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You Can Rest Assured That The Insurance Industry Is In For Guaranteed Losses!
The insurance industry is next up for BoomBustBlog subscriber
scrutiny. Quite frankly, it’s amazing this industry has gone this long
without getting the bank treatment, ex. Shorted into oblivion. Just
imagine, and industry that is:
1. extremely cyclical,
2. prone to booms and busts (the fodder of BoomBustBlog),
3.
and relies as much, if not more, on investment income borne from bonds
(primarily sovereign debt [whaaaat?] and bank/financial institution debt
[whoa!!!??] for earnings as much as their core business of underwriting
risk.
If this is not a group of shorts made in investor heaven, I
truly don’t know what is! This article is the first in several to help
my subscribers make sense of the list of insurers that I posted for
download earlier this week (Addressing Risks In The Insurance Industry)
· Insurance Cos. Operational Stress
(Insurers, Insurance & Risk Management)
· Insurance cos. EU exposure 11-2011
(Insurers, Insurance & Risk Management)
· Exposure of European insurers to PIIGS_051210
(Property, Casualty, Specialty & Monoline Insurers)
Since
some of the lexicon in the insurance/risk management industry may be a
little jargon-ish, let’s take it from the top and work our way down –
courtesy of heavy excerpting from the web’s most useful collaborative,
groupthink knowledge utility, Wikipedia.
How Do Insurance Companies Make Money?
Insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain
loss. Insurance is defined as the equitable transfer of the risk of a
loss, from one entity to another, in exchange for payment. An insurer is
a company selling the insurance; an insured, or policyholder, is the
person or entity buying the insurance policy. The insurance rate is a
factor used to determine the amount to be charged for a certain amount
of insurance coverage, called the premium.
The transaction
involves the insured assuming a guaranteed and known relatively small
loss in the form of payment to the insurer in exchange for the insurer's
promise to compensate (indemnify) the insured in the case of a financial (personal) loss. The insured receives a contract, called the insurance policy, which details the conditions and circumstances under which the insured will be financially compensated.
The insurance industry has it own lexicon of performance and risk, with the most pertinent being the following three measures:
Expense ratio
Relatively
easily calculated as the underwriting expenses divided by net premiums
earned. Since many insurers bill periodically (i.e. annually), they
collect monies that they haven’t performed for. As they perform for said
monies, they earn them. So, P/C insurer accepts a $10,000 premium
payment on January 1. By February 1 it has only “Earned” 1/12th
of that premium although it has had physical possession of the
(investable, very important concept here that we will review in a
moment) full amount of the funds. The expense ratio measures an
insurer's efficiency in conducting its business. The lower the expense
ratio the better the insurance operation is run. Expenses include
typical business outlays, ex:
1. advertising
2. commissions to sales force whether in-house (insurance agents) or external (brokers)
3. salaries
4. taxes and other operational expenses.
Keep
in mind that every single penny sucked in in the expense ratio through
underwriting expense is a penny that doesn’t get to stay in the
insurer's pocket, thus tight expense ratios are a must.
Loss ratio
The
loss ratio is simple enough – the monies lost divided by the net monies
acquired through underwriting (not investment, which we will get to in a
minute). It is calculated as loss and loss adjustment expense (the
expense of minimizing loss) divided by the net premium earned (as
explained up top). The loss ratio measures the proportion of acquired
premium paid out in claims and claims related expenses. The loss ratio,
over the longer term (shorter term are really just a matter of
happenstance and luck) is an indicator of an insurer's risk management
skills combined with its underwriting discipline.
Combined Ratio
The
combined ratio is, simply enough, the combination of the loss ratio and
the expense ratio. It is a simple, yet effective measure that reflects
the operational excellence (or lack thereof) of an insurer. It measures
what an insurer has to pay out in claims and expenses. Of course, even
this metric has flaws, primarily in that it doesn't reflect the
investment expertise of the insurer, which (particularly in the longer
tail risks) can have a very significant effect on the bottom line.
A combined ratio of 104% means that an insurer is underwriting at
a loss -- for every $1 in premiums taken in, $1.04 in claims and
expenses are paid out. Fortunately, insurers also earn investment income
from their float, so an insurer can still earn a profit even with a combined ratio in excess of 100%.
In
general, those who invest in the low long-term combined ratio companies
have been handsomely rewarded with above market returns. One of the
most famous combined ratio consumers is the venerable Warren Buffett.
