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Insurance Industry Questions/Discussions


jay21
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As many people on this board know, insurance companies can be some of the best companies in the world.  I thought it would be helpful to have a thread where we can ask questions about and discuss the insurance industry.

 

First, can someone explain to me sidecars?  I saw they were discussed in the LRE thread, but I feel like I still do not understand their structure.  Is there a primer (or even prospectus) that someone could give me?

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This will be a great reference thread.  I have a couple to start:

 

1.  Why don't more specialty insurance companies build out the investing side of the equation?  Marrying smart, conservative underwriting with low volatility, preservation of capital focused investing is a proven and powerful compounding machine.  I believe Lancashire had a value manager run some capital for a few quarters but abandoned it.  Instead of returning that capital to shareholders when management isn't finding asymmetrical underwriting opportunities, why not use the inherent leverage in the insurance model to generate better returns than the shareholder can?

 

2.  Is there any good reference piece on common attributes of insurance companies that ultimately failed?  Obviously bad underwriting and inadequate reserves but what were common red flags leading up to it?  Due to survivorship, I can follow the ones that have done it well but I haven't followed the insurance industry long enough to identify the train wrecks before they happen.

 

 

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1.  Why don't more specialty insurance companies build out the investing side of the equation?  Marrying smart, conservative underwriting with low volatility, preservation of capital focused investing is a proven and powerful compounding machine.

My uneducated guess is the risk involved. And I believe it was mentioned elsewhere that various rating agencies will rate/discount the investments differently (i.e. T-bills are given a much higher rating than equity investments) which could affect regulatory levels of capital and future business. However I am an insurance noob so this is just my armchair analysis.

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A great idea jay21 -- I will follow this thread with much interest.

 

+1

 

giofranchi

 

PS

I won't even try to answer your question about sidecars, because we all know who is really knowledgeable on that topic (among many others! :) )

 

Here's the two cents worth from the board's resident student (non expert).  Sidecars are off balance sheet vehicles.  Think Enron.  (just kidding). :)  Actually, the insurance sidecars set up in the US, Bermuda, and reputable, international insurers adhere to a standard that is the same as something in the US tax code for trusts. It's  Section 4--- something.  Once the sidecar is established as being fully collateralized, it is then rated by S&P or some other reputable rating agency who will then assign a rating to it.  At that point, it's something solid that investors can count on. 

 

For example, in one that I'm familiar with, the manager of the sidecar has two seats on the board of directors of the sidecar and the investors or outside directors have a majority of the board seats.  That oversight helps ensure that the managers will adhere to the covenants of the doccuments that define the sidecar, the chief of which is that the maximum possible payments on policies written by the sidecar will not exceed the liquid assets.  Those monetary assets typically would be invested in T bills as specified in the trust documents.

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This will be a great reference thread.  I have a couple to start:

 

1.  Why don't more specialty insurance companies build out the investing side of the equation?  Marrying smart, conservative underwriting with low volatility, preservation of capital focused investing is a proven and powerful compounding machine.  I believe Lancashire had a value manager run some capital for a few quarters but abandoned it.  Instead of returning that capital to shareholders when management isn't finding asymmetrical underwriting opportunities, why not use the inherent leverage in the insurance model to generate better returns than the shareholder can?

 

Based the statutory requirements and inherent difficulty of value investing, I think most insurers think of themselves as spread based business.  Their cost of capital is X and their investments earn Y-X.  One of the biggest problems I have with most insurers is that they are asset gatherers.  This ensures average performance from the left hand of your balance sheet.  When the market softens, they have a choice: 1. Lessen premiums and put the extra capital into average investments, which will cause you to not earn your cost of capital 2. shrink the B/S (not too many do this from what I have seen)  3. continue to write insurance to lever your balance sheet to provide adequate returns (probably the most chosen) 4. Invest in higher return investments (most people reach for yield).  What makes firms like MKL and BRK so great is that they have/seek safe higher return activities (growing CF companies at reasonable prices) .  This allows them to earn their cost of capital without levering the balance sheet so they have the luxury of writing less in soft markets and more in hard markets.

