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Life Insurance - Watsa Comment


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I need help to understand something.  At the FFH AGM Prem was asked the question:  Why doesn't FFH get into Life Insurance.  He stated that Life and Health can be a dicey game due to the possibility of a run on the bank.  This is particularly possible if the ratings get cut. 


Can someone help me to understand this better?  In lay terms.  A.

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As a policy holder, you can (typically?) only surrender "for cash value" after quite a few years of dutifully paying your premiums.  Even though I worked in that area right after school, I did buy such a policy, which I canceled a few years later when it became too painfully obvious that I had made an error.  The amount I recovered was close to 0 in spite of having put roughly $300/month for over 2 years, perhaps 3.  So Watsa, I'm not sure that it such a valid reason? Or at least I'm not sure it is the only one.



My own understanding of why Life/Health insurance isn't such a good thing is that you are taking a much bigger risk on the underwriting front.  With P&C, you know very quickly if you have to adjust prices; the lead time can be measured in decades in the long-tailed insurance businesses. Then again, I'd think customers are not very price sensitive in Life/Health insurance, since (1) it is so hard to compare prices, and (2) the fees are so hidden that even the insurance brokers don't know how they are calculated (only the company actuaries do).  The credit rating may be a key factor as well.



Now, there might be some regulation issue as well, I dunno?  New York Life and a few others seem to be doing just fine.




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Al, I asked this question because I thought that life cos long term float was a perfect match for FFH's long term investing skills. Also, because lifeco float grows cumulatively (as life policies are long term) the float can grow very large. Consequently, lifecos tend to have much higher leverage (assets to equity) than P&C cos.


The key difference between lifecos and P&C cos is that the insurance reserves (i.e. the float) for lifecos relate primarily to policies still in force while the loss reserves for P&C cos substantially relate to policies that have already expired (loss reserves remain on the books even for expired policies until claims are finally settled). Policies in force can be cancelled/surrendered but expired policies obviously cannot be cancelled - this is what differentiates the two industries in terms of exposure to runs.


So, under certain circumstances, policyholders may be motivated to cancel their policies and ask for their money back thus causing a run on the insurer. Prem mentioned a ratings downgrade as one such circumstance - actually, this is not a good example because a ratings downgrade would similarly affect a P&C insurer (only slower) in that policyholders would likely not renew their policies. A better example would be a situation when interest rates rose sharply to levels that made the embedded returns implied in life policies unattractive as happened in the early 1980s. In such a situation, you could still have a run on lifecos completely independent of their financially soundness.


Hope this helps.


UhuruPeak, I don't think underwriting risk is the issue that concrns Prem. He made no mention of it.





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I suspect Prem knows the Life Insurance business very well.  He was at Confederation Life leaving about 2 years prior to its collapse.  The collapse itself was a liquidity crisis driven by policy holders cashing in though in those days it was a mutual company owned by the policy holders.



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Life Insurance has large payments (high $/payout x few payouts) x a small prob of occurrence, spread over a long period of time. The long term liability being matched against generally illiquid long term assets.


A 'run' suddenly increases the number of payouts, makes them all immediate, & drops the premium cashflow to almost zero. If you can't sell your more liquid assets & repo your less liquid ones, you will rapidly burn through your credit lines & run out of cash. Bankrupt.


To some extent, Confed Life went under because weak derivative 'settlement' controls triggered a 'run'. A valuable lesson.






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Another risk as Prem pointed out is guaranteed floors for policy holders.  This can be a long-term liability with insurance companies assuming they can roll their holdings forward to capture the difference in investment returns and guarantee floor.  In an inflationary environment this does not present a problem but in a low-interest rate deflationary environment this can crush an insurer under its own guarantees.  Per Prem, this is what happened in Japan and most life insurance companies failed as a result. 



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