Friday, September 19, 2014

How Different Insurance Actors Handle Recent Changes in Market Judgment of Risk

A dominant characteristic of the insurance market right now is that it does not have enough large loss to maintain pricing stability.  On Monday, the Insurance Journal ran three different stories that demonstrate several types of institutional behavioral responses to changes in the market judgement of risk.

The first article covered the recent Reinsurance Rendezvous, an annual event in Monte Carlo where the world's reinsurers get together and do whatever it is that they do behind closed doors such as, throw lavish parties.  The article reported that reinsurers are very much disgruntled with market pressure to bring their pricing down.   According to the article, originally from Reuters, Nikolaus von Bomhard, chief executive of Munich Re  claimed, “I am disappointed, exasperated, and even rather appalled by what is happening in the market."

Reinsurance shareholders are expected to benefit from the market dynamic.  The article reports, “Returning capital to shareholders reduces the pressure to do something that has higher risk,” said Moody’s analyst Stan Rouyer.  Earlier this year year, Swiss Re was reported to have done this in the form of a special dividend.

In the second article, the Insurance Journal reported that the Louisiana Citizens Property Insurance Corporation seeks to lower rates for a handful of residential policyholders and, overall, for some commercial policyholders.  The reason for the change is reported as the cost of reinsurance.   Here, the ability to offload more risk onto reinsurers for cheap has led to lower overall pricing for the public.

In the third article, the Insurance Journal reported that primary insurers (i.e. State Farm, Farmers and Allstate) in Texas are increasing homeowners rates.

The article reports the primary insurers are claiming that increased risk warrant raising rates,
Luis Sahagun, a spokesman for Farmers, said the insurer needed to adjust its rates to account for the “increasing costs associated with covering the risks faced by customers” in Texas. That includes tornadoes and hailstorms. 
“The costs associated with paying for losses resulting from fires and water damage have also kept growing,” he said.
Deeia Beck, the Texas Public Insurance Counsel reportedly argued that the raising rates are driven by profit margins,    
She said State Farm’s new rates were excessive and based on projections that “exaggerate future expected losses.” Further, the company is citing unreasonably high expenses to justify its new rates, she said.
Farmers, meanwhile, is trying to reap a “greatly excessive” profit in Texas, she said. That includes substantial profit generated from management contracts between Farmers’ holding company and its subsidiaries. 
To the extent primary insurers are able to pass perceived increases in risk onto reinsurers at a low cost, charging the policyholder for the cost of additional risk while the actual cost of managing the risk may not have changed because of the substantial decrease in reinsurance pricing would seem like a means of creating additional profit as Beck suggests.  

Here, the advantage of low reinsurance pricing is had by the primary insurer.

Though, the geophysical risk hasn't changed, pricing of the risk has changed quite a bit due to reinsurers market conditions.  Which again highlights that pricing catastrophic weather risk likely has more to do with market perceptions than scientific measures of the hazard.

Thursday, September 4, 2014

Rating Agency Outlook Performance

My understanding of a rating agencies outlook is that it is a generalized prediction about more specific predictions to be made sometime over ~2 years.  A rating is itself a prediction about a company's credit worthiness- will they or will they not pay someone.

Interestingly then, what you have with outlooks are predictions about future predictions.

How do outlooks perform?

(unless otherwise noted, a year's outlook was published the previous September.  So, the 2013 outlook was published in September 2012)

2013 Outlook

Fitch: Stable outlook over the next 12-24 months
Moody's: Stable outlook over the next 12-18 months

2014 Outlook

Fitch: Stable over the next 12-24 months; moved to NEgative outlook in January 2014
Moody's: Stable for next 12-18 months

2015 Outlook
Fitch: Negative over next 12-24 months
Moody's: In June- Negative outlook over the next 12-18 months; Can't find September report

It looks like outlook predictions don't perform all that well.  Consider Fitch's:

  1. In September 2012, they guessed stable over 12-24 months.  
  2. Twelve month's later they guessed stable again.  
  3. Three months later this became negative. 
  4. Nine months later (ie. this month) they guess negative for the next two years.  

This means that the original outlook was only good out to 15 months.  The second outlook did not hold true very long at all.  We will have to wait to see how the negative outlook of January and September 2014 will perform.