 

LRE is one of the few firms that chooses 2.  They will only keep capital they can use effectively.

 

2.  Is there any good reference piece on common attributes of insurance companies that ultimately failed?  Obviously bad underwriting and inadequate reserves but what were common red flags leading up to it?  Due to survivorship, I can follow the ones that have done it well but I haven't followed the insurance industry long enough to identify the train wrecks before they happen.

 

This is the biggest flaw I have.  If I cannot identify a bad insurer, how do I know the insurers I like are good? 

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This will be a great reference thread.  I have a couple to start:

 

1.  Why don't more specialty insurance companies build out the investing side of the equation?  Marrying smart, conservative underwriting with low volatility, preservation of capital focused investing is a proven and powerful compounding machine.  I believe Lancashire had a value manager run some capital for a few quarters but abandoned it.  Instead of returning that capital to shareholders when management isn't finding asymmetrical underwriting opportunities, why not use the inherent leverage in the insurance model to generate better returns than the shareholder can?

 

Based the statutory requirements and inherent difficulty of value investing, I think most insurers think of themselves as spread based business.  Their cost of capital is X and their investments earn Y-X.  One of the biggest problems I have with most insurers is that they are asset gatherers.  This ensures average performance from the left hand of your balance sheet.  When the market softens, they have a choice: 1. Lessen premiums and put the extra capital into average investments, which will cause you to not earn your cost of capital 2. shrink the B/S (not too many do this from what I have seen)  3. continue to write insurance to lever your balance sheet to provide adequate returns (probably the most chosen) 4. Invest in higher return investments (most people reach for yield).  What makes firms like MKL and BRK so great is that they safe have/seek higher return activities (growing CF companies at reasonable prices) .  This allows them to earn their cost of capital without levering the balance sheet so they have the luxury of writing less in soft markets and more in hard markets.

 

LRE is one of the few firms that chooses 2.  They will only keep capital they can use effectively.

 

2.  Is there any good reference piece on common attributes of insurance companies that ultimately failed?  Obviously bad underwriting and inadequate reserves but what were common red flags leading up to it?  Due to survivorship, I can follow the ones that have done it well but I haven't followed the insurance industry long enough to identify the train wrecks before they happen.

 

This is the biggest flaw I have.  If I cannot identify a bad insurer, how do I know the insurers I like are good?

P

 

This is the biggest flaw in valuing insurance companies: all sorts of hidden risk.  Insurance companies fail for every reason imaginable.  Let me count the ways:

 

1) Fraud, especially with smaller, unrated, or lightly regulated companies.  This usually begins with inadequate reserving that gets papered over and then continues to grow until the company blows up.

 

2) Tail risk. This goes back to the 18th and 19th centuries and earlier.  Read The merchant of Venice.  Typically, a fire insurance company would do well until a fire in a city coincided with a big wind that sparked a conflagration.  End of insurance company.  Enter Cologne Re a new type of reinsurance company that other companies could access to lay off their geographical risk.

 

3) Regulatory risk.  Geico, for example, got  between a rock and a hard place in the 1970's when they

had been expanding by offering attractive rates and targeting poorer risks.  Then, the regulators wouldn't let them raise rates as inflation started to bite around the time Nixon imposed price controls.

 

4) Black swan.  The massive development of asbestos  claims decades after policies had been written was a true black swan that almost put Lloyd's of London under""

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Here's the two cents worth from the board's resident student (non expert).  Sidecars are off balance sheet vehicles.  Think Enron.  (just kidding). :)  Actually, the insurance sidecars set up in the US, Bermuda, and reputable, international insurers adhere to a standard that is the same as something in the US tax code for trusts. It's  Section 4--- something.  Once the sidecar is established as being fully collateralized, it is then rated by S&P or some other reputable rating agency who will then assign a rating to it.  At that point, it's something solid that investors can count on. 

