Category: Insurance

Annuities, Once More, With Feeling

Posted on by David Merkel

Picture Credit: Mike Cohen || Ordinarily, the only annuities worth buying pay income at some fixed date, whether present or future. Oh, and they aren’t variable annuities.

I’ve written a number of articles on annuities. Here are a few examples:

In general, I don’t think anyone should buy variable annuities, with some rare exceptions where the actuaries pricing the policies have mispriced the guaranteed portion of the benefits too cheaply. I have seen this about a dozen times in my life. Actuaries are not quants (me and a few others excepted), and so some of them don’t get option pricing. But actuaries tend to be conservative, and so they don’t typically offer a free lunch.

Annuities are typically an expensive way to get returns. Typically, the all-in expenses of annuities range from 1.0-2.5%/year. As such returns are typically poor.

But there is one competitive portion of the annuity market, which is where companies compete to pay a fixed income to people, whether presently, or at some future date.

This article was prompted by three articles at Morningstar. Here they are:

Morningstar basically agrees with my point of view on annuities. They like annuities that have fixed terms and pay out income.

Now, these annuities have two risks: default and inflation. But they come with a benefit — longevity insurance — they pay as long as you live.

Default risk is minimal as you have the state guaranty funds backing them up to $250,000 of present value. Like CDs that risk can be mitigated by buying multiple fixed payout annuities from many companies, keeping the amount invested under $250,000.

Inflation is not a solvable issue. It is better to treat your annuity as a part of you bond portfolio, invest the remainder of your bonds at short durations, and invest in stocks, especially cyclicals and dividend-payers. That is a reasonable approach to hedging inflation.

Morningstar’s policy recommendations to the US Government are reasonable, but I would not think they are crucial to most people. If you are motivated, you will find ways around the restrictions. If not, you pay more taxes. Well, someone has to pay it.

Summary

In general, insurance is meant to hedge risks, and not be an investment. If you are hedging longevity risk, fixed payout annuities can be a useful part of your portfolio. Otherwise, avoid buying annuities.

Should You Become an Actuary?

Posted on by David Merkel

Image credit: Word Cloud by Epic Top 10 || It is a great profession, but for most people, the exams are tough.

Note: at the end of this article, there is a note on GameStop.

Here’s a letter from a reader:

David,
I am a longtime reader of your blog, which I enjoy greatly. I will retire from the military in about three years and am considering becoming an actuary via self-study and taking the requisite exams. Given your experience in the field, I would like to ask you some questions:

1.       If I do this, will anyone hire me, or is this field one that strictly recruits new graduates from certain established schools?  My degrees are in Chemical and Aeronautical Engineering (BS & MS respectively) if that matters.

2.        If this is a reasonable path to take, which organization’s certifications should I pursue (SoA or CAS)?

3.       How do I go about applying for positions outside of a formal recruitment process (e.g. one established for recent graduates)?

Thank you for your time and attention.

Recent email

I haven’t gotten an email like that in a while. You can become an actuary if you are good at math, statistics, quantitative methods, and are reasonably good at taking exams. That can get you in the door, but oddly, there ‘s another set of skills that the best actuaries have. Let me phrase it in terms of questions:

  • Do you like solving business problems?
  • Can you write and speak well in the language of the company that you want to work for?
  • Can you come up with creative solutions to problems?
  • Do you like solving mysteries, without forgetting that time is limited?
  • It is helpful to have a few ancillary skills like programming, knowledge of accounting, investing, business, economics, law, etc. You can pick up a lot on the way. At certain companies with foreign subsidiaries, knowing a foreign language could help.

I was a generalist life actuary who could do almost everything, but I had a specialization in investing long before that became valuable. That made me very valuable to a few life insurers that I served, as well as one hedge fund that focused on financial stocks. Eventually, I got called a “Non-traditional actuary” because I no longer worked directly in insurance or employee benefits. And I eventually dropped my FSA credential because I couldn’t justify the cost, AND the continuing education requirements, which were not relevant to what I was doing.

My guess is that you have sufficient math ability to pass the exams. Note that the actual amount of math that you need to know for work is well below what the exams test for. I never used calculus or statistics with calculus in all the time I was an actuary. The highest level math that I ever used was a quadratic equation, and that was once. Don’t get me wrong, there was a lot of math, but it was all add, subtract, multiply, and divide repeatedly, with exponentials for discounting.

