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Archive for September, 2009

ur doing it rong

Occasionally financial professionals really don’t understand insurance and it amuses me to point this out. Today, I will indulge myself on this piece. You don’t need to go much farther than the first line of the abstract for a head-scratcher:

We provide a model of the effects of catastrophic risk on real estate financing and prices and demonstrate that insurance market imperfections can restrict the supply of credit for catastrophe- susceptible properties.

Insurance market imperfections? Hmm… Let’s get back to that in a sec. First, my summary of the article: insurance markets don’t supply enough catastrophe cover, so banks don’t want to lend to businesses because they don’t want to bear the risk. There’s the usual GIGO about positive NPV projects being rejected by banks because they can’t get the cover. Well, obviously it’s positive NPV if you truncate the downside to not include it being wiped out by a natural disaster every few years. duh.

So, back to the insurance market ‘imperfections’. Turns out our intrepid academic didn’t figure this one out on his own, but cited a few papers that did the work for him. I’ve chosen two papers that seem to discuss this, first this (gated, sadly, so I’ve only read the outline), and this one. It appears that the authors conclude that there is an undersupply of insurance because the insurance industry can’t pay for 100% of losses and, puzzling over this fact, suggest that the problem lies in market power of reinsurers (price-gouging?) and inadequate supply of capital.

Think Swiss Re agrees?

Here’s the logic:

Insurers are overcharging, the evidence being that someone’s fancy little model says so and, lo, insurers don’t have 100% coverage (no margin at which customers are happy to run the risk?). Presumably this would lead to higher profits, but wait, capital markets don’t want to invest in insurance because all those excess uncorrelated excess returns are just so unwelcome.

Um, right.

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blog_drawing_scam_artist

I’ve said it before: innovation is tough to come by in financial services. It’s all about research and producing more and better information. Usually what is called innovation is a shell game of repackaging data and finding suckers.

Why, for instance, would oil companies, these global conglomerates with gigantic operations and balance sheets to match, ever buy anything from a highly leveraged financial institution that they dwarf? They don’t even have the Florida government to shield their virgin eyes from the real market cost of insuring big expensive structures in an incredibly dangerous neighborhood.  So if they had any real need for insurance, they’d have to buy, right? But instead they’ve been starving the market of demand recently, after cleaning the insurers’ clocks a few times over the years (Katrina, Rita, Ivan, Ike, Gustav…).  Could it be that they’re just waiting for a sucker?

Enter Willis.

Artemis is right in that we don’t know of the details of this transaction. Maybe they’ve successfully reinvented the wheel. Maybe they’ve figured something out that none of the rest of us have. Maybe they found some suckers.

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follow the leader

follow the leader

Jolyjonpatten recently went to a seminar put on the by the lawyer that won the decision for the reinsurers in Wasa v Lexington.

Le jist? Well, Lex wrote a property policy for Alcoa, who got the Uncle Sam Smackdown for 40-odd years of polluting. Whew, at least we have insurance.  Obligingly, the courts decide that the insurers were all jointly and severally liable for decades of muck-raking. Lex waves around its fac policy.

Declined, natch.

To the courts.

The problem is that pesky ruling that Lex and its brethren are jointly liable for decades of wrongdoing, pitching the period clauses in their policies out the window, which, apparently, is cool in PA, but not in the UK. Final ruling? Reinsurers are off the hook because under UK law Lex wouldn’t be jointly liable. The interesting thing is that the fac policy is chock-a-block with follow the fortunes references, etc. Don’t matter, though. Jurisdictions matter. Ouch.

It’s a powerful reminder that capital regulations and tax law aren’t the only reasons to go jurisdiction shopping. Why don’t we think more about it, then? Well, my gut says that finance geeks and top-line cowboys are much more likely to hit the corner office than anyone who cuts his teeth on cathedral-like multi-generational insurance litigation.

You might honor the gods with that well argued case, but the shareholders that hired the underwriter who wrote that policy are gone. Long gone.

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