In their 2014 outlook, Fitch argued that would could trigger a downgrade in their outlook is, "Catastrophic Loss with Interest Spike,"
A sizeable catastrophic loss in conjunction with significant unrealised investment losses from an abrupt jump in interest rates is viewed as the greatest threat to the sector’s stable outlook at this time.  
I don't monitor interest rates but a sizeable catastrophic loss has not occurred (2013, 2014).  So something other than a 'catastrophic loss with interest spike' encouraged a downgrade.

This means that not only are the outlooks not so great but the reasoning behind them may not be so wholly transparent.

Tuesday, September 2, 2014

Financial Morality

In the academic world there is a group of social scientists who discuss the use of "risk" as a modern form of moral regulation: Alan Hunt, Tom Baker, Richard Ericson, etc.  That risk has moral connotation seems intuitive.  The idea of doing something that has the potential for harm or loss inherently conjures feelings of goodness and badness.

From this, Hunt Baker and Ericson, have argued, modern institutions of risk such as, insurance, act as morally governing.  They define good and bad risks and to the extent that this aligns with certain portions of the population, the result is good and bad people or populations.  

In my experience, the idea that financial decision making has moral implications and/or depends on moral judgements meets a great deal of push back by those that see financial decisions (and the decisions behind those decisions) made by a group of "rational agents."  From this perspective, judgements are not really value based on considerations of good ideas and bad ideas but simply on what is economically advantageous.

The circular argument in this perspective is that to prize economic theory or economic advantage over other considerations IS a value judgement.  And to consider some judgements better than others to achieve profit or financial sustainability IS a moral judgement: Profit is Good/ Financial ruin is Bad.

A good example showed up in the comments section to a recent FT article foreshadowing a financial crisis even more dire than the last.  Bagehot by-the-Bay wrote, 
In some industries — high tech and the airlines, for example — bankruptcy is not a sin, it’s part of the natural order of things. I suppose one either believes this, or not.  ...
Mr or Mrs Bagehot identifies bankruptcy as a moral bad (i.e sin) for some but a virtue for others- much like taking multiple wives is morally good for some and morally bad for others.  It depends on what flavor of marriage industry to which one subscribes.  It depends, according to Bagehot, on what one "believes" about the meaning of bankruptcy beyond the identification of its occurrence.

There is nothing about the fact of bankruptcy that is inherently value laden but it is how one responds to the risk or realization of bankruptcy that gives it significance.  At times, bankruptcy has the potential to impact,  directly or indirectly,  a broad range of people with different value sets.  For example, bankruptcy may cause loss of employment, economic volatility, "bad credit," etc.  Different groups may approach the bankruptcy event differently much like "high tech" may approach it differently from some other industry.

Making decisions about risk including financial risk, necessitates consideration of outcomes to be sought after or avoided, values to be upheld or neglected.  In short, consideration of what is morally good and bad.

Thursday, August 28, 2014

Economic Politics and Expert Judgements

Commonly, economists, actuaries, risk managers and economic decision makers, generally, are both viewed and view themselves, as disinterested, objective purveyors or economic truth.  They simply call it as they see it or rather, make decisions based on market indicators.

However, individual experts may interpret information differently.  Scholarly literature from the social sciences demonstrates that people, laymen and experts alike, rely on desired objectives, culture, and values for decision making.

Thus, expert judgements reflect the relationship between what the decision maker thinks to be desirable and their expectation of what will be.

In short, an expert judgement is indicative of perspective.  

From the political arena of economic policymaking, two recent examples are found.

One recent example comes from the recent speech given by the Federal Reserve System's Chairwoman Janet Yellen,
In my remarks this morning, I will review a number of developments related to the functioning of the labor market that have made it more difficult to judge the remaining degree of slack. Differing interpretations of these developments affect judgments concerning the appropriate path of monetary policy.
The Chairwoman dedicated the majority of her speech to discussing different economic factors and trends that provide a complex picture of the US economy.  

