Posts Tagged ‘insurance’
“What is really amazing, and frustrating, is mankind’s habit of refusing to see the obvious and inevitable until it is there, and then muttering about unforeseen catastrophes”*…
One of the effectively-secret ingredients in the world’s economic growth over the last couple of centuries has been insurance. The ability to insure against catastrophic loss has underwritten (pun intended) the trillions and trillions of dollars of loans that have funded the construction and acquisition that has enabled the growth of both commercial endeavor and the the accumulation of personal wealth (directly through home ownership and indirectly through equity ownership in those commercial endeavors or participation in pension schemes that own that equity).
But in a way that was enitrely predictable, climate change is rendering a growing portion of the world uninsurable. Gavin Evans ponders what that might mean…
The Florida peninsula looks like a sore thumb. It juts into the Gulf of Mexico and the Atlantic, where the water is getting warmer year on year, prompting fiercer hurricanes that can blow down houses like collapsing decks of cards. Climate scientists are convinced all hell will break loose sooner or later when a monster-sized, property-destroying storm makes a direct hit on Miami or Tampa-St Petersburg. Given three near-misses in the recent past, the experts view such a calamity as inevitable. It’s a huge risk for anyone living there – they stand to lose everything – but also for those bearing the financial side of this risk, the insurance companies. Some in the industry are seeing this as a portent for their future – an impending existential threat with profound implications for the economic system.
There are no easy solutions for people still paying off mortgages and those who want to buy property along the Florida coast, because the potential payout on the back of a mammoth storm is so high that the reinsurers (who insure the insurers against catastrophe) are refusing to underwrite their clients and, with no reinsurance, there’s no insurance; and with no insurance, no mortgages; and with no mortgages, no property market. Insurance protects investments against loss and is therefore a pillar of the economic system. If it goes, economies are destabilised.
Many panicked homeowners have rushed to make their houses less risky for insurance companies by reinforcing their roofs with hurricane clips, installing impact-resistant windows, doors and shutters, and strengthening their foundations. But it’s not just storms and higher, warmer seas that concern insurers. Rising temperatures mean that the frequency, range and ferocity of wildfires are also on the rise.
So far this year, 3,374 wildfires have burned an area of Florida totalling 231,172 acres (at the time of writing), and it is even worse in California where 7,855 blazes have killed at least 31 people, destroyed more than 17,000 houses and devoured 525,208 acres of land, at an estimated cost of more than $250 billion. Here, too, homeowners rushed to make their properties more palatable to cold-footed insurers – clearing their surroundings of anything flammable, covering yards with gravel, sheathing houses with fire-resistant stucco, and replacing wooden roofs with steel.
But, even for the most diligent, insurance companies have turned tail, dumping existing clients and abandoning fire-prone and storm-prone areas altogether. On the Californian fire front, 2024 was a turning point as several insurers ceased issuing new policies because of fire-associated risks, including the United States’ biggest property insurer, State Farm, which cancelled policies in parts of Los Angeles. It is all too easy to view this cynically, but it’s happening because property insurers have been reporting year-on-year losses from climate change-related payouts.
Insurance companies survive by making more money from covering risk than they lose from these risks, which is why they prefer clients less likely to claim (insofar as they can predict the risk involved) and require them to pay substantial excess to discourage claims. When payouts rise above the premium intake, insurance companies either hike up these premiums or withdraw. But when that risk is considered catastrophic, potentially affecting many thousands of clients, as with Floridian storms and Californian fires, it is the reinsurers who are the first to retreat because they will ultimately bear most of the cost.
Reinsurers aggregate payout patterns to establish the likelihood of having to make huge payouts from future natural catastrophes. They do this by gathering exposure data from existing insurers in a geographical area, and by examining catastrophe models (computer simulations that estimate potential losses from natural perils). When they put all this together with detailed analysis of conditions within the area, they come up with a figure for their total potential loss if a catastrophic event strikes.
