answer a question

[Kuciwalker]

pair of you? 4 people posted in this thread.

So, Kuci, any thoughts or are you just dismissing everything I said because I just have a pathetic Finance degree from a public university?

Nothing you said was relevant to my question.

[Al B. Sure!]

Nothing you said was relevant to my question.

How is it not relevant? Does 'default' mean something different in the insurance world than it does everywhere else?

Insurance companies don't default even if they regularly undercharged customers because their revenues are derived primarily from investments, not premiums.

I was also interested in your defense of this remark:

An insurance company could save money and lower its premiums by forgoing that insurance.

(*granted, it could happen but generally speaking, it's not the best business decision for reasons I said earlier)

[Bugs ****ing Bunny]

I doubt there are enough false and fraudulent claims to really affect insurance companies as a whole. Could be wrong though but I doubt it.

[Kuciwalker]

Insurance companies don't default even if they regularly undercharged customers because their revenues are derived primarily from investments, not premiums.

No, insurance companies don't default because they face extraordinarily tight regulations and [at least in the United States] are compelled to purchase what is effectively reinsurance from the state.

(*granted, it could happen but generally speaking, it's not the best business decision for reasons I said earlier)

Missing the forest for the trees, AS. If assumption 1 were true, then while doing so would be a bad long-term decision, its consequences would not be felt until after the company that made it had already put all the others out of business by taking all of their customers.

[KrazyHorse]

Insurance companies don't default even if they regularly undercharged customers because their revenues are derived primarily from investments, not premiums.

No, insurance companies don't default because they face extraordinarily tight regulations and [at least in the United States] are compelled to purchase what is effectively reinsurance from the state

I don't think this is true (the causal relationship, that is). It is a defensible claim, however.

[Al B. Sure!]

No, insurance companies don't default because they face extraordinarily tight regulations and [at least in the United States] are compelled to purchase what is effectively reinsurance from the state.

Bullcrap. If an insurance company operates at an 'underwriting loss' (I believe that's the term for when premiums < claims so undercharging), it can definitely make up the difference and then some with returns on investing the float. I actually believe that is SOP in the insurance industry. So again, your conclusion is half-right that insurers undercharge but it is not true that they default because of the returns from the float.

Regulations and re-insurance have nothing to do with this except for the point that I mentioned earlier that insurance companies are compelled to purchase re-insurance because of regulations limiting uninsured policies to a ratio of net worth. Therefore, they purchase reinsurance to be able to issue more policies which gives them a larger float to invest, economies of scale, and all that good stuff.

Missing the forest for the trees, AS. If assumption 1 were true, then while doing so would be a bad long-term decision, its consequences would not be felt until after the company that made it had already put all the others out of business by taking all of their customers.

Hey answer me how the insurance company would be able to take all those customers and write so many policies if they're "saving money and lowering premiums by not buying re-insurance" and operating under those regulations I mentioned?


The point is this conclusion:

conclusion: the equilibrium state of the insurance market is one where insurers universally undercharge and regularly default

Your premises could be true but it doesn't follow from your premises that companies will default because of the investment factor.

[Al B. Sure!]

Looks like underwriting profitability tends to be mixed. There isn't consistent undercharging:

According to an A.M. Best Co. statistical study, the total industry registered a 104.7 combined ratio in 2008, compared with 95.1 in 2007. The combined ratio for the top 25 writers based on net premiums written rose to 102.3 in 2008 from a profitable 94.5 the prior year.

Still, when there is, what's the annual return on the S&P? 7-8%? Underwriting losses, as long as they aren't too high, generally would not be a problem for an insurer.

[Kuciwalker]

I don't think this is true (the causal relationship, that is). It is a defensible claim, however.

Those were supposed to be two distinct reasons - "tightly regulated" and "required to..." [obviously the latter is a subset of the former].

[Kuciwalker]

Holy ****, AS, you just don't get it. The reason insurers behave the way they do - the reason they have the reserves they do, the reason they have the little equity slush fund on top, etc. - is because they are tightly regulated. Thus saying "they won't go bankrupt because they do all these things to obviate the possibility" is pointless, because the relevant issue is that they are forced to do those things.