Now, the riskier forms of insurance that entail insuring risks with very
long tails (basically, insurable events that can take many years in the
making, as opposed to car insurance which has a 1 year or so maximum
[short] tail) are also some of the potentially most rewarding. Medical
malpractice is a good example. The field is treacherous, and the risks
are murky and hard to see. But the possibility arises for claim to be
made 3 or 4 years after the insured incident, and even after the claim
is made payout may not occur for another 4 or 5 years due to litigation.
Even after litigation is settled, the claim can be paid out as an
annuity (if the plaintiff is foolish enough to accept such), which
extends even further the amount of time the insurer has access to the
investable premiums. Add all of this time up, and you have insurers that
can invest monies for 12 to 20 years and rake investment income off of
said funds for all of that time. This is why asset/liability management
is so important in the insurance industry. A medical malpractice insurer
that manages to earn 10% after taxes and expenses on its investments on
premiums earned on long-tail risk business written with even a 104
combined ratio can do very well if payouts don't start until 8 years
after the claim and don't end until 26 years after the claim (due to
annuitized payouts). How many businesses do you know of that can do so
well while making an operating loss?
Think about it.
This is one of the few industries where you can take a distinct and
material operating loss and still post a material accounting AND
economic profit! Of course this works both ways. If the insurer with a
high combined ration takes significant losses, then you (as an investor)
had best grab your ass cheeks with both hands and hold on tight. It's
going to be a sickening ride.
Let's use the data from the BoomBustBlog post How Greece Killed Its Own Banks! to
further illustrate this point. Assume we had Insurer EuroX, who wrote
long tale risks and invested heavily in European sovereign debt,
including the sterling credit (at least as asserted by the big rating
agencies) of Greece, Portugal and Ireland...
...
imagine what happens when a very significant portion of your bond
portfolio performs as follows (please note that these numbers were drawn
before the bond market route of the 27th)...
The same hypothetical leveraged positions expressed as a percentage gain or loss...
Of
course, insurers don't use the leverage that banks do - or at least
they don't use it explicitly. AIG did, and my analysts and I busted
other US insurers packing the leverage in through the use of exotic
derivatives, sold to them by.... Who the hell else? Banks! Subscribers,
see the reports dated between 11/08 to 1/09 in the Life and Health Insurance subcategory
for examples. Even without the use of leverage, significant losses are
being taken in insurance company portfolios. The Greek bonds are being
bid at 18 cents on the dollar. Try paying claims with that investment
portfolio, purchased at par! Now, imagine you have a near 100 combined
ratio - with no margin for error, god forbid the 82% margin that is
needed just to break even. Wait, it gets worse...
The underwriting cycle (excerpted from Wikipedia)
Because
most insurance policies are commodities, insurers generally lack
pricing power. In other words, most people don't care who writes their
insurance policy as long as the price is cheap. Thus, insurance prices
are a function of supply and demand. When times are good, insurers make
underwriting profits, and loss ratios decrease. As a result of the
smaller losses, some insurers, driven by short-term greed, increase
capacity by writing more policies. This increase in supply results in
decreasing prices. Eventually, the cycle turns, losses increase, and
insurers who wrote a lot of policies at low prices are left holding the
bag. This situation is extremely similar to the boom-bust cycle of the
stock market.
Have experienced a boom in the stock, credit
and real estate markets? Are we know in a boom? 'Nuff said? No, not this
time. Next to banks, insurance companies are the largest sources of
cash for mortgages and private equity/mezzanine financiing for real
estate deals. Despite massive bubble blowing by .govs, you know where we
stand with real estate, right?
...
It is the reporting company’s responsibility to report, not to
obfuscate. The big problem with this “hide the market marks” thing is
that markets tend to revert to mean. Unless said market values
fundamentally catch up with said market prices, you will get a snapback.
That is what is happening in residential real estate now. That is what
happened in Japan over the last 21 years!!! That’s right, it wasn't a
lost decade in Japan, it was a lost 2.1 decades!
This
has been the first balance sheet recession that the US has ever had,
but there is precedence to follow. Japan had a balance sheet recession
following their gigantic real asset bust. They made a slew of fiscal and
policy errors, which essentially prolonged their real asset recession
(now officially a depression) for T-W-E-N-T-Y O-N-E long years! For those that may have a problem reading that, it is 21 long years.
has been the first balance sheet recession that the US has ever had,
but there is precedence to follow. Japan had a balance sheet recession
following their gigantic real asset bust. They made a slew of fiscal and
policy errors, which essentially prolonged their real asset recession
(now officially a depression) for T-W-E-N-T-Y O-N-E long years! For those that may have a problem reading that, it is 21 long years.
And here we are full circle, back to the list that I asked my subscribers to study earlier this week (Addressing Risks In The Insurance Industry).