This is why reinsurers focus so intensely on climate change. Take a glance at the websites of big ones like Swiss Re and Munich Re and you get a sense of how central this is to their calculations – a concern that has spread to property insurers who are starting to hire climate consultants. Even more than market volatility, climate is their biggest headache. ‘You won’t meet a single insurance or reinsurance CEO who doesn’t believe in climate change,’ the insurance investor and former Lombard Insurance CEO James Orford told me. ‘They see it in the numbers – a combination of more extreme, less predictable events, combined with big losses of sums insured. All the modelling suggests these are uninsurable risks.’…
[Evans recaps the history of insurance, starting in Genoa, in the mid-14th century, with the insuring of maritime expeditions; examines the current state of play; examines the efforts (and gauges the weaknesses) of state’s efforts to step up with coverage when insurers step away; then considers another role for states…]
If states do withdraw from insurance and reinsurance, some of the most lucrative areas of the US, Canada, Europe, Asia, Africa and Australia will be devastated: no mortgages and no banks, leading to more ghost towns and villages. ‘It ends with depopulation and abandonment,’ said Agarwala. ‘Climate change reduces the operating space for humanity.’ In the UK, rising sea levels and coastal erosion could literally reduce operating space, putting 200,000 British homes at risk by 2050. There’s no coastal-erosion insurance, which puts more burden on the state, mainly to pay for new defences, but also to help people move.
Governments can take action in other ways, by investing greater sums in risk-prevention and management. There are signs of this happening such as the ‘fire-hardening’ and storm-prevention efforts in Florida, and improved flood defences in the UK; meanwhile, the EU’s Recovery and Resilience Facility is being used in several countries to build and renovate operations centres to cope with wildfires, and to buy firefighting helicopters.
In future, it is likely that voters will demand that their state and national governments do far more, regardless of the cost. They will want tougher building codes, including limitations on building in risky areas; expensive fire-prevention and fire-fighting schemes; better flood and storm defences; improved early catastrophe management, involving relocating people from risky areas and, when disaster strikes, rapid life-saving interventions such as large-scale emergency evacuations. If the insurance industry is forced to retreat by the climate crisis, all of this infrastructural investment will require vast chunks of taxpayers’ money. It is hard to avoid the feeling that this is part of our destiny, and that the sore thumb of the Florida peninsula is pointing us to the future…
Whole regions of the world are now uninsurable, bringing radical uncertainty to the economy: “The insurance catastrophe,” from @aeon.co.
See also: “An Uninsurable Country” (a report form NRDC), “The Insurance Crisis Is So Desperate People Are Turning Socialist” (a gift article from Bloomberg), and “The Uninsurable Future: The Climate Threat to Property Insurance, and How to Stop It” (from Yale Law Review)
* Isaac Asimov
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As we cover up, we might send highly-charged birthday greetings to a man who made foundational contributions both to the detection of climatic conditions and to a technology that may help allieviate climate change: John Frederic Daniell was born on this date in 1790. Named the first professor of chemistry at the newly founded King’s College London in 1831, he was an avid meteorologist. He invented the dew-point hygrometer known by his name and a register pyrometer; in 1830 he erected a water-barometer in the hall of the Royal Society.
But Daniell is better remembered as a chemist (and physicist), especially for his invention of the Daniell cell, an element of an electric battery much better than voltaic cells, the standard before him. Indeed, the Daniell cell is the historical basis for the contemporary definition of the volt (the unit of electromotive force in the International System of Units). All advances in battery technology since then were “from” the base that Daniell laid.
“We use the term risk all too casually, and the term uncertainty all too rarely”*…
How private-equity giants are overhauling the financial system, and its potential impact on pensions…
A decade or so ago private equity was a niche corner of finance; today it is a vast enterprise in its own right. Having grabbed business and prestige from banks, private-equity firms manage $12trn of assets globally, are worth more than $500bn on America’s stockmarket and have their pick of Wall Street’s top talent. Whereas America’s listed banks are worth little more than they were before the pandemic, its listed private-equity firms are worth about twice as much. The biggest, Blackstone, is more valuable than either Goldman Sachs or Morgan Stanley—and has the confidence of a winner. “It’s the alternatives era,” proclaimed the company’s ebullient Taylor Swift-themed festive video in December. “We buy assets then we make ’em better.”
This is not, though, the business that has recently boomed for them. Traditional private equity—using lots of debt to buy companies, improving them, and selling or listing them—has been lifeless. High interest rates have cast doubt on the value of privately held companies and reduced investors’ willingness to provide new funds. It does not seem to matter. Core private-equity activity is now just one part of the industry’s terrain, which includes infrastructure, property and loans made directly to companies, all under the broad label of “private assets”. Here the empire-building continues. Most recently, as we report this week, the industry is swallowing up life insurers.
All of the three kings of private equity—Apollo, Blackstone and KKR—have bought insurers or taken minority stakes in them in exchange for managing their assets. Smaller firms are following suit. The insurers are not portfolio investments, destined to be sold for a profit. Instead they are prized for their vast balance-sheets, which are a new source of funding.