Don’t pass too many exams before you seek work. Companies often don’t know what to do with those who have many exams, but no experience. Passing the first exam is enough to show the company that you are smart.

Insurance isn’t like certain investment firms that tend to be clubby, and only hire from one school. If you put your mind to it, you can likely get hired. Many firms want well-rounded actuaries that aren’t merely math nerds. Getting a mathematical result is one thing, but can you express it in such a way that marketers, underwriters and service staff can understand? Can you understand the business processes that produce the numbers? Can you tear apart the results that come out of the operating computer system for the enterprise, reverse-engineer them, and prove them to be true or false? Can you take the data from financial reporting, and feed it back to pricing, so that they can figure out whether their pricing assumptions are correct? Many insurance computer systems are inadequately designed, and being able to manipulate data for analysis can be a challenge.

A few more notes: your degrees will not hurt you… actuaries have all manner of different majors. Mine was economics. It s even possible that your degrees could come in useful at a company that writes specialty lines of property and liability insurance for various industrial firms… and engineering background can be applied in a lot of different ways.

As such, I would recommend that you join the Casualty Actuarial Society, and not the Society of Actuaries. Both are great organizations, but your background would fit the Casualty mold better. There are two other reasons to join the CAS. 1) I always found CAS members to be more businesslike than most members of the SOA. 2) There is more growth potential in P&C insurance, unless interest rates rise to the point life insurers can invest in long duration bonds to make a profit. Even then, there are so many niches in P&C insurance, whereas in life insurance and pensions opportunities are limited.

In looking for work, there are two ways to go. I have used both of them.

  1. Use a recruiter. Look at the ads in the National Underwriter, or any other major insurance publication and look for the ads from recruiters. Call them and talk to them. Jacobson and Associates is pretty big. But remember that the employer has to pay more for your services for the first year because of the recruiter. It could affect your salary.
  2. Analyze the insurers that you might want to work for. Call the Chief Actuary and ask for an informational interview (a la What Color is Your Parachute?) Talk to him, be honest, tell him what you would like to do, and ask for his honest advice. That in its own right could get you a job. It did for me as a 25-year old grad student whose Ph. D. dissertation was foundering. In many ways I seemed overqualified, but they took a chance on me at Pacific Standard Life, which three years later would be the biggest life insurance insolvency of the 1980s.

Some final notes: realize that there are a lot of insurers and actuarial consulting firms out there. Some are public, some are private, and some are mutual. If you are able to look at a membership list of the CAS or SOA, you can get quite a view of where actuaries get hired, and how many of them. You can ask the SOA or CAS to see such a document. In the old days, all actuaries received one. I don’t know what they do today.

Get a sense of where you would like to live, and what insurance-related enterprises are there. Or, do it the other way, and look at the insurance companies you might like to work for, and ask yourself if you would like to live there.

I wish you the best in your job hunt. The important thing is to get your foot in the door, and after that, demonstrate competence.

==========

To my readers: Regarding GameStop — in some ways, this is like the Go-go years of the sixties, where speculation was rampant, or like the period from 1900-1929, where wealthy men manipulated the markets for their own ends, trying to snare profits in the process, much as penny stock operators have done in the last ten years. What I would be concerned with here is that the SEC might do something stupid, and regulate stock prices the way some futures prices are regulated: if the price for the futures moves by more than a given amount, the market closes for the day. Note that that does not get rid of the volatility; it only shifts it into the future.

One more note for GameStop management (I know you read me, right?): the best thing you could do is to do a PIPE (Private investment in Public Equity) overnight and issue 30 million shares at ~$200/share to a variety of institutional investors not including Fidelity or Blackrock (unless they want to play). What would this do?

  • All of your 10%+ holders would be free to sell their shares, because their stakes would be below 10%.
  • You would have more than enough money to retire all of your debt and then some.
  • With the remaining $5 billion bucks, you could be assured of a happy outcome where the GME stock price is over $50, and you would have time to consider how to restructure the firm into some business that actually has a future. The only ones that lose are the idiots who believe in magic, and think that stock prices don’t reflect economic realities, only trading values.