My next post on this topic this weekend will go over the number one
pick from that list, along with the reasons for such pick using the
logic outlined in this post. This will be quickly followed up by a
forensic summary. Shortly after that will be either a full forensic
report on said company or another shortlist of companies from another
industry at risk from the impending debt crisis.
· Insurance Cos. Operational Stress
(Insurers, Insurance & Risk Management)
· Insurance cos. EU exposure 11-2011
(Insurers, Insurance & Risk Management)
· Exposure of European insurers to PIIGS_051210
(Property, Casualty, Specialty & Monoline Insurers)
- advertisements -
industry would come to a screatching halt with out risk managment and insurance products
go pay cash for a 200,000 dollar home no body will lend a person 160,000 without a policy to protect their interests
go pay cash for a 35,000 auto.. who is going to loan the money with out some ability to collect if car wrecked
try to do a large construction project with out insurance , bonds , workers comp..
the list goes on and on trucks move with cargo insured for loss . airlines have insurance for large messes ,
the leverl of ignorence about insurance is plain to see . from the armchair gang watching the womens roller derby with a six pack of beer and a wad of gum in their hair
Reggie,
I've become concerned that Guaranteed Investment Contracts will kill some insurers if ZIRP goes too long.
If you're guaranteeing 5% for 10, 20 years from the early 2000s the math doesn't work
You missed so much. Your thought process is there, but you missed what those outside of the industry often miss. Its OK, I wouldn't expect you to know, but it is there. It has to do with investment products being offered with actual risk deducted from reserved for risk discounting reinsurance and adding back in hedges. It is simply more complex than leveraged bond risk.
Bbbbbut, the insurance companies bought the CDS.... What's that ISDA, there was no credit event?
Insurance certainly does suffer from the same maladies as banks, they can be undercapitalized and be invested in many undesirable or unsafe financial instruments.
lets get real here- If insurance companies increase premiums they are criticized if their combined loss is inexcess of 100% they are criticized. You can't have it both ways. The fact they were operating a 100% combined ratio is testimony to the operations of a free market that required the insurance companies to share their investment gains with their policy holders. As they adjust to lower investment gains their premiums will go up and their combined ration will come down below 100%
The article fails to recognize other than in passing the very different types of insurance companies. The investment risk associated with cars. homes , P&C and even term life is very different to those faced by companies that are involved in annuities or more traditional life insurance. The latter I think have a very serious problem.
I can't believe that any sane person thinks that the modern economy can operate without insurance. What sane person would purchase a house without being able to get insurance on it in case it burns? That is true for virtually every area of the economy.
What a kool-aid crock of shit.
Any "business" that can deny claims and break commitments at their discretion only isn't a business it's a fucking racket.
Insurance has done themselves in by treating people worse than fucking dogs.
I cant read this guy he is too long but the worst part is the format is a litteral headache to read. He needs to clean that up so we actually read it like a normal article.
A very cogent and timely warning, Reggie! (As always).
Mind boggling that Berkowitz buried himself in AIG.
Even if the defaults are on the low end,
these lint like interest rates being paid on the ever higher level of reserves- are going nowhere fast.
Can't won't read badly formatted articles.
Insurance, another effin scam.
Only to those who don't understand the common good. REAL insurance like REAL banking is a vital and critical component of a functioning economy. Modern civilization can't exist without both. Sadly, when you combine fake insurance (derivatives) with fake finance (TBTF banking) you get our current situation.
i lived in japan in the 90s; the insurance companies will fail; and the banks will consolidate, to form even bigger banks; think BOA + Citi.
its up & down with brought of deflation; which was wonderful in Japan cause imported goods fell massively in price; tougher competition.
its misery for those without jobs/good jobs; cause even if prices are lower; you still can't afford it. If you have a good job; safe employment; it's heaven. save your money, wait till the retailers drop prices, buy.
In an even moderately capitalist system, the insurers would already be gone. Poof! Disappeared. But the world's economies are mercantilist, not capitalist. The central banks will not allow the world's insurance industry to go down without a fight. Many of the toxic "assets" that cloud the balance sheets now were "insured" remember.
Many of the large insurance companies ALREADY have Savings & Loan subs that have allowed them to tap into the Govt's & The Fed's bailout schemes. See Nomi Prins' PILLAGE book
I am with you Obadiah. I think the big bankruptcy is coming, but I have to be very careful about what to tell my wife least I derail her with worry.
Don't worry Reggie, they can all do an AIG while raising their rates, deductibles, and cutting coverage.
This is bullish for the grim reaper.
Myself and my two sitsers are to recieve a payout from guess who...American General (AIG) within the next couple of months.
The yearly premiums were $15K for a $500K payout.
Oh Snap!!!
