A good book on the insurance industry with a focus on Catlin and the London market/Lloyds.
If you prefer to read the pdf version click here. (links may not work in pdf)
(as in my previous book review I focus more on my learnings/insights/personal summary vs writing style etc.)
Great teaser. Forward by Bomhard (MunichRE) and preface about differences between theory and practice are clear signals for a great read. The author did fail his final exams in marine insurance several times b/c he was not able to give the required theoretical answers – despite working exactly in marine insurance.
Part 1: Insurance Fundamentals
The value of insurance is high. Insurance is an exestential product in our modern societies and economies, but, it is not a product customers get excited about (vs ie, electronics / an iPhone), neither does the industry explain it well.
Underwriting became more competitive as more (quantitative) tools became available, and thus, margins shrank and underwriting errors became more costly. And obviously, the less data and the more uncertainty the better the margin, and need for the underwriter’s judgment. Sometimes, actuaries rely too much on information from the fast. Building relationships by being seen doing the right thing and acting with integrity is key… even if playing bad golf (#20). Underwriting is cyclical: after good periods capital floods into the marketplace exceeding what is required and competition lowers prices. For standard wording contracts there is case law, whereas ‘manuscript’ wording or non-standard wording allows the client to get exactly the protection needed, it is less certain from a legal perspective.
The claims process is made difficult by some insurers, instead of using it as the ‘shop window’ by paying valid claims quickly, fairly and without hassle.
Reserves are money put aside to cover an insurer’s obligations. But how much is enough but not too much? Reserves for unearned premiums would cover repayments to a client if a policy was canceled before expiration. Loss reserves shall cover all claims plus related costs that must be paid in the future from policies in force.
Within the reserving process the greates uncertainty comes from long-tail casualty insurance which sits rather on the opposite of short-tail property insurance, and is much more contingent on (US) civil justice system. A balance of long-tail and short-tail insurance business offers cashflow from the former to pay the latter, and if catastrophes happen, short-tail insurance reprices rather quickly, whereas long-tail can take ist time until trends emerge.
Insurers unpricing risks, almost always under-reserve as well and are insolvent pretty quickly after discovering that they underprice.
The term cheating phase refers to insurers over-reserving in profitable years and releasing these excess reserves during less profitable years to mask their true profits, which do not show true profitability.
Brokers offer efficient distribution for commercial insurance. Insurers often fail to promote their value add / differentiator to brokers, of paying valid claims quickly which should enable brokers to keep accounts (instead of losing the few who experience losses and unsufficient claims settlement processes)
Data processing is very inefficient in commercial P&C Insurance since the data is so diverse, meaning on class of business only has 50% of the data of another class on avg. Thus, much data handling is nin-aumomated, error prone and sever versions of truth exists in parallel. In times of higher interest each Party waits a bit longer to pass money along earning interest income on money owned to insurers or customers. The processing of data is so inefficient and costly that Catlin fears companies outside of the insurance industry, ie Microsoft or Google, could ultimately build a disruptive solution.
Part 2: Building a business for the future (the Catlin story)
Raising capital at an unusual time, before FY results were released seemed appropriate since the books were DDs already during an M&A process, and turned out to be a blessing: many investors had a lot of cash and not many options to deploy it. The preferred issue was raised and strongly oversubscribed at a small spread a ove risk free rate. Two months later the market changed. This was lucky timing. Having surplus capital when competitors don’t allows to grow organically in a hard market which really makes a difference.
Banks and insurers are grouped together but their balance sheets dynamics are different. Insurers assume and manage risks daily and charge for it while banks try to operate with minimum risk on their balance sheets.
Selling Catlin (the business) was well thought through since industry consolidation made it necessary for Carlin to become bigger, still Catlin (the founder) became very much emotional the day the company did not exist as an independent entity. He prioritized shareholders’ interests first as the CEO besides all other stakeholders.
Part 3: Lloyd’s and the London market
Trust is important in the insurance – broker relationship, since brokers do not want to place business with you if their is doubt about solvency. This results in sources of capital being important.
Part 4: Important issues
Culture is important and makes mergers more challenging to work out successfully. Integration has to largely happen within the first six months.
Brand has to be consistent with actions, and ideally marketing.
Regulation is necessary in the insurance industry. There are good regulators in England, Singapore, Bermudas according to the author, but Solvency II (Europe) is much too complex not serving its goal of better regulation and a more secure industry. The US is a wierd beast with very limited federal regulation and its 50 state regulators, often led by persons with less than ideal industry specific experience.
Insurance and reinsurance is bought in local markets to a much greater extend vs a time when London/Lloyds was much more important. The US represent about 40% of global P&C premiums but America is not the center of the insurance industry. Tax codes play a role but so do capital requirements and regulation. Whereas London is very concentrated in the ‘square mile’ making face-to-face business and syndication of big sums easy undertakings, the US lacks an insurance centre. Bermuda is a reinsurance center and its regulator regarded as higher quality today. The EU awarded Bermuda Solvency II equivalency in 2016. Switzerland another insurance centre has the same status. Bermuda is framed as a tax heaven but it simply chose to tax differnetly. Operating costs are very high and there are tensions between Bermudians and expatriates.
A big protection gap looms in poorer countries especially, for reasons as: unappropriate regulations, diffcult distribution, unaffordable, not enough data to underwrite risks at appropriate rates.
Challenges certainly include cyber insurance because by its very nature the internet is connected, and thus, so are global cyber risks and potential losses. Current limits are rather low. It is difficult for companies to get limits above 100m. Expense ratios are rising because insurers do so much more: IT, modeling, data, regulation, lawyers, actuaries. This will result in more consolidation and makes life harder for niche players – which should be attracive M&A targets with attractive niche portfolios. The process problem is still unsolved (above). Insurance market cycles are an important and unavoidable subject. Alternative capital provided by opportunistic hedge funds and diversification-seeking pension funds. The former might leave the re-insurane makret with rising rates. How long HF will stick around is yet unclear and is their willigness to pay claims without arbitration, or seeking long-term relationships.
A great book telling the story of a founder steering his company though industry change, taking great risks at times, doing a lot right, and taking care of shareholders and other stakeholders, despite being personally emotionally difficult to let go.
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