Anyway, what I said last night still applies — in the long run the price of GME will fall. Bubbles can only be sustained by an ever-larger amount of money buying in, which is impossible. Eventually, people need the money to live, rather than speculate.

The Challenge for Warren Buffett

Posted on by David Merkel

Photo Credit: Javier || THis is a much younger version of Buffett. Has the present Buffett learned to adapt?

Barron’s ran an article called Why Berkshire Hathaway Stock Has Rarely Been This Cheap. It was written by Andrew Bary, a man that I respect. I wrote a comment at the article, and it reads as follows:

So long as the government & its commercial paper financing arm (The Fed) is willing to create grants and credit out of thin air to rescue businesses, Buffett will not get opportunities to buy stock at the discounts that he has liked to see in the past. The cash pile will grow, & BRK stock will likely muddle.

Buffett’s justification for the cash pile changed at his last annual meeting, saying BRK needed it for catastrophes from their insurance underwriting. He has always faced that risk, and in the past has said that he might need $20B for that. (And he commented that his insurance companies were well-reserved, which is probably true.)

Choices for Buffett: 1) lower his hurdle rates for purchase down to levels where the government starts to act. 2) let the cash pile grow, and buy a huge business with significant moats that he could never dreamed of owning. 3) Start a slow buyback of stock and set a slightly higher multiple of book for where to cut it off. 4) Pay a special dividend, or, start a regular dividend. 5)Tell the managers of the operating businesses to look for decent-sized private businesses that they admire, particularly ones with succession issues. Send Buffett a proposal, and he will send a price. You can make the offer to the firm to join the BRK family. 6) Give Ted and Todd and the operating managers lower hurdle rates for investment. 7) Just muddle along, as it is now.

Order of likelihood: 7, 2, 3, 5, 6,1, 4. I don’t think Buffett will change much.

Why Berkshire Hathaway Stock Has Rarely Been This Cheap

My main contention with Buffett, as I am a shareholder, is that you can’t rely on the past when considering how far the market may fall when there is a crisis.

The nature of the US economy is that the Fed, and maybe the Treasury, or Congress, may borrow money to bail out those in distress, partly because the US economy is so indebted, that they can’t let debts be liquidated, lest we have a depression. Thus, low interest rates, low marginal productivity of capital, and low GDP growth.

In such a situation, the market will not fall enough to offer the values of a lifetime. The Fed will dilute the capital stock to provide a rescue, while Buffett finds himself diluted. Buffett’s money can’t buy a good company at a cheap price.

I sold half of my holdings in BRK recently, after I learned that Buffett did nothing during the recent fall in the stock market. Market values are relative, and there were certainly decent values to be realized in late March. You wouldn’t blow the whole wad, but surely you should have bought something.

I may sell off the rest of my holdings in BRK. Under the right conditions, I would buy more. The question is whether Buffett has an outdated view of how much the market could fall, given the skittish attitudes of economic policymakers.

Full Disclosure: long BRK/B for myself and clients

Dissent on Triple-S Management II

Posted on by David Merkel

Photo Credit: Morris Zawada || Looked at many dissent pictures, and they did not represent my views. A Pro-life march, in its principled and relatively quiet nature, with people who are mostly otherwise apolitical, fits.

I’ll give the big news up front, then I will explain. I decided to put Triple-S Management in the “too hard” pile, to use a phrase of Buffett’s. I am flat the stock for my clients and me. I don’t short, but if the price drops severely if/when Propiedad (the P&C subsidiary) goes into insolvency, I will buy in again.

Here’s my overall thesis: 1) I find it difficult to believe that Propiedad is solvent on a current basis. I do think there are reasons for the PR insurance department to play along as if they are solvent, giving them time to become solvent… but that’s a gambit that might not work if enough policyholder lawsuits succeed and get payments significantly higher than the amounts at which they are reserved. If that happens, and claims incurred from prior years goes significantly positive, there will be a lot of disbelief about the solvency of Propiedad.

2) If Propiedad goes insolvent there may be an effort to allege or force the parent company to stand behind all claims. That may take a number of forms, some of which are informal and messy, and are not likely to work. The formal methods of trying to do it are also not likely to work. That said, who can tell how a judge might rule on some marginal things that Triple-S did.