On a related note:
My wife has been looking at thoses dammed "Nursing home policies" cause they would allow a huge tax write off for the business, but I keep telling her I dont trust them... I just cant tell my wife the whole truth and that the sky is about to fall... Her positive mindset is critical to her success in business and she is a rockin it! Praise GOD for that.
there is not enough short action to write down the bailout costs with accumulated short squeeze profits, yet.
Wait! Yes there is!!
But the more monies collected the better!
Sell the shorts!
CME Group Sets OTC Clearing Volume Record for the Fourth Consecutive Month
Tue, 06 Dec 2011 01:10
CME Group announced Monday that it set new monthly records for clearing interest rate swaps (IRS) and credit default swaps (CDS). For the month of November, the company cleared $61.9 billion in combined OTC IRS and CDS volume, a 36 percent increase over the previous record monthly total of $45.5 billion set in October 2011.
Unless Ben prints, insurers will take a bath and premiums will skyrocket at every level my insurance agent told me.
Get ready for more negative GDP for years to come as gross and Shiller have stated.
Sad.
..that is, "reducing the level of demand needed to incite price inflation."
And what about all those annuities fixed income seniors are relying on. And they already paid the hefty commissions! Really sad
Sorry Mr. Middleton, the only guaranteed losses occur on the backs of the taxpayer.
Insurance is another leg of the lawless fraud-mafia. Losses are promptly remedied by the women and children they rob again and again and again.
You wish there was a real man in the insurance racket to take a loss!
What a puff piece, ignoring the obvious -- denial (just like insurers).
Maybe that's why they have an acronym for it FIRE: Finance Insurance Real Estate. Real Estate and Finance already getting grinded down. Insurance the next one to fall. Or why we all get burned no matter how many oven mitts we put on.
Reggie,
I recall asking (badgering) you about this sometime quite a while ago. At that time it seemed that *NO ONE* wanted to talk about the enormous pile of invested premium cash that the health and life insurance industries had in MBS and other toxic paper.
Why? Here's one possibility...suppose the health insurance industry woke up one morning marked to market on all this crap. Would they even live to have lunch that day? And then, the kicker: What would happen to the health care system in the US if the big insurance firms started turning up dead?
Was THIS the apocalyptic scenario that really motivated the 'No Bond Haircuts' policy from which we all suffer, unto our children's children? Why is it so goddamn secret? Too close to the kitchen table of every American family, maybe???
MORE ON THIS is imperative. I assure you, the rabbit hole is every bit as deep as the other Financial Crisis Rabbit Holes...maybe even deeper.
The problem is, we don't need insurance, we need health care.. another argument for the single-payer idea.
ok, so the insurers go by the wayside and new ones take their places???? who the fuck cares... same systemic argument the banks put forth...
the successors will be born hard and will be insuring less nominally... and probably won't be stuffed to the gills with bullshit.
I guess I'm at a loss for how a business model fails that is predicated upon paying people less in claims than they take in with premiums... skim the difference and everyone is happy... not sure why you need to partake in even more sophisticated financial endeavors... core competencies and all.
It is interesting to see the ways and means of denying claims. The example is Hurricane Katrina. Insurance companies refused to pay legitimate claims, and did so with the most convoluted excuses they could imagine. I call the insurance industry what it is. It's a protection racket, preying on vulnerable people, using fear as a tool of coercion. In the present stage of the currency collapse, the insurance companies will find new ways to tap into public treasuries. Heads they win, tails you lose.
http://georgesblogforum.wordpress.com/2011/11/02/the-daily-climb-2/
Bullshit. Homeowner insurers pay for wind damage. Flood coverage pays for surface water. If you don't pay for flood coverage, tough titty. I'm sick of banjo state whiners who live in hurricane flood zones bitching about the mean old insurance company. Boo frickin hoo.
You need to do a little more research before you talk shit -- - it wasn't just about wind vs. flood. People in New Orleans/Gulf Coast got fucked by insurance companies' stonewalling, undervaluing, etc.
They will deny completely legitimate claims, force you through multiple appeals, basically try to wear you out, or OUTLIVE YOU.
It's not a "free market" when these "regulated" industries are exempted from anti-trust laws and are shielded from lawsuits. Instead of complex regulations written by industry lobbyists and vested interests, we need simple, neutral, common sense laws demanding and enforcing straightforward contracts. It is under heavy regulation that we get cases of insurance companies paying for cosmetic procedures and lifestyle 'medications' but letting people die of curable illnesses ostensibly covered but nevertheless disputed by the insurer.
About the only insurer I've seen issue any news release of a positive nature regarding their solvency in the past 15 years was Northwestern Mutual Life's disclosure a couple years ago that they had purchased $500 Million of physical gold....
