Warren Buffett urges more insurance underwriting discipline…

Is this just another opportunity for UK insurers to determine that such warnings, obviously, DON’T apply to them!?

“At bottom, a sound insurance operation requires four disciplines:

(1) An understanding of all exposures that might cause a policy to incur losses

(2) A conservative evaluation of the likelihood of any exposure actually causing a loss and the probable cost if it does

(3) The setting of a premium that will deliver a profit, on average, after both prospective loss costs and operating expenses are covered

(4) The willingness to walk away if the appropriate premium can’t be obtained,”

the letter states. “Many insurers pass the first three tests and flunk the fourth. The urgings of Wall Street, pressures from the agency force and brokers, or simply a refusal by a testosterone-driven CEO to accept shrinking volumes has led too many insurers to write business at inadequate prices. ‘The other guy is doing it so we must as well’ spells trouble in any business, but none more so than insurance.”

via Warren Buffett Urges More Insurance Underwriting Discipline, Fewer “Testosterone-Driven” Decisions.

This is a much bigger issue than even WB appreciates

When “the Oracle” speaks he tends to worth listening to and this pearl is no different. However, the dire warnings of, such as PwC and Citi have previously been ignored and there is little evidence to suggest that this is about to change! Have insurers (and the wider industry) failed to learn anything from their (rightly) vilified “cousins” in banking?

Do they not realise that, whilst Banking institutions were deemed TBTF (see below), insurers most certainly are not.

I wrote, recently, about the differing views of insurance and systemic risk on the two sides of the Atlantic. For my money the UK view is dangerously naive and has little basis in evidence. The precarious state of global FS and the, tightly-coupled, national economies that rely upon them, are such that the failure of an insurer or, for example, a major consolidator in the broking sector, could trigger a new financial collapse.

As we know from recent economic history, systemic risk in FS moves at lightning pace. BUT, when (not if) the impact of a new and avoidable crisis cascades into social and cultural domains  – adding to the existing financial burden WE are having to live – this could prove to be the “death knell” for FS greed-mongers and inept Political Klepocrats.

This is not a new phenomenon: Welcome to Art class: The “art” may be survival

Whilst no-one relishes the idea of more financial uncertainty should events unfold in such a manner it may serve as the necessary “release”, that was forestalled by bailouts and enable us to create a more resilient – less complex – post-critical society. So, before anyone asks: YES, I do believe that this is how dangerous a game Financial and Political elites are playing. It may yet prove to be final and most noble act, in which the tables are finally turned and they become the victims of the win/lose contracts that, for so long, have underpinned their power and wealth.

It wasn’t Warren Buffett but another wise man who spoke, some time ago, about the meek inheriting the earth…perhaps the meek, having seen the corrosive power of greed, ego and fear, are the only means by which an environmental inheritance can be ensured!?

17 Responses to Warren Buffett urges more insurance underwriting discipline…

  1. nick gogerty says:

    minor point of clarification.

    Insurers are TBTF in many instances. AIG was bailed out after its CDS adventures and the Muni bond insurers MBIA and ABK are both systemically important enough from a liquidity and state funding perspective that it would be surprising if they were allowed fail. Interestingly MBIA ABK oversight mandate is the NY insurance regulatory office not SEC etc., even though the scope of their roles and negative impacts are potentially nationwide in scope.

  2. nick gogerty says:

    Another important point about insurers is they are usually run on a loss basis of 1-2%. the operating loss is made up on the float investment from the underwriting. So for example a 5% yield debt financed with 2% cost of capital float yields a 3% gain. more here: http://web523.login-24.hoststar.ch/A_Tail_of_Two_Capital_Structures.pdf

    The fact remains of course the dynamics of insurance and banking are similar in that a gresham’s law means bad practice crowds out sound practice in the short term leading to chronic recurring instability.

    • Thanks Nick: Your, consistently well-informed, input is always welcome!

      In fairness I was endeavouring to put the message across to some of my former peers in the composite market, dealing with commercial/mid-corporate/corporate, rather than those, experienced in underwriting bonds and similar contracts related directly to financial markets but, apparently, STILL ignorant of the potential impact of failing to adequately assess the national and global risks and uncertainty associated with them.

      Here is a recent UK Government perspective: “…insurance firm failure is generally less likely to be of systemic importance”.

      US Fed perspective: “The Federal Reserve unveiled a rule defining two crucial terms that U.S. regulators will use to determine which financial firms, other than banks, are so risky they warrant tougher scrutiny and regulation,” the Wall Street Journal has learned. The Dodd-Frank financial-overhaul law contains a provision that grants top regulators the authority to designate financial firms as “systemically important,” placing them under central bank supervision and subjecting each to additional capital and liquidity requirements. Several firms at the center of the crisis were subject to uneven or absent regulation, especially big financial companies that didn’t fit the traditional definition of a bank. According to the Journal, “The Fed’s proposed rule defines two key criteria that regulators will use to decide which nonbank financial firms should qualify as systemically important.” First, the rule would permit regulators to label as systemically important only those firms where at least 85 percent of their revenue is related to activities that are financial in nature. “The second part of the rule would direct regulators to look only at relationships between a firm and other institutions that have at least $50 billion in assets or have already been designated by regulators as systemically important,” the Journal adds.

      I know which version I believe.

      In reality it will not take much for the levee to break AGAIN and for all that QE money that has provided the illusion of stability to disappear as quickly as it did the last time along with those that, in any other circumstance, would survive. Even if the funds were “generated” do the political institutions have the credibility to mount “Bailout 2: the sequel”?
      Of course, who really knows? Not me, not the economists and not the risk modellers!

      I am not normally a glass-half-empty kinda guy but, as you will have gathered, I can’t help but think that the post-critical landscape is more relevant than ever before!


  3. NN Taleb on Too Big To Fail:

    The notion of fragility and robustness that I am bringing is applicable across domains. The human body has built-in redundancies: two eyes, two kidneys, two lungs. It is good to incorporate that model into everything we create. In financial entities it creates less growth but more robustness. Also, wherever you have a lot of interactions, it is important to have nothing too large. Why has evolution made an elephant the largest thing on land, and in the ocean a whale?

  4. nick gogerty says:

    Another way of looking at robustness in nature from a systems engineering perspective is diversity. In ecological niches diversity of species prevents a single opportunistic virus or other vector from wiping out and entire ecosystem. monocrop agriculture (potatoes) for example are an example of efficiency traded for diversity which lead to system failure.

    another form in nature is timing. Some species such as cicadas and locusts have birth cycles that act in environment on prime numbered years. 13 and 17 year cycles. This most likely prevents overlap with other plant or animal species cycles by having timing or event horizon diversity. http://en.wikipedia.org/wiki/Cicada

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