3) The stock is not going to zero. My base case is around $30/share if Propiedad is allowed to fail without additional cost to Triple-S.

Why Propiedad might Fail

I spent a decent amount of time thinking about the reserving issues, and it is possible for a P&C insurer to estimate values considerably lower in the short-run than what the company might ultimately pay. This is particularly true with long-tail coverages like asbestos and environmental, but less true with home and property claims.

In the 1980s, it was alleged by some industry observers that the entirety of long-tail P&C reinsurers that were active at that time were effectively broke. They were under severe stress. They delayed paying claims. They played for time hoping that they would earn enough on new business that they could stay afloat. Like the old joke, they hoped to eat the whole elephant “one bite at a time.” And for many of them with forbearing regulators and insureds, it worked. In similar situations, if regulators or insureds don’t play along, they can be forced into insolvency.

That may end up being the case with Propiedad. Insureds may win in court cases, and the initial winners will deplete the claims paying ability of Propiedad, leading the PR insurance department to take over to preserve value for the remaining claimants.

We are now more than two years past the Maria hurricane, and much of Puerto Rico is still a mess. Part of that stems from slowness in the US Government in giving aid. Some of its stems from insurers being slow to pay, and the courts of PR possibly being clogged as a result of all of the lawsuits being filed.

It seems that Propiedad has saved the worst for last in its effort at paying its claims. Thus comparisons to what has been paid already may be less than valid. It’s unusual to have so many claims hanging out past two years. Part of this is due to the size of the disaster relative to the size of Puerto Rico. Part of it also is that claims contested in court will take longer, and the courts may have their hands full.

But another aspect could be the insurance department trying to maximize claim payments to commercial insureds. If Propiedad survives, claimants have the opportunity to get a full payment. If Propiedad fails, and goes into liquidation, claimants will be limited a share of the assets in Propiedad, and whatever can be assessed by the PR Insurance Department on the premiums of surviving P&C insurers serving the state, up to a limit of $300,000/claim and $1,000,000 to any given entity.

In other words, you can sue Propiedad for what you would like, but the maximum you can recover if it is insolvent rests on:

  • the maximums as specified by the guaranty fund, or if there is more money from the insolvent estate of Propiedad
  • pro-rata reimbursement of claims over the maximums of the guarantee fund.

If Propiedad is afloat and earning money, and not paying dividends to Triple-S, the recovery levels of all claimants above the guaranty fund limits get higher. Also note that the PR Insurance department may not want to assess the remaining insurers. With the limited supply of insurers active in PR, it would likely mean higher premiums for all who are insured, in order for the companies to pay the assessments.

(As an aside, the P&C guaranty funds have a nice website with lots of data. I’ve cited some here already. It would have been more interesting if a means of contacting the PR guaranty fund were there, or how many claims their guaranty fund has had, and the assessments needed to fund them. But alas, PR has not reported financial data to them since 2010.)

But that brings us to the next point which will be:

Will Triple-S Pay the Claims of Propiedad?

I don’t think so. First, such an obligation is not listed in the 10-K or the statutory statements. A. M. Best rates them that way also. Propiedad has made statements like Triple-S stands behind Propiedad, but those are far short of a “full faith and credit guarantee” from the parent company. I should know: for four years I wrote GICs [guaranteed investment contracts] from a bankruptcy-remote subsidiary of the parent company. When my credit rating was no longer good enough to sell GICs because of buyers insisting on higher ratings, I could not get the parent company to agree to guarantee the GICs, and so I closed down the line of business.

It’s not impossible, though, that a judge would look at the vague statements and conclude otherwise. I think Triple-S would have meritorious arguments that other companies have said things like that, and they were not used to create a “full faith and credit guarantee.”

It is more likely that implicit pressure against the health subsidiary could be used to have Triple-S pay a limited amount to help with claims as they send Propiedad into insolvency.

If Triple-S Avoids Claims Due to Propiedad

The tangible book value of Triple-S excluding their equity in Propiedad is a little more than $34/share. Imagine Triple-S closing down operations because PR takes away their ability to write more health business. There would be a minor panic as many people and companies would have to go to the remaining health insurers in PR for coverage, and insurance rates would certainly rise. Triple-S would keep a skeleton staff for one year, and a smaller one for the next year as they pay out terminal dividends to the shareholders of at least $30/share.