Probably did it only to secure the compensation and bonuses for Officers and Excecutive Staff, but what a concept! Bound to have been some major-league bitching about how it affected THE DIVIDEND, the NML Sacred Cow. Wonder how much the Golden Oxen cast by the hebrews after delivery from Egypt weighed??? $500M in 08/09 would've bought about 2,000 lbs of physical gold.
In 2004, I familiarized myself with derivatives. The icing on the cake was an article in an English Insurance Industry trade magazine, like America's National Underwriter or Best's Review. In this article was disclosed that "... all insurers were actively committed to derivatives, except the very small capitalized regional specialty houses who couldn't rationalize/afford the cost of derivative valuation software and personel to run the operation." Pretty much a verbatim quote... All doubts were gone that there could remain hope for solvency among insurers; at least to my perspective.
It ain't so much the carriers themselves as much as it is the Re-Insurers.
Every aspect of modern business has been Just In Timed with All Risk Laid Off... None have the unencumbered assets and inventory of raw materials which used to mark a "successful enterprise" before the late 80s & 90s.
In its race to "optimize, maximize, and generate s/h return" The Ship Of State called World Business more resembles the vessel Phinneas Fogg buys and burns literally to the hull to make his ocean crossing in Around The World in 80 Days. There are no promises to pay worth more than a tinker's damn. All excess capacity has been spent to genereate Kick The Can numbers and put off the reckoning onto the next hired-hand...
In the aftermath of Enron, and the 2008 world crisis, what auditors or auditing standards inspire confidence? There are none and therefore no reason to insure beyond minimum mandated requirements.
This is the time to have all your eggs in one basket and watch your basket!
say whaaaaaaat!
I agree with Reggie - this is yet another industry that ZIRP will kill.
Very true. Unless you can get some sort of investment return on interest, the Bernank is going to kill off all who rely upon interest for future needs.
This is also the reason for the impetus associated with tort reform... In short, to ensure that insurers have statutorily mandated limits on liability while at the same time not being required to pass on the savings to insureds. Apparently they haven't learned after the dotcom bust.
Look out, Reggie is on the case !
insurance is just another scam. the insurance companies can't possibly make good with their promises at these interest rates.
wait a couple years - and then try to collect on whole life policy - ha !! The money is not there.
"Sorry folks - you got tricked fair and square - and now its time to move on.
Concerning Risk:
Many years ago PBS aired a program on air bags and seat belts.They said that human nature being what it is, after air bags came out people drove faster and took more risk. Someone suggested that they should advertize that in every 1000th car instead of a steering wheel air bag they put a spike.
Of course TBTF banks simply can not be forced to adjust their risk without a priori regulation.
I recall that study was later in some dispute. Regardless, humans are poor judges of risk. Bruce Schneier often blogs about this. http://www.schneier.com/
Ha! I know one person that started driving faster.
Nietzsche famously said “What does not kill me makes me stronger.” The corollary is “What constantly rescues me makes me weaker.” The world will only stop looking for bailouts when policy makers stop handing them out.”
http://pragcap.com/what-constantly-rescues-me-makes-me-weaker
ANy significant writedown in bonds across the board in EU would cripple many insurance companies. Maybe not bankrupt but definitely depress share prices. Accessing capital would only be available from equity (or bailouts which would just compound the problem). German bonds might not be an issue and it would be useful to see their exposure risk for their respective portfolios.
Reggie, where is the Squid?
Alliance, axa, groupeama, Generali...here in eurozone
The discussion could be taken to a higher level by separating insurers into types: life, casualty and health insurers. All of them hold bonds. The duration varies by type.
Also consider insurers by country. American insurers hold US treasuries when they hold sovereign debt. Dangers include bond defaults and rapidly rising interest rates.
It is not enough to consider the balance sheet of the insurers themselves. The more dangerous activity occurs at the holding company level or at non-insurance subsidiaries.
The question now is, and this is the crux of the matter; to what extent have mutualist, risk aversive insurance companies been sucked into the derivative ponzi, of easy money, to keep up with the Jones'. It is now a haunting cry as we don't know who is still kosher and who is contaminated. Groupeama a french mutualist owned by stockholders, not constrained to quarterly reports, has gone under, thanks to dubious toxic links to Italian insurance companies.
You could even further segregate into mutuals vs. stock companies. A mutual insurer is owned by its policyholders and is not as beholden to quarterly earnings via the market. Good point though.
'Guaranteed losses"? Reggie, you're just soooo sweet! Big companies aren't allowed to make losses any more. That would be Bad For The Economy.