Following Yellen's speech, the FT reported on the mood of the market,
Ms Yellen’s comments on the level of slack in the US labour market were deemed more balanced than had been seen previously – and the mild sell-off in the equity and bond markets appeared to suggest some disappointment among those expecting her to live up to her dovish reputation. 
In effect, these market interests act as a constituency some were pleased and other's displeased by Yellen's interpreation and her foreshadowing of future decision making.

Another example comes from the voting experience of the Bank of England on appropriate monetary policy.

Disagreement by members of the BoE Monetary Policy Committee demonstrates that the same economic information can render different judgements based on perspective.  In addition, the FT suggests that the voting conflict indicates that BoE has a different perspective on appropriate action given information about the global economy,

This leaves the BoE as the only major monetary authority in the world edging closer to a rate rise. In the eurozone, the European Central Bank has pledged to keep interest rates low for an “extended period of time”. The Bank of Japan has pledged to continue with its quantitative and qualitative easing programme until it hits its newly established inflation target of 2 per cent.  

Expert judgement on appropriate monetary policy or means of obtaining monetary policy goals clearly integrate something other than market factors alone.  

The idea that expert judgements about economic matters are somehow objective and not riddled with perspectives, values, desires, personal experience etc. is a form of "boundary work."  The phrase comes from the social science literature and refers to the efforts and practices by some decision makers or practitioners to exclude other types of interests (examples here and here).

Often, boundary work is used to describe the efforts of technological experts to exclude the interests of the public and regulators.  However, delineation between technological decision makers and societal politics is not possible because the two are part of the same social system.

The above examples demonstrates that expert economic decision making is itself political and social. Therefore, decision making is not predetermined by market forces but malleable based on interpretation of information and decision maker's desires about who's values to maximize and how best to do so.  

Tuesday, August 19, 2014

Miami-Dade's Master Plan

From Flickr: Veronique Lee

Miami has a Comprehensive Development Master Plan that is the holy scripture for all that is Miami-Dade County land management.  It is an immensely powerful document.

Its creation and management is generally guided by Florida Statutes Chapter 163.  But specific goals for the Master Plan are set out by County Ordinance Chapter 2, Article XV, Sec. 2-113.  The purpose of the Master Plan is mandated as  follows:      
It is the purpose and intent of this plan to assure for all people of Miami-Dade County safe, healthful, productive and aesthetically and culturally pleasing surroundings; to attain the widest range of beneficial uses of the environment without unreasonable degradation, risk to the health or safety, or other undesirable and unintended consequences; to preserve important historic, cultural and natural aspects of our national heritage; to maintain, wherever possible, environment which supports diversity and variety of individual choice; to achieve a balance between population and natural and man-made resources which will permit the high standards of living and a wide sharing of life's amenities, and to enhance the quality of renewal resources and approach the maximum attainable recycling of depletable resources. 
Obviously land management in the County is intended to meet a smorgasbord of goals.  Policies like these can be difficult to hold decisions makers accountable too because the goals are varied, perhaps conflicting and vague.  It is easy for a decision maker to point to any part of this legislation to argue the morality of their decision.

 Digging deeper into the Master Plan, one comes across naturally conflicting statements and double-speak.  For instance, the Master Plan's section on Land Use sets out the objective of development that encourages
"contiguous urban expansion when warranted, rather than sprawl."
Sprawl however, is generally synonymous with expansion of urban areas.   Galster et al (2001) define sprawl as,
a pattern of land use in a UA [urbanized area] that exhibits low levels of some combination of eight distinct dimensions: density, continuity, concentration, clustering, centrality, nuclearity, mixed uses, and proximity.  
 Despite the double-speak in the Master Plan objective, it is clear that the concept of sprawl or urban expansion is seen as in conflict with higher order goals developed by the County for the creation of the Master Plan.

Further, there is reason to believe that Miami land management planning is failing miserably at meeting those goals set out in by the Land use objective and the County mandate.  For one, Miami is seen to have one of the greatest degree of sprawl in the country (Galster et al. 2001).    As well, it is seen as one of the most stressful places to live.  It also, is notorious for its risk.

Can Miami-Dade County decision makers be held accountable to the public policies they are intended to uphold?

Update, later today:
Other scientific work by Lopez and Hynes (2006) indicates that Miami has very low sprawl.  Lopez and Hynes use a different process of defining and measuring sprawl.  Both Galster et al and Lopez and Hynes offer lengthy discussions about the difficulty of defining sprawl.