[Al B. Sure!]

I checked out some statements and looks to me that typically, insurers have average investments around or greater than their yearly premiums.

And yeah, I'm sure Berkshire Hathaway invests only because of regulations

From their 2009 letter to shareholders:

Insurers receive premiums upfront and pay claims later. In extreme cases, such as those arising from certain workers’ compensation accidents, payments can stretch over decades. This collect-now, pay-later model leaves us holding large sums – money we call “float” – that will eventually go to others. Meanwhile, we get to invest this float for Berkshire’s benefit. Though individual policies and claims come and go, the amount of float we hold remains remarkably stable in relation to premium volume. Consequently, as our business grows, so does our float.

If premiums exceed the total of expenses and eventual losses, we register an underwriting profit that adds to the investment income produced from the float. This combination allows us to enjoy the use of free money – and, better yet, get paid for holding it. Alas, the hope of this happy result attracts intense competition, so vigorous in most years as to cause the P/C industry as a whole to operate at a significant underwriting loss. This loss, in effect, is what the industry pays to hold its float. Usually this cost is fairly low, but in some catastrophe-ridden years the cost from underwriting losses more than eats up the income derived from use of float.

In my perhaps biased view, Berkshire has the best large insurance operation in the world. And I will absolutely state that we have the best managers. Our float has grown from $16 million in 1967, when we entered the business, to $62 billion at the end of 2009. Moreover, we have now operated at an underwriting profit for seven consecutive years. I believe it likely that we will continue to underwrite profitably in most – though certainly not all – future years. If we do so, our float will be cost-free, much as if someone deposited $62 billion with us that we could invest for our own benefit without the payment of interest.

The raison d'etre of insurance companies is to invest premiums before they have to pay them out in claims and generate a profit from investment returns. Regulations isn't why this is so. It's the nature of the entire industry regardless of regulations.

Don't think like an actuary Think like a banker... You bring in cash but it's tied to liabilities that will be due some time in the future (someone's saving account or someone's insurance policy); you have to pay them a bit more than you bring in (interest or a claim that was higher than the premiums brought in); but in the meantime, you make your money with all this cash that you're holding on to.

(I realize commercial banking is or was heavily regulated but having to keep reserves didn't change the basic business model; and yes, there are differences between insurance and banking but the simplified analogy is still valid)

Now regulations limit WHAT they can invest in but they wouldn't stop investing if it weren't for regulations.

[Kuciwalker]

The fact that they invest the money doesn't obviate the possibility of default - in fact, certain forms of investment could substantially increase the probability - and it doesn't change the logic of the OP.

[Al B. Sure!]

What are you saying, Kuci? From the original post:

conclusion: the equilibrium state of the insurance market is one where insurers universally undercharge and regularly default

No. They don't regularly default, even if it is true that they universally undercharge. But the reason for them not defaulting is not primarily because of any regulations; it's because of returns from relatively low risk investments.

Why do you think they don't default because of regulations even if they universally undercharge? How do regulations change let's say a 105% combined ratio and the inevitable default in the absence of investments?

[KrazyHorse]

Those were supposed to be two distinct reasons - "tightly regulated" and "required to..." [obviously the latter is a subset of the former].

And my point is that "do things which reduce the possibility of going bankrupt" and "are required to do these things by law" are not related to each other causally.

[KrazyHorse]

Also, Albert is a ****ing moron.

[Al B. Sure!]

Also, Albert is a ****ing moron.

yay! Frogger comes to defend his minion Kuciwalker by calling me a ****ing moron (always with the same insults to intelligence accompanied by curse words) without saying anything as to why I am a moron. If I'm missing the forest for the trees or the mountain for the molehill or something else, that could very well be possible, but it would be nice to know why or how I am making a mistake rather than just be called a ****ing moron. I find it more productive to explain why someone is wrong rather than insult them.