But I could be wrong. Clever lawyers could find a way to charge Triple-S with the full value of claims owed by Propiedad, and those claims would have to be over $1.2 billion to drive the stock to zero. Those are the two victory criteria for the shorts. If Maria claims against Propiedad end up less than $300 million or Triple-S can send Propiedad into insolvency, then it is worth more than the current price.

But for now I will sit back and watch. There are too many jolts and bumps here, and I have safer ideas to invest in.

PS — I think the shorts would do better if they laid off the sensationalism of certain events associated with the management of Triple-S, and focus on the main question: can Triple-S be charged with the claims that Propiedad can’t pay? That is the key question.

Full disclosure: no positions in any companies mentioned in this article, for clients or me. This updates my views since the last article.

Issue Longer Treasury Debt

Posted on by David Merkel

Picture credit: DonkeyHotey || Should bonds get longer?

When I visited the US Treasury during the first Treasury/Blogger summit I encouraged the US Treasury to issue debts longer than 30 years, and also floating rate debt. I said the insurance companies, pension funds and endowments would be willing buyers, and that it would be cheaper than issuing 30-year bonds. I thought that the yields on (say) 50-year bonds would be lower than 30-year bonds, because the yield curve for most of my life (at that point) had the yield curve peaking out at around 22 years or so. 30-year bonds usually yielded less than 20-year bonds.

The case for issuing longer debt was easy when 30-year bonds yielded less than 20-year bonds. That is no longer true, and has not been true since the financial crisis. In a low interest rate environment, 30-year bonds yield more than 20–year bonds. In a higher interest rate environment, the relationship flips.

So, should the US treasury issue 50-year, 100-year, or perpetual bonds? I still think the answer is yes, and for three reasons.

1) It’s an experiment. The market doesn’t always know what it wants until you offer an option to it. No degree of discussion with the advisory committee can beat an actual offering to the market. There used to be callable T-notes, and even a Treasury note denominated in Swiss Francs. Experiments are worth trying on a small level just to see what happens. Knowledge is a valuable thing — theory is worth less than tangible data.

2) Rates are low. Why not lock in the low rates? Even if 50-year bonds have a premium yield to 30-year bonds, those yields are likely lower than what you might get when interest rates are high.

3) It would be genuinely useful for life insurance companies and pension funds to have a benchmark for 50-year bonds, which would encourage the corporate market to issue debt as well. Those who make long promises need others who will make similarly long fixed commitments.

Then there are the speculators, who I don’t care much about. They would appreciate longer debt as well, as it would give them a greater place to speculate.

My advice to the US Treasury is this: issue longer debt as an experiment. If there is additional cost in the short-run, see if it is cheaper in the long run. There is a market for longer debt, even if your advisory committee thinks differently.

Getting a Job in Insurance

Getting a Job in Insurance

Posted on by David Merkel

Photo Credit: Boston Public Library

Well, I never thought I would get this question, but here it is:

Thank you for your dedication to your blog.

I was wondering if you have any skill development advice for recent graduates to gain a job in insurance – is technical or programming skills the most important or perhaps making business cases, or showing that you can make sound and reasonable conclusions?

Thank you for your time.

Kind regards,

There are many things to do in insurance.? Some are technical, like being an actuary, accountant, investment analyst/manager/trader, underwriter, lawyer or computer programmer.? Some take a great deal of interpersonal skills, like being an administrator, marketer or agent.? Then there are the drones in customer service and claims.? Ancillary jobs can include secretaries, janitors, human resources, and a variety of other helpers to the main positions.

Before I begin, I want to say a few things.? FIrst, if you work in insurance, be kind to the drones and helpers.? It is the right thing to do, but beyond that, they don’t have to go beyond their job description — they know their opportunities are limited — it is only a job.? Treat them with respect and kindness, and they will go above and beyond for you.? I learned this positively first-hand, and a few of them 20-30 years older explained it to me when I noticed they weren’t helping others who were full of themselves.

Second, the insurance industry does a lot to train drones, helpers, agents, marketers, underwriters, and younger people generally, if they are willing to work at it.? There are self-study courses and exams that vary based on what part of the industry you are in.? Take the courses and exams, and your value goes up — it is not obvious how that will work, but it often pays off.