Without a clear definition offered as a policy goal, it is difficult to evaluate if a policy has produced sprawl or not.  This is akin to affordability issues in Florida insurance.  Without a quantitative definition of affordability, evaluation depends on the mood of the public.  

Public discontent about the environment, risk, sprawl, blight etc.  perhaps, has less to do with any of these specific ill defined goals than with discontent about land management practices.

Friday, August 15, 2014

Flood Risk and the Miami-Dade Urban Development Line

Several days ago I wrote about how Miami's climate change flood risk is the latest rational for development.  Much akin to the 1970's urban blight.   I'd like to follow up on the assignment of Commissioner Rebeca Sosa to the Sea Level Rise Task Force.

In 2013, Sosa voted to move the Miami-Dade's contentious Urban Development Line westward.

The switch from Ruvin to Sosa for chair of the Task Force is telling of Miami-Dade County's politics.   Ruvin has long been a proponent of environmental protection and specifically to that pertaining to the Everglades.  His Task Force report advocated for protecting the Everglades.  Sosa, clearly does not feel quite the same about the importance of leaving the Everglades undeveloped.

As shown in the satellite image above, the region is wetlands.  To build on it requires draining the land.  More recent residential development shows the land drained to create "waterfront" properties.  These are high flood risk properties.

The image below (taken from this report) shows regions of Miami-Dade and the era of which they were developed.  The red shows progressive movement into the Everglades.

Florida's entire economy is rests on the assumption that population will continue to grow.  Population is assumed to drive real estate development and jobs.  The below image is frequently reproduced by the Florida Legislature's Office of Economic and Demographic Research.  
However, the wetlands are prone to flooding and impacts from sea level rise.  So, while Florida grows its population and Miami puts them in flood prone areas, the state's flood risk grows.

This puts Miami in an interesting situation.  On one hand it advocate for a perspective of growing flood risk due to climate change.  On the other they seek to develop high flood risk areas while the state attempts to develop an "affordable" private flood insurance market.  These goals are incompatible.

It will be interesting to see how this continues to develop.

Tuesday, August 12, 2014

Are catastrophe bonds worth it?

Earlier this year, the Wall Street Journal had an article on catastrophe bonds.  At the end of the article, they mention that over the lifetime of the market (since 1996) the cumulative total risk is $51 billion.  At Artemis, they estimate the total risk at about $61billion.

The WSJ reports that total losses from natural hazard events is $682 million.  Assuming that some losses came from somewhere else too the total loss over the last 15 years is likely somewhere between $682 and $1B.  The latter is a nice round number so I will use it.

Over the last 10 years, the average yield on catastrophe bonds has been about 8% (dat from same WSJ article).  That is the money paid to investors in the bond.

So, estimated total paid out to investors since 1996 is somewhere around $3B (taking into consideration the $1B loss).

Since 1996, for every dollar an insurer pays the investors to make the risk worthwhile, they have seen a return of about 25 cents (all unadjusted dollars).

Obviously, this seems a good deal for investors.  It is a nice trickle of money from policyholders, to insurers, to the capital markets.  But what are the opportunity costs policyholders?

In recent years, CPIC has offered the largest catastrophe bonds ever.  This year, the bond is $1.5 billion.

With the assumed average 8% yield, if CPIC doesn't end up needing the bond, then it pays investors somewhere around $120 million.  If they do need the bond, they get $1.5 billion.

With at least some possibility that CPIC will exhaust their total claims paying capacity (bonds and all), is there something more productive that can be done with $120 million of policyholder money (aka taxpayers)?

Where resources are limited, such is the case with policyholder pocketbooks, and public policy is to manage risk for the public welfare, policy makers ought to consider if this scenario is an effective use of public funds.

Especially considering that capital markets are fickle- what is relatively cheap and available now can become scant and pricey in a matter of moments.

Would $120 million invested elsewhere have an improved return, reduce the total risk in Florida and thereby contribute to social stability over a longer term?


Mitigation, infrastructure and education come to mind.  I have no doubt there are innovative ideas that could arise if the question was critically examined.