Insurance is Complicated

Posted on by David Wright

Insurers are set up to pay three kinds of expenses:

1. overhead and commissions (under their control);

2. predictable claims (whose risk insurers ‘understand’); and,

3. crazily aggregating black mamba catastrophe claims (bolts from the blue).

Let’s play CEO: which one of these keeps me up at night?

Well, #3 looks pretty scary: that’s where the jacked-up Hollywood-style company killers lie in wait. It’s not just hurricanes, earthquakes and asteroids, either. Corporate scandals (think Enron and all the resulting litigation) and ‘latent’ exposures (Asbestos). Lots of drama, lots of victims and look! There’s Anderson Cooper, brows a-knitted, standing knee-deep in a floodplain shouting at a TV camera.

Meh.

Believe it or not, just knowing that some hairy stuff can happen keeps things in check: lots of capital, expensive insurance for Florida homeowners and constant testing of the market through the reinsurance process.

The softer blood-suckers (Asbestos and Corporate Scandal) resolve through the courts, which drag things out for EVER. This means an insurer, now anticipating lots of claims, can crank up the prices and effectively earn its way out of trouble.

Ok, how about #2? Tread carefully, there’s some action here, but the problem isn’t the cost, it’s the revenue and pricing. An organization needs to willfully brush aside good sense and undercharge for this to be a problem. And as stupid as that sounds, it happens because of…

#1: here’s the killer. No sucker is going to pay a premium for a fancy Louis Vuitton logo on the top of his/her policy, so insurers differentiate on price.

There are two ways of going about this: first, by identifying a poorly served subgroup. This is everyone’s favourite because the ‘winners’ feel smart for identifying a niche and the ‘losers’ feel smart for avoiding a trap. Realistically, this is hardly a scalable and sustainable business model.

The real answer is to pull costs from your process. Think like a manufacturer. Make. It. Cheaper. Then you know you’re in a better financial position at any market price. And the market does weird things.

For instance, imagine you’re a typical underwriter CEO when he finds he’s too expensive.

You’re losing money, but out of ideas. Cut your prices, fiddle the reserves a bit to buy time and hope the market turns!

I imagine these poor suckers like submarine captains who just realize they’ve been spotted on sonar and quickly rig for silent running.

Hundreds of feet beneath the sea, quiet as a mouse, on the brink of death and waiting, desperate for a happy ending…

Jumping the Shark?

Posted on by David Wright

Back in 2008 I started following a blog called “Obama in Kenya”. It was a catalog of pictures of Obama paraphernalia in Kenya. Kenyans were pretty fired up.

It was neat but fell into disuse in the February, 2009 or so but I never took its RSS feed off my reader.

This morning I got a blast of posts from the blog dating back to November, 2010 which I would call… different:

Someone starting today can certainly generate more income than a few other individual who has been around for over a year. It’s strictly between you and also the one that you invite to find out about your dollars gifting activity and sharing club. Should they just like the concept, they could accept to offer you a cash gift. Direct. Individual to individual. No pyramid anywhere.*

That’s a pretty typical post in terms of comprehensibility and content and is titled (I kid you not):

tructured by having an make an effort to copy or “clone” [sic]

Obviously this site has been taken over by some pretty shady folks who have kept the url intact and spend a lot of time thinking about,  um, legal process and cash gifting?

Here’s another title (reproduced in whole with punctuation intact):

people would walk approximately

What was that? You want some content from this gem? Sure:

Plus, through the years I’ve supported many ministries and charitable organizations financially. Not just that, there are lots of instances when people would walk approximately me and hand me cash as being a gift to bless me.

Hilarious. And no deposed King of Nigeria for me to bail out? Come on!

Maybe this is a Turing test.

*I’m not going to link to this thing for fear of tee-ing off a blast of spam.

Triceps Surae

Posted on by David Wright

Otherwise known as the calf muscles. Weird word.

(did a bit of research and, apparently, the muscle and the baby cow are only coincidental homonyms).

Anyway, the first book I ever read on exercise was by Joe Weider, who more or less invented the ‘sport’ of bodybuilding. I now think that whole system of exercise is, at best, ridiculous and, at worst, harmful, but recently I was reminded of a passage describing Ah-nold’s struggles with his calves.

