Inflation and Insurane

Posted on by David Wright

I like this presentation by Bob Hartwig at the III (haven’t finished it yet).

I find his treatment of real vs nominal variables frustrating, though. The CPI measures what people spend on stuff and is ultimately driven by wages, imho.

Wages might drive many insurance prices (rating basis for insurance costs for many companies is their payroll). But, realistically, insurance rates are not set by some theoretical link between the driving variable (wages or whatever) but by claims experience. Any changes from ‘inflation’ are competed away if the claims don’t show up. What drives claims? Well, of course they’re driven by changes in some components in the CPI, among many other things (legislative changes, exogenous shocks, etc). But this year’s claims cost is often driven by the CPI level from when the claim occurred, which may be years in the past. So there’s a lag. Tough to predict.

Bob’s an economist, so he lives and breathes ‘economic’ variables and probably doesn’t often dig into his preconceived notion of what they measure. Inflation is different depending on what you’re doing. I imagine the correlation between changes in the driving variable for an insurance policy (wages or whatever) and the actual claims cost changes is much smaller than one would think. I’d bet real money it’s less than 0.5 in the short/medium term (1-5 years).

Arts & Science

Posted on by David Wright

So is insurance an art or a science?

Strange question, but it’s hardly above the towering ego of a CEO to nod in the direction of Einstein and Picasso when discussing insurance business strategy.

Let’s put it differently: what the correct balance is between capital and labour? Or, because we always start with 100% labour: can a computer program do this stuff profitably?

Wearingly, the answer is: sometimes.

People, relative to computers, are good at at identifying when another person is making an error or trying to mislead/screw you. Let’s be generous and call this insight artistic.
Computers are good at crunching through datasets in a scalable and standardized way. This would be the ‘science’ of insurance.

Now, there are instances when the artist is needed more than the scientist. How can this be? Well, insurance isn’t so monolithic as it may seem because different lines of businesses need different combinations of skills.

So, if the answer is ‘both’, then are the opportunities better for artistic lines or scientific lines of business?

Good question, let’s look into that shall we?

What is the Optimal Insurance Company Strategy?

Posted on by David Wright

Good question.

Insurance companies have three revenue streams:
1. Premiums
2. Investment Income/Gains
3. Other Revenue (usually fee income or something).

and three expense streams.
1. Claims and related expenses (adjustment, etc)
2. Underwriting expenses (salaries, etc)
3. Overhead and taxes

The question of insurance strategy is mostly about picking which of these factors you want to focus on optimizing. There’s an answer for each. Sometimes, a strategic solution will address more than one, even. Exciting, isn’t it?

BUT WAIT. There’s more.

The thing that really makes insurance really baffling is risk.

For example.

At Wal*Mart, and many conventional businesses, they have one lever, costs, and their success depends on just how damn hard they can push the thing. Costs go down, prices go down, sales go up, pricing power increases, costs go down… Lather, rinse, repeat. Their services, like insurance services, are a commodity.

An insurance company is weird, though. You fundamentally don’t know what your COGS are, sometimes until much later. So you can trick yourself into thinking you’ve made money when you haven’t. We’ll get to that later.

Most importantly, there’s a philosophical battle that needs to be fought before you really start analyzing strategy. And that is whether insurance underwriting an ART or a SCIENCE.

Blogging

Posted on by David Wright

So I haven’t written much recently. Got married, been busy. Usual stuff.

More importantly, I had it in my mind to use this medium for a project that is a bit bigger in scale than my previous entries. So big, in fact, that I haven’t done a thing. Too big, then, is the point. I’ll see if I can break it up.

The project is: what is the optimal insurance company strategy?

Skills and Work

Posted on by David Wright

When the G20 came to town, offices downtown were closed and cops flown in from around the country to patrol the streets. We substituted knowledge workers for security workers.

Under the logic of fiscal stimulus, the govt should have just shut the offices down and hired all the workers as cops.

(More) Powerful Thoughts from Robin Hanson

Posted on by David Wright

From Robin Hanson:

Watching this film twice made it clear to me that the main classroom dynamic, at least in inner city classrooms, is status moves. Teachers struggle to maintain control and respect, while students struggle to one-up one another and to avoid being dominated by teachers. When getting lower grades is the price of preserving their pride, it is a price most students are willing to pay.

I like where he’s going with this. Like Robin, vague promises of future ‘success’ were useless as motivational tools in my education. Unlike Robin, however, I didn’t really care for teacher-praise. Parental feedback had an effect, but only to get me to do the minimum to achieve what I now see as a similar relative status to them.

I found the prospect of being a leader intoxicating, however, and the only time I ever really broke out of my shell when working in groups. If I had to do outstanding work to assume leadership, then that was what I would do.

That doesn’t mean that I would do outstanding solo work in the hope of being put in charge of a group. That strategy is way too painful. You get the same result with less work by coasting into the group and turning on the jets to execute a coup.

The only job I seriously ever told anyone I wanted (since age 14 or so) was to be a CEO. Nothing else really mattered. And, contrary to my mother’ admonition, in small group settings you *can* be a CEO without any experience.

People Can’t Deal With Change

Posted on by David Wright

Robin Hanson has a great comment that I can’t seem to link through to but have on my RSS reader:

Most people are surprised to hear that the world economy doubles roughly every fifteen years; when they think back fifteen years, the world doesn’t seem that different… In fact, one of the reasons why change can be so fast is that most of it happens behind the scenes. If ordinary people had to notice and deal with more changes, we just couldn’t change this much.

Here’s a contentious thought: what if the 90s tech “bubble” wasn’t in fact a bubble at all, but was rather an accurate prediction for how much an economy will change, but over the wrong time horizon. The Internet and related technologies require adoption by individuals – change you not only can see, but need to implement. The baby boomers were just never cut out for this. It won’t be until people born in the 80s and later, who grew up with computers, take over industry that we can hope to see widespread adoption.

And when I say accurate prediction, I don’t mean general economic growth, but economic growth specifically attributable to technologies developed in the 90s.

Forager Cultures

Posted on by David Wright

From Robin Hanson:

It seems that our distant forager ancestors beat wives but not kids, and weren’t remotely monogamous. They had huge inequalities in status and sex, but low material inequality, due to generous sharing and few durable goods.  They had little overt dominance or positions of power, and valued trust and honesty greatly.  Justice was personal, with personal violence and suicide rare.