of these events were. Did BRK tell Moody’s they were going to drop their stake and Moody’s responded or is this a retaliation for the downgrade?

All sorts of hat tips to Felix.

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