 

For example, in one that I'm familiar with, the manager of the sidecar has two seats on the board of directors of the sidecar and the investors or outside directors have a majority of the board seats.  That oversight helps ensure that the managers will adhere to the covenants of the doccuments that define the sidecar, the chief of which is that the maximum possible payments on policies written by the sidecar will not exceed the liquid assets.  Those monetary assets typically would be invested in T bills as specified in the trust documents.

 

Thanks.  I always have a problem with off balance sheet transactions or people laying off risk (cat bonds, reinsurance, sidecars, etc.).  If the policy is attractively written, why would you want to unload it?  It appears that the sidecar can help insurers raise capital quickly to take advantage of hard markets.  It appears that these SPEs are tranched.  Do you know if retained interests are always equity or can they be a mix across the capital structure?  How levered are these vehicles usually (how about LRE's)?

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Here's the two cents worth from the board's resident student (non expert).  Sidecars are off balance sheet vehicles.  Think Enron.  (just kidding). :)  Actually, the insurance sidecars set up in the US, Bermuda, and reputable, international insurers adhere to a standard that is the same as something in the US tax code for trusts. It's  Section 4--- something.  Once the sidecar is established as being fully collateralized, it is then rated by S&P or some other reputable rating agency who will then assign a rating to it.  At that point, it's something solid that investors can count on. 

 

For example, in one that I'm familiar with, the manager of the sidecar has two seats on the board of directors of the sidecar and the investors or outside directors have a majority of the board seats.  That oversight helps ensure that the managers will adhere to the covenants of the doccuments that define the sidecar, the chief of which is that the maximum possible payments on policies written by the sidecar will not exceed the liquid assets.  Those monetary assets typically would be invested in T bills as specified in the trust documents.

 

Thanks.  I always have a problem with off balance sheet transactions or people laying off risk (cat bonds, reinsurance, sidecars, etc.).  If the policy is attractively written, why would you want to unload it?  It appears that the sidecar can help insurers raise capital quickly to take advantage of hard markets.  It appears that these SPEs are tranched.  Do you know if retained interests are always equity or can they be a mix across the capital structure?  How levered are these vehicles usually (how about LRE's)?

 

Sidecars can have different purposes.  The advantages include: limited lifespan. They can be liquidated when the reason for their existence is no longer there, for example if extraordinary rates go down.  They don't have to be concerned with downgrades if they experience large losses because they are fully collateralized.  Therefore, they can take on more risk if their owners like high risk/high return opportunities.  Insurance companies that need to lay off tail risk like them because they help lower the risk of a downgrade.  Hedge funds like them because their gains and losses are not generally positively correlated with financial risks.  They generally aren't leveraged with debt, but some have preferred equity in their structures.  :)

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Here's the two cents worth from the board's resident student (non expert).  Sidecars are off balance sheet vehicles.  Think Enron.  (just kidding). :)  Actually, the insurance sidecars set up in the US, Bermuda, and reputable, international insurers adhere to a standard that is the same as something in the US tax code for trusts. It's  Section 4--- something.  Once the sidecar is established as being fully collateralized, it is then rated by S&P or some other reputable rating agency who will then assign a rating to it.  At that point, it's something solid that investors can count on. 

 

For example, in one that I'm familiar with, the manager of the sidecar has two seats on the board of directors of the sidecar and the investors or outside directors have a majority of the board seats.  That oversight helps ensure that the managers will adhere to the covenants of the doccuments that define the sidecar, the chief of which is that the maximum possible payments on policies written by the sidecar will not exceed the liquid assets.  Those monetary assets typically would be invested in T bills as specified in the trust documents.

 

Thanks.  I always have a problem with off balance sheet transactions or people laying off risk (cat bonds, reinsurance, sidecars, etc.).  If the policy is attractively written, why would you want to unload it?  It appears that the sidecar can help insurers raise capital quickly to take advantage of hard markets.  It appears that these SPEs are tranched.  Do you know if retained interests are always equity or can they be a mix across the capital structure?  How levered are these vehicles usually (how about LRE's)?