“Everyday you walk around. When you walk you are using your calves. You are pushing at least your body weight every time you take a step. So, when you go to the gym and work out your calves with light weight, are you really stressing your muscles?”*

So lately I’ve taken up barefoot running. Actually, it’s sock-footed running until I get my new ‘shoes‘ – who knew treadmills got scalding hot as you run on them?!

And my calves are toast.

Ever thought about the difference between walking and running? Walking is when you always have a foot touching the ground. Running is more like small controlled jumps. When you land, you’ve got your entire bodyweight slamming into the ground.

With the standard modern running style, this force is absorbed by the heel of your shoe as your foot strikes and, apparently, can cause ‘downstream’ problems in your knees, hips and back.

Barefoot running is stealth running; think of it as trying to run without making any noise, on the balls of your feet like a thief in the night. Now there is no heel strike and the shock gets totally gobbled up by those hard-to-stress calf muscles.

So Ah-nold is right, but for the wrong reasons. Calves would be hard to ‘build’, but not because you walk around; I’d say it’s because they evolved to absorb a ridiculous amount of punishment (running long distances barefoot) and all that toughness lies dormant.

*swiped this from another website, but it’s the right sentiment

Brokers

Posted on by David Wright

Second-hand story:

A colleague of mine was at the bar before dinner with a client and a few others. A reinsurer walks in (reinsurers sell, client buys, we’re in between) and this client, a rambunctious sort, challenges him:

“So, [blank], what do you think about BROKERS?”

“Honestly?… I think they slow things down, cost money and favor the client.”

Zing!

-=-=-=-

Let’s break it down. The third point is irrelevant: there’s no such thing as impartiality and besides, at the margin, buyers have more power than sellers in commodity businesses.  They can take their ducats elsewhere all to easily. We’re supposed to favor the client, dumbass.

The second point is (as they say) what it is.

The first, though? That’s not playing nice-nice, is it.

But even as narrowly and stupidly put as it is, it’s still not really a burn. Negotiation is a tricky business* and it isn’t obvious what helps and what doesn’t. Sometimes, slowing things down is a good thing. Most times, brokers play a role SOMEBODY has to play and, if not for brokers ready to take the blame, you’d be bitching about slow internal processes at the client for generating the data.

Our friend [blank] was probably stirring the pot, though, because he decided to completely overlook what we actually do.

We’re matchmakers. Building and servicing a network of people that buy and sell hundreds of millions of dollars of reinsurance every year takes a lifetime. It’s a weird job, for sure, but one that has withstood the ultimate test, competition from direct (ie non-broker) markets, for generations.

It’s very hard to create economic value. Very very hard. It’s also hard to identify economic value sometimes.

Luckily money talks.

*(TED has loads of good stuff on this, from a related field.)

That Ship has Sailed, Boi

Posted on by David Wright

This is a neat little story about the starup scene, and, from what I read, is fairly typical.

1. Guys move to the SF Bay area

2. Invent a product that flops

3. But their by-product flies!

4. JUST successful enough to survive (literally and professionally).

5. Now they know their stuff and get started for real.

In my head, entrepreneurship (of the young guns tech variety) is all about chucking yourself at an incredibly steep learning curve and persevering.

Minimum Requirements: Boundless motivation, comfortable with life in the bottom income quintile and enough coding skill to stay afloat. All while you learn.

Self-imposed desperation as your motivating force? How SWPL.

I can relate. But that ship has sailed for me.

I already have too much to lose!

Stop the Thoughts! I Need to WORK!

Posted on by David Wright

Ok, Cringely has a post that I need to get out of my head.

He says that he approves of Nokia’s move of ditching their in-house operating system by “Trading Symbian for Windows Phone 7 with a $100 bill attached”  because Symbian is “crap”.

Never used it, but it doesn’t surprise me. I expect the mobile phone universe is going follow the PC and migrate from a hardware-driven market to a software-driven one with the old guard mostly screwing it up.

I love his advice, though:

Hire a Bob Lee (or heck, hire Bob Lee), set up a small development office somewhere in the USA, and spend $5 million per year aiming at mobile life after Microsoft.