Judged by the fundamentals, the strategy makes sense. Insurance firms invest over long periods to fund payouts, including annuities sold to pensioners. They have traditionally bought lots of government and corporate bonds that are traded on public markets. Firms like Apollo can instead knowledgeably move their portfolios into the higher-yielding private investments in which they specialise. A higher rate of return should mean a better deal for customers. And because insurers’ liabilities stretch years into the future, the finance they provide is patient. In banking, long-term loans are funded with lots of instantly accessible deposits; with private assets and insurance, the duration of the assets matches the duration of the liabilities.
Yet the strategy brings risks—and not just to the firms. Pension promises matter to society. Implicitly or explicitly, the taxpayer backstops insurance to some degree, and regulators enforce minimum capital requirements so that insurers can withstand losses. Yet judging the safety-buffers of a firm stuffed with illiquid private assets is hard, because its losses are not apparent from movements in financial markets. And in a crisis insurance policyholders may sometimes flee as they seek to get out some of their money even if that entails a financial penalty. Last year an Italian insurer suffered just such a bank-run-like meltdown…
Funding pension providers with private equity: “The risks to global finance from private equity’s insurance binge” (gift article) from @TheEconomist.
And lest we think that publicly-funded defined benefit pensions are less risky, see “Akin to Fraud” by Mary Willliams Walsh, an account of the sorry state of the public pension fund in New Hampshire (the state with the second-oldest population in the nation).
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As we rethink retirement, we might recall that it was on this date in 1728 that John Gay‘s The Beggar’s Opera premiered. A “ballad opera” (a satirical work with lyrics set to vernacular music), it was a huge hit– it has been called “the most popular play of the eighteenth century“– a watershed in Augustan drama.
The original idea of the opera came from Jonathan Swift, who wrote to Alexander Pope in 1716 asking “…what think you, of a Newgate pastoral among the thieves and whores there?” Their friend, Gay, decided that it would be a satire rather than a pastoral opera.
In 1928, Bertolt Brecht (working from a translation into German by Elisabeth Hauptmann) adapted the work into Die Dreigroschenoper (The Threepenny Opera) in 1928, sticking closely to the original plot and characters but with a new libretto, and mostly new music by Kurt Weill.
“It’s very easy for trusted companies to mislead naive customers, and life insurance companies are trusted”*…
Systemic risk in the financial system– the kind that can create devastation like the Crash of 2008— has been the province of regulators for many decades, primarily the SEC and the Federal Reserve. But as our financial system has become more complex and intertwined, that risk may have moved from the stock market and banks to other sectors, sectors less well regulated. As John Ellis explains in his terrific newsletter, News Items, we might do well to turn our attention to the seemingly staid insurance industry…
The Fed exists to oversee banking, but lately it’s been keeping an eye on life insurance, too. Its recent Financial Stability Report flagged some life-insurance practices that might make the system vulnerable. Some insurers invest in assets that “can suffer sudden increases in default risk,” the report said. And some use “nontraditional” funding sources that could dry up “on short notice.”
That sounds ominous. But not long after that, Jon Gray, the president of private-equity giant Blackstone, turned up in a Financial Times article, saying life insurers had the wherewithal to bolster America’s weakened regional banks.
Gray said private equity firms like Blackstone could get “very low-cost capital” from life insurers and extend it to regional banks, to fund their lending operations. That would be a boon, because the banks’ usual source of funding, customer deposits, has grown more expensive and flighty in the wake of this year’s bank failures. So the life insurers could help ease a credit squeeze.
And once the banks make the loans, Gray said, the insurers might like to acquire some of them as investments. Blackstone manages billions of dollars of insurance investments, and Gray said the firm was already talking with large, unnamed regional banks about such deals.
So, what’s up with life insurance? Is the industry so flush it can send money to shore up America’s weakened banks? If so, then what’s the Fed worried about?
As it happens, a group of Fed economists has some answers. They got under the hood of the life insurance industry and combed through the voluminous regulatory filings of more than a thousand life insurers in the years since the crash of 2008. The U.S. financial system was going through major changes then, and they wanted to understand how the insurers had navigated the changing landscape.
One trend they observed: First, America’s bailed-out banks, seen as having gambled with their depositors’ money, were brought under the broad financial-reform legislation known as Dodd-Frank. It steered them away from making any more loans to big, low-rated borrowers. Then, once the banks had departed that space, life insurers moved in.
As a result, “These insurers have become exponentially more vulnerable to an aggregate corporate sector shock,” wrote the three economists, Nathan Foley-Fisher, Nathan Heinrich, and Stéphane Verani, in a paper first published in February 2020 and updated in April of this year.