 

Sidecars can have different purposes.  The advantages include: limited lifespan. They can be liquidated when the reason for their existence is no longer there, for example if extraordinary rates go down.  They don't have to be concerned with downgrades if they experience large losses because they are fully collateralized.  Therefore, they can take on more risk if their owners like high risk/high return opportunities.  Insurance companies that need to lay off tail risk like them because they help lower the risk of a downgrade.  Hedge funds like them because their gains and losses are not generally positively correlated with financial risks.  They generally aren't leveraged with debt, but some have preferred equity in their structures.  :)

 

Right.  But let's walk through a structure.  A hard market starts, then I think the SPE/sidecar ("B") is activated. 

 

1.  The premiums written by the Company ("A") will be shared on a quota basis with B

2.  B books the premiums received and the LAE

3.  Investors in B contribute securities to B and receive debt or equity in B in return

4.  Losses develop and are paid.  B pays down the waterfall/capital structure

 

A usually invests in B.  I am guessing they are in the equity.  How levered is that equity piece?  In other words, how risky is their investment?

 

Let me know if those steps don't match your understanding.

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Right.  But let's walk through a structure.  A hard market starts, then I think the SPE/sidecar ("B") is activated. 

 

1.  The premiums written by the Company ("A") will be shared on a quota basis with B

2.  B books the premiums received and the LAE

3.  Investors in B contribute securities to B and receive debt or equity in B in return

4.  Losses develop and are paid.  B pays down the waterfall/capital structure

 

A usually invests in B.  I am guessing they are in the equity.  How levered is that equity piece?  In other words, how risky is their investment?

 

Let me know if those steps don't match your understanding.

 

Also, that was just an example of a structure.  I just found this link: http://www.mondaq.com/unitedstates/x/131334/Insurance/A+Reinsurance+Sidecar+Checklist    and it shows how tailored this vehicles could be.

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Here's the two cents worth from the board's resident student (non expert).  Sidecars are off balance sheet vehicles.  Think Enron.  (just kidding). :)  Actually, the insurance sidecars set up in the US, Bermuda, and reputable, international insurers adhere to a standard that is the same as something in the US tax code for trusts. It's  Section 4--- something.  Once the sidecar is established as being fully collateralized, it is then rated by S&P or some other reputable rating agency who will then assign a rating to it.  At that point, it's something solid that investors can count on. 

 

For example, in one that I'm familiar with, the manager of the sidecar has two seats on the board of directors of the sidecar and the investors or outside directors have a majority of the board seats.  That oversight helps ensure that the managers will adhere to the covenants of the doccuments that define the sidecar, the chief of which is that the maximum possible payments on policies written by the sidecar will not exceed the liquid assets.  Those monetary assets typically would be invested in T bills as specified in the trust documents.

 

Thanks.  I always have a problem with off balance sheet transactions or people laying off risk (cat bonds, reinsurance, sidecars, etc.).  If the policy is attractively written, why would you want to unload it?  It appears that the sidecar can help insurers raise capital quickly to take advantage of hard markets.  It appears that these SPEs are tranched.  Do you know if retained interests are always equity or can they be a mix across the capital structure?  How levered are these vehicles usually (how about LRE's)?

 

Sidecars can have different purposes.  The advantages include: limited lifespan. They can be liquidated when the reason for their existence is no longer there, for example if extraordinary rates go down.  They don't have to be concerned with downgrades if they experience large losses because they are fully collateralized.  Therefore, they can take on more risk if their owners like high risk/high return opportunities.  Insurance companies that need to lay off tail risk like them because they help lower the risk of a downgrade.  Hedge funds like them because their gains and losses are not generally positively correlated with financial risks.  They generally aren't leveraged with debt, but some have preferred equity in their structures.  :)

 

Right.  But let's walk through a structure.  A hard market starts, then I think the SPE/sidecar ("B") is activated. 