I’m going to write more about Tyler Cowen’s awesome The Great Stagnation (really want to solidify the concepts in my mind), but I can’t resist parroting a point here: software is a revolutionary industry in the midst of its revolution.

Unlike other ‘industrial’ revolutions, though, this one isn’t going to require millions of retrained workers.

Software teams work best when they’re manageable. And that means small. Big scale does not mean big staff.

The Ultimate Commodity

Posted on by David Wright

Two economic facts make the insurance business peculiar:

1. Insurance is a commodity

2. Claims take a long time to pay

Being a commodity means margins are thin. Delayed claims payments means interest rates really matter and costs are very hard to estimate.

First, the commodity part.

Insurance companies are, economically speaking, simply pools of money. Mining companies have ore, oil companies have oil and insurance companies have money. All commodities. I like how Wikipedia approaches the definition: “a commodity is the same no matter who produces it”. How true.

But money is super weird stuff.

First, money is the medium of exchange, which means that we can use it for all anything you want. At “The Price is Right” insurance company, you’d claim for a boat if you broke your boat, a house if you broke your house or a hospital stay plus a vacation if you slipped a fell outside a convenience store. Not so elsewhere; you get moolah.

Second, unlike other commodities, it’s plentiful, unlimited and everyone has it in its pure form.

The second point means, conceptually, the barriers to entry are very low. Insurance isn’t like pencils, anyone can self-insure just by saving their money. Most of us don’t, though, because that would be impractical: we’d need help.

There was a time when insurers were mostly mutuals: basically bands of people/companies that agreed to pay each others’ losses. But this ain’t Soviet Russia, we don’t like paying for others’ screw-ups, so you’ve got to define very carefully when and how losses are covered. Now you’re worried about moral hazard and you build out the policy language (rules), infrastructure (payments and records), staff (audit, etc) and management to keep things straight.

Wait, that’s an insurance company!

I Do/Don’t Understand Risk

Posted on by David Wright

I hear this all the time and get irritated. Consider these two statements:

1. An investor at a conference: “we think that investors are good at understanding super-catastrophe risk, reinsurers are good at understanding higher frequency risk and insurers best understand high frequency risk”

2. We are looking at this marketplace and just don’t understand the risk.

What does it mean to “understand” risk? I’ll tell you: not a damn thing. If you understood it, it wouldn’t be risky, would it?

Statistics can useful at describing processes without using incorporating any ‘fundamental’ analysis of the drivers of that process.

Coin flipping? Sure, I can get my head around the probabilities in that. Aggregate cost of slip and fall accidents in Montana in 2006 being greater than 2005? Yeah, right!

So we approximate, test, get it wrong and (hopefully) refine. Nobody understands risk any better than anyone else. Those two statements SHOULD read:

1. Investors are happy with returns commensurate with insuring extremely rare events because we don’t ever expect to pay any claims and we (the managers) are happy to get fired if we do. Everything else? I have no idea how their businesses work.

2. We like markets where we think people don’t know what they’re doing and we can convince ourselves that we do. Risk is in the eye of the beholder and we can’t believe that REAL risk exists here. We must be the sucker at the poker table.

Market Avatars

Posted on by David Wright

Really cool article on how entrepreneurs think, here’s the gist:

Rather than meticulously segment customers according to potential return, they itch to get to market as quickly and cheaply as possible, a principle Sarasvathy calls affordable loss.

And the zinger:

They do not believe in prediction of any kind.

The point is that you’re only focused on something when you’re asked to spend money. This is why prediction markets are so interesting. No amount of fancy pants grad degrees or big scores on I.Q. tests can replace the focusing power of cash on the line.

I work in a business that is obsessed with forecasting the future: no surprise when you sell a product without knowing how much it will cost! The people who are in charge of figuring out the COGS are actuaries, who use all kinds of fancy math for describing (and so forecasting!) processes nobody really understands.

Now, the frustrating thing about actuaries is that they know they’re going to be wrong. And that if they’re wrong in the wrong direction (ie understating the COGS), the company blows up and everyone has to go find a new job. The incentive is pretty strong to overstate the COGS.

Not only is this forecasting, but it’s deeply biased forecasting. To an entrepreneur this kind of thinking is radioactive.