Archive for the ‘reinsurance’ Category


Scienceblogs has a nice review of a book called Unscientific America. Here’s the money quote:

Whereas good science is rewarded for being painstaking and nuanced, politics is the enemy of subtlety–political battles are fought in sound bites, decided in up or down votes. In this context, the politician often suspects that the scientist cannot see beyond his or her narrow specialty and spends too much time on minutia.

I actually think politics unfairly gets the monopoly on ridicule here. Or, at least, the behaviour of politicians is unfortunately all that is represented by the term “politics”.

Reinsurance professionals live in the awkward middle territory between ‘science’ (if actuarial analysis can be called such) and ‘commercial reality’. Sometimes the ‘science’ is right and sometimes it is wrong. Most times it is horribly, needlessly complicated and, perhaps tellingly, the people that ultimately make the decisions are not ‘scientists’ (though this is slowly changing).

Politics happens when you have the opportunity to exploit imperfect information. There’s a quote out there (Feynman? Einstein?) that goes: “if you can’t explain it to a 6-year-old, you don’t understand it”. Since 6-year-olds probably don’t understand much about actuarial pricing theory, I imagine there’s a pretty fair degree of error in it.

The message? Science can be overrated and, because of that, anyone with a view on something is a politician.

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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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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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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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