 

1.  The premiums written by the Company ("A") will be shared on a quota basis with B

2.  B books the premiums received and the LAE

3.  Investors in B contribute securities to B and receive debt or equity in B in return

4.  Losses develop and are paid.  B pays down the waterfall/capital structure

 

A usually invests in B.  I am guessing they are in the equity.  How levered is that equity piece?  In other words, how risky is their investment?

 

Let me know if those steps don't match your understanding.

 

You are correct.  Sidecars may have different purposes.  Some may not be fully collateralized.  Some may not be intended to lay off tail risk.  :)

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One thing I noticed when reading Buffet is that he will never risk all of BRK's capital.  In other words, insurance losses can't wipe out everything.  Is there anyway to verify this?  How about my two other favorite insurers: MKL and LRE?

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One thing I noticed when reading Buffet is that he will never risk all of BRK's capital.  In other words, insurance losses can't wipe out everything.  Is there anyway to verify this?  How about my two other favorite insurers: MKL and LRE?

 

Well, I guess one way is to check the ratio Net Premium Earned / Surplus. If it is lower than average, an underwriting loss will be less detrimental than average to shareholders equity. Also, and most important of all, you must have confidence in the management of the company. You must be sure you have partnered with true achievers. Because insurance is nothing but a promise. And how could you know exactly what management has promised?! Paraphrasing Mr. Buffett, if you are willing to promise silly things, people will find you! :)

twacowfca, any thought on this crucial topic?

 

giofranchi

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One thing I noticed when reading Buffet is that he will never risk all of BRK's capital.  In other words, insurance losses can't wipe out everything.  Is there anyway to verify this?  How about my two other favorite insurers: MKL and LRE?

 

FFH is about equally robust to extreme events as BRK, according to statements Prem has made.

 

LRE has more tail underwriting risk than FFH or BRK, although they continue to reduce that risk. Recently Prem says that their risk of a 20% or so hit to their capital from underwriting is about zero.  Same with BRK for a  greater than 10 % underwriting hit to their capital.  Looking at LRE's 100 year and 250 year PML's (Projected Maximal Losses), I estimate that they have about a 5% chance per annum of an 18% to 25 % hit to their capital at any point in time and about a 2% chance that  they will have more than an 18 percent loss over an entire  calendar year.

 

So far over almost 7 years of operation,  LRE has had a couple of about 10% hits to their capital at two points in time on an accident year basis.  One of these produced a loss for that quarter and about a 10% profit for that year.  The other 10% loss, allowing for subsequent loss creep, produced a tiny profit for that quarter, thanks to reserve releases, and a 13% ROE profit for that year.  Markel's underwriting risk, I think is less than, but closer to LRE'Vs than to BRK's. 

 

All things considered, FFH has the lowest risk profile because of their hedges, then Lancashire is probably next lowest because they aren't exposed on the asset side even though they have more underwriting risk than BRK and probably more than Markel.  Remember that BRK's and Markel's mark to market loss was greater than 20% during the financial crisis and their stocks lost about half their market values.  LRE's only quarterly loss from investing was one half of one percent MTM, and their stock price actually went up during the financial crisis even thought they took a big hit from hurricane IKE in September, 2008.  :)

 

 

 

 

 

 

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One thing I noticed when reading Buffet is that he will never risk all of BRK's capital.  In other words, insurance losses can't wipe out everything.  Is there anyway to verify this?  How about my two other favorite insurers: MKL and LRE?

 

Well, I guess one way is to check the ratio Net Premium Earned / Surplus. If it is lower than average, an underwriting loss will be less detrimental than average to shareholders equity. Also, and most important of all, you must have confidence in the management of the company. You must be sure you have partnered with true achievers. Because insurance is nothing but a promise. And how could you know exactly what management has promised?! Paraphrasing Mr. Buffett, if you are willing to promise silly things, people will find you! :)

twacowfca, any thought on this crucial topic?

 

giofranchi

 

Net premium/surplus isn't representative for comparison of insurance companies with different underwriting profiles, because one line of underwriting may be more exposed to large losses than another.