Their findings cast the life insurance industry in a very different light from the traditional image of dull, stable companies plodding along under the weight of big, safe, bond-laden investment portfolios.
“Within ten years, the U.S. life insurance industry has grown into one of the largest private debt investors in the world,” the three wrote.
At the end of 2020, life insurers managed one-fourth of all outstanding CLOs, or collateralized loan obligations – bond-like securities backed by pools of loans to large, low-rated borrowers. Because the underlying borrowers have low ratings, CLOs pay a higher yield than the high-grade corporate bonds a conventional life portfolio would hold.
The insurers were also using unusual sources of capital to fuel their growth (funding-agreement-backed repos, anyone?). Not all life insurers, but a certain cohort was doing the kind of business the big banks did before the financial crisis, “but without the corresponding regulation and supervision.”
The economists called it “a new shadow-banking business model that resembles investment banking in the run-up to the 2007-09 financial crisis.”
Their reports describe the trends in detail, but in measured tones. No flashing red lights or alarm bells. But they do tell how things could go south: “A widespread default of risky corporate loans could force life insurers to assume balance sheet losses” from their CLO holdings.
Institutional investors watch life insurers carefully and know where the shadow-banking activity is concentrated; they would presumably see the losses coming and withdraw from the affected insurers in time. That’s what we’ve been seeing in the regional banking sector this spring, where savvy investors have identified potential problem banks and sold or shorted their stocks. The trouble is, such trading can turn a potential problem into a real one.
Upshot: “U.S. life insurers may require government support to prevent shocks from being amplified and transmitted to the household sector,” the three warn…
[Ellis explains how this happened; TLDR: life insurers chased yield; private equity firms obliged.]
The Fed researchers said the private-equity firms appear to be giving their affiliated insurers “some of the riskiest portions” of the CLOs that they package. Since risk and reward go hand in hand, presumably the insurers are getting better returns than they would from safe bonds.
But still, should America’s insurance regulators be allowing this? Remember, America’s banks were told to stop.
The National Association of Insurance Commissioners has, in fact, proposed a change in the post-crisis rule that’s been letting insurers count risky CLOs as if they were safe bonds.
But the NAIC isn’t a regulator; it’s a non-governmental organization that represents America’s 56 insurance regulators (one for each state, five for the territories, and one for the District of Columbia). The regulators often have different priorities and viewpoints, and when the NAIC makes a proposal, it can take years to get the necessary buy-in.
So here we are. Countless policyholders and annuitants are diligently paying their premiums to keep their contracts in force, unaware of these trends. The Fed’s economists see undisclosed risk, but the Fed has no legal authority to regulate insurers. The insurance regulators don’t seem in any rush to rein in the risk-takers. Keep in mind: Life-and-annuity is a $9 trillion industry that doesn’t have anything like the FDIC…
Eminently worth reading in full (along with the report and the paper linked above): “Risky Business,” from @EllisItems.
(Image above: source)
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As we whack the mole, we might recall that it was on this date in 1931 that the New York Stock Exchange began regularly reporting short selling data for the first time. The Crash of 1929 had rocked the stock market; the Dow dropped 32.6% in 1930 as the American economy took a nosedive (unemployment doubled to 16.3% by 1931, as the Great Depression set in). But short sellers in the stock market made a killing. Consequently, those short sellers took a lot of heat for the stock market crash of 1929, which led to the enactment of the uptick rule (requiring that short selling orders be filled only during upticks in share prices and meant to mitigate the negative impact of short sales) shortly thereafter. The reporting of short orders/sales was another step toward reining in the phenomenon.
The uptick rule was abolished in 2007, just prior to the market crash of 2008.
“With the greater part of rich people, the chief enjoyment of riches consists in the parade of riches”*…
As insurance premiums rise, global warming’s effects are impacting collectors’ bank accounts, especially in disaster-prone states like California and Florida where risky conditions have become the norm…
Art collectors in California, Florida and other states experiencing weather-related disasters aggravated by climate change are finding fine art insurance becoming more expensive, with policies increasingly difficult to obtain (or renew) and containing new restrictions.
Earthquake-prone California, which has faced a series of massive wildfires (often followed by landslides) in recent years, is one epicentre in this struggle to find insurance coverage for homes and the art within them, with the annual cost of homeowners policies rising as much as 40% and the premiums for fine art insurance coverage increasing between 5% and 12%, according to Amee Yunn, assistant vice president of the New York-based Berkley Asset Protection, an insurance company specialising in fine art, jewellery and other high-value, personal and commercial assets. Florida, with its increasingly intense hurricanes and floods, is also a concern for the insurance industry.
“Many wealthy people flocked to Florida due to the pandemic,” Yunn says, “and they took their art with them.” That concentration of wealth assets in areas prone to flooding and hurricane damage creates significant risks to the financial wellbeing of insurance carriers. “We are seeing far more billion-dollar claims now than just 10 years ago,” Yunn says, causing companies like hers to write fewer new policies, increase their prices and add deductibles and exclusions. “The problem is acute.”
…
These days, insurance carriers track the advance of climate change as much as environmental scientists. “We have a corporate catastrophe team, which tracks the company’s total catastrophe exposure,” Yunn says. The risks from tornadoes in the Great Plains, hurricanes up and down the East Coast and earthquakes on the West Coast are well known, but the increasing intensity of hurricanes and tornadoes, as well as the rising numbers of them, are alarming signals. The tornado that ripped through Kentucky and several other states last year in a 200-mile path during the unlikely month of December was yet another sign of a climate that is becoming less predictable, as were a series of hurricanes, wildfires and freezing temperatures that have struck in Texas since 2017. In February 2021 a combination of snow, sleet and freezing rain paralysed Texas’s power grid for weeks, causing more than 200 deaths and nearly $200bn in damage.
“It would seem that there is nowhere safe from the effects of climate change,” [senior managing director at Risk Strategies Steve] Pincus says, all of which impacts the fine art insurance world, leading to higher prices and less available coverage…
“‘The only way to stop the bleeding is to stop writing policies’: climate change is making it more expensive to insure art,” from @TheArtNewspaper.
Via @WaltHickey, in his invaluable Numlock News, who observes “Listen, if ‘boo hoo, it’s getting too expensive to insure my vast art collection’ is the thing that gets rich people to actually care about climate change I’m still gonna take that as a win.”
* Adam Smith
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As we ponder protection, we might recall that it was in this date in 1885 that the first issue of Good Housekeeping was published. A “woman’s magazine” (featuring articles on women’s interests, recipes, diet, and health), it is also known for its product testing service and its the “Good Housekeeping Seal”, a limited warranty program that is popularly known as the “Good Housekeeping Seal of Approval.” One of the oldest continuously-published magazines in the U.S., it remains popular in its category.
It wasn’t the snake’s fault…
From Collectors Weekly:
These days, “snake oil” is synonymous with quackery, the phoniest of phony medicines. A “snake oil salesman” promises you the world, takes your money, and is long gone by the time you realize the product in your hands is completely worthless. But… the original snake oil actually worked.
In the 1860s, Chinese laborers immigrated to the United States to work on the Transcontinental Railroad. At night, they would rub their sore, tired muscles with ointment made from Chinese water snake (Enhydris chinensis), an ancient Chinese remedy they shared with their American co-workers.
A 2007 story in Scientific American explains that California neurophysiology researcher Richard Kunin made the connection between Chinese water snakes and omega-3 fatty acids in the 1980s.
“Kunin visited San Francisco’s Chinatown to buy such snake oil and analyze it. According to his 1989 analysis published in the Western Journal of Medicine, Chinese water-snake oil contains 20 percent eicosapentaenoic acid (EPA), one of the two types of omega-3 fatty acids most readily used by our bodies. Salmon, one of the most popular food sources of omega-3s, contains a maximum of 18 percent EPA, lower than that of snake oil.”
However, it wasn’t until several years after Kunin’s research that American scientists discovered that omega-3s are vital for human metabolism. Not only do they sooth inflammation in muscles and joints, but also, they can help “cognitive function and reduce blood pressure, cholesterol, and even depression.”
So why does snake oil have such a bad rap?
Well, hucksters that sold patent or proprietary medicine caught wind of the miraculous muscle-soothing powers of snake oil. Naturally, they decided to sell their own versions of snake oil—but it was just much easier to forgo using actual snakes…
Read the whole story (and see more nifty pix) at “How Snake Oil Got a Bad Rap.” [TotH to Presurfer]
As we give credit where credit is due, we might recall that it was on this date in 1721 that John Copson of Philadelphia became the first insurance agent in the Americas, and took out the first advertisement for insurance (in the American Weekly Mercury); he opened the first insurance office several days later. While there’s no record of how Copson fared, his initiative was sufficiently precedential that four years later the first book printed by Benjamin Franklin contained a long passage extolling the virtues of indemnification.
Happy Towel Day!
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