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One thing I noticed when reading Buffet is that he will never risk all of BRK's capital.  In other words, insurance losses can't wipe out everything.  Is there anyway to verify this?  How about my two other favorite insurers: MKL and LRE?

 

Well, I guess one way is to check the ratio Net Premium Earned / Surplus. If it is lower than average, an underwriting loss will be less detrimental than average to shareholders equity. Also, and most important of all, you must have confidence in the management of the company. You must be sure you have partnered with true achievers. Because insurance is nothing but a promise. And how could you know exactly what management has promised?! Paraphrasing Mr. Buffett, if you are willing to promise silly things, people will find you! :)

twacowfca, any thought on this crucial topic?

 

giofranchi

 

Net premium/surplus isn't representative for comparison of insurance companies with different underwriting profiles, because one line of underwriting may be more exposed to large losses than another.

 

So, I guess the question is: how can we compare underwriting profiles? First of all there is “frequency” and “severity”: it seems to me that most of the time frequency business is less risky than severity business. Then what? Is there usually sufficient disclosure to dig deeper and know which kind of frequency or severity contracts each insurer is underwriting?

 

giofranchi

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One thing I noticed when reading Buffet is that he will never risk all of BRK's capital.  In other words, insurance losses can't wipe out everything.  Is there anyway to verify this?  How about my two other favorite insurers: MKL and LRE?

 

Well, I guess one way is to check the ratio Net Premium Earned / Surplus. If it is lower than average, an underwriting loss will be less detrimental than average to shareholders equity. Also, and most important of all, you must have confidence in the management of the company. You must be sure you have partnered with true achievers. Because insurance is nothing but a promise. And how could you know exactly what management has promised?! Paraphrasing Mr. Buffett, if you are willing to promise silly things, people will find you! :)

twacowfca, any thought on this crucial topic?

 

giofranchi

 

Net premium/surplus isn't representative for comparison of insurance companies with different underwriting profiles, because one line of underwriting may be more exposed to large losses than another.

 

So, I guess the question is: how can we compare underwriting profiles? First of all there is “frequency” and “severity”: it seems to me that most of the time frequency business is less risky than severity business. Then what? Is there usually sufficient disclosure to dig deeper and know which kind of frequency or severity contracts each insurer is underwriting?

 

giofranchi

 

Monte Carlo model simulations are helpful, but these are dependent on the inputs.  For example, the people in Japan who shaved the hill down to build the power station that was swamped in the Tsunami referenced a couple of hundred years of recorded history to project that there was essentially no flood  risk in what they were building.  However, had they looked at the geological strata, they would have seen that there was a similar monstrous Tsunami that hit that same area 1800 years ago.

 

Models rarely allow for true "black swans", or "unknown unknowns."  the Japan Tsunami wasn't even a black swan because it could have been predicted as a low frequency event based on modeling the available data.

 

PML's are usually estimated on the basis of Monte Carlo simulations.  I like Lancashire's because they are more robust than most.  Even so, all Monte Carlo simulations likely understate risk because of the black swan phenomenon.

 

All things considered, I like catastrophe exposed insurance companies because they think a lot about tail risk and try to model it. That's a lot better than putting your head in the sand and hoping things will turn out OK the way many insurance companies operate.  The so called "frequency" types of insurance can be blow ups waiting to explode.  Consider the now insolvent mortgage insurers that staked their business on modeling data that only went back a few years while ignoring data from other countries that had had blow ups from inflated property values.  Mortgage insurers even neglected to reference US data from the 1930's that would have exposed the fallacy of what they were doing.

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Greetings everyone.

 

Love the concept of this thread and I would love to learn more about insurance.  Would anyone be able to explain or point me to a resource on how insurers model and price super cat insurance?

 

Welcome to the board, Ghost.

 

Whenever there is a super cat, the new data leads to substantial improvement in the accuracy of the models.  This often leads to important improvements in terms and conditions to the advantage of catastrophe insurers or reinsurers.  After 911, Richard Brindle led the group of London insurers that rewrote the policies to exclude automatic terrorism coverage and put caps on the usual policies that  are written.  The terms and conditions can be even more important than the pricing when there is tail risk.  The sweetest niches are sometimes not evident unless one is very familiar with the implications of how the policy is written.

 

That said, pricing is not usually perfectly rational.  Rates often go up dramatically after a big loss.  Risk, as a fractal phenomenon, often is also elevated, but not always.  For example, Thai flooding risk is now much lower than before the big floods of last year because the extent of flood damage was largely a consequence of human error.  Thailand had experienced drought up until the year of the large flood, so the water authority made a bad decision to keep the level of water in their main dam at a high level going into the monsoon season.  They won't make that mistake again, at least not until the current generation dies out.  Plus, the flooded factories are being rebuilt at higher elevations with flood walls around them.  Plus, one major new diversion channel has been completed and another is under construction. 

 

Objectively, flood risk is dramatically lower now than before the deluge, but rates are dramatically higher.  Interestingly, my three favorite owner operator companies, BRK, FFH & LRE all jumped in and wrote a lot of business in that area, as other companies tucked tail and ran away, licking their wounds.

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All things considered, I like catastrophe exposed insurance companies because they think a lot about tail risk and try to model it. That's a lot better than putting your head in the sand and hoping things will turn out OK the way many insurance companies operate.  The so called "frequency" types of insurance can be blow ups waiting to explode.  Consider the now insolvent mortgage insurers that staked their business on modeling data that only went back a few years while ignoring data from other countries that had had blow ups from inflated property values.  Mortgage insurers even neglected to reference US data from the 1930's that would have exposed the fallacy of what they were doing.

 

Do you ever think about the overlap/diversification between your insurers?  For instance most of your insurers are exposed to cat losses. If a big one hits, you will lose a good amount of capital.  Do you take that into account when thinking about your portfolio?

 

Although, it seems like most of your insurers think about the maximum they could lose and charge appropriate prices for that risk.  So maybe you feel comfortable being exposed to that risk?

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All things considered, I like catastrophe exposed insurance companies because they think a lot about tail risk and try to model it. That's a lot better than putting your head in the sand and hoping things will turn out OK the way many insurance companies operate.  The so called "frequency" types of insurance can be blow ups waiting to explode.  Consider the now insolvent mortgage insurers that staked their business on modeling data that only went back a few years while ignoring data from other countries that had had blow ups from inflated property values.  Mortgage insurers even neglected to reference US data from the 1930's that would have exposed the fallacy of what they were doing.

 

Do you ever think about the overlap/diversification between your insurers?  For instance most of your insurers are exposed to cat losses. If a big one hits, you will lose a good amount of capital.  Do you take that into account when thinking about your portfolio?

 

Although, it seems like most of your insurers think about the maximum they could lose and charge appropriate prices for that risk.  So maybe you feel comfortable being exposed to that risk?

 

There is very little tail risk with BRK and FFH, even with multiple, extreme events.  Lancashire is more exposed to tail risk than BRK and FFH, but less exposed than their close peers. The acid test is what happens in an extreme catastrophe loss.  Lancashire has passed these tests with about half the losses of their peers. 

 

That doesn't answer the question of what would happen if they experienced a couple of 100 year loss events in the same year.  Say a hurricane two and a half times as damaging as Katrina and an earthquake in California twice as bad as Northridge.  That could wipe out 30 to 40% of their capital. However, if they experienced one such extreme loss in a year, I think they would hedge their remaining tail exposure so that their maximum exposure might be only the one loss, maybe 20%+ or so of their capital.  That's manageable without doing anything more than perhaps floating a preferred stock offering the way MRH did in 2011.  If they did have to raise equity, they would be at the head of the line because of their outstanding record.

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Thanks so much for your participation, twacowfca.

 

I feel like I am learning a lot and feel much more comfortable increasing my positions in BRK and MKL.  I will most likely make LRE a big position as well (once I get the tax situation figured out) and I started looking into FFH too.

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