Third, it is not a growing industry, but lots of Baby Boomers are retiring, and leave openings for others.? Also, drone and helper positions often don’t pay so well at the entry level, and turnover is somewhat high.? The same is true of agents — more on that later.

Fourth, watch “The Billion Dollar Bubble,” and episodes of Banacek if you want.? The actual practices of how they did things in the ’60s and ’70s don’t matter so much, but it gets the characterization of the various occupations in insurance right.

FIfth, insurance is a little like the “Six Blind Men and the Elephant.”? Actuaries, Accountants, Administrators, Marketers, Underwriters, and Investment Managers (and Lawyers and Programmers) each have a few bits of the puzzle — the challenge is to work together effectively.? It is easier said than done.? You can read my articles on my work life to get a good idea of how that was.? I’ve written over 30 articles on the topic.? Here are most of the links:

DId I leave out the one on insurance company lawyers?? Guess not.

Sixth, it is easier to teach those with technical skills how the business works than to teach drones and helpers technical skills.? It’s kind of like how you can’t easily teach math and science to humanities and social science majors, but you can do the reverse (with higher probability).? It is worth explaining the business to computer programmers.? It is worth explaining marketing and sales to actuaries.? Accountants get better when they understand what is going on behind the line items, and maybe a touch of what the actuaries are doing (and vice-versa).

Seventh, only a few of the areas are close to global — the administrators, the underwriters, the actuaries, and the marketers — and that’s where the fights can occur, or, the most profitable collaborations can occur.

Eighth, insurance companies vary in terms of how aggressive they are, and the dynamism of positions and ethical conundrums vary in direct proportion.

So, back to your question, and I will go by job category:

  1. Drones and helpers typically don’t need a college education, but if they show initiative, they can grow into a limited number of greater positions.
  2. Computer programmers probably need a college degree, but if you are clever, and work at another insurance job first, you might be able to wedge your way in.? While I was an actuary, I turned down a programming job, despite no formal training in programming.
  3. Lawyers go through the standard academic legal training, pass the bar exams, nothing that unusual about that, but finding one that truly understands insurance law well is tough.
  4. Accountants are similar.? Academic training, pass the accounting exams, work for a major accounting firm and become a CPA — but then you have to learn the idiosyncrasies of insurance accounting, which blends uncertainty and discounting with interest.? The actuaries take care of a lot of it, but capturing and categorizing the right data is a challenge.
  5. Actuaries have to be good with math to a high degree, a college degree is almost required, and have to understand in a broad way all of the other disciplines.? The credentialing is tough, and may take 5-10 years, with many exams, but you often get study time at work.
  6. Agents — can you sell?? Can you do a high quality sale that actually meets the needs of the client?? That may not require college, but it does require significant intelligence in understanding people, and understanding your product.? Many agents can fob some bad policies off on some simpletons, but it comes back to bite, because the business does not last, and the marketing department either revokes your commissions, or puts you on a trouble list.? “Market conduct” is a big thing in insuring individuals.? The agents that win are the ones that serve needs, are honest, and make many sales.? Many people are looking for someone they can trust with reasonable returns, rather than the highest possible return.? One more note: there are many exams and certifications available.
  7. Marketers — This is the province of agents that were mediocre, and wanted more reliable hours and income.? It’s like the old saw, “Those who cannot do, teach. Those who cannot teach, administrate.”? It is possible to get into the marketing area by starting at a low level helper, but it is difficult to manage agents if you don’t have their experience of rejection.? Again, there are certifications available, but nothing will train you like trying to sell insurance policies.
  8. Underwriters — as with most of these credentials, a college degree helps, but there is a path for those without such a degree if you start at a low level as a helper, show initiative, and learn, learn, learn. Underwriters make a greater difference in coverages that are less common.? Where the law of large numbers applies, underwriters recede.? The key to being an underwriter is developing specialized expertise that allows for better risk selection.? There are certifications and exams for this, pursue them particularly if you don’t have a college degree.? Pursue them anyway — as an actuary, I received some training in underwriting.? It is intensely interesting, especially if you have a mind for analyzing the why and how of insured events.
  9. Investment personnel — this is a separate issue and is covered in my articles in how one can get a job in finance.? That said, insurance can be an easier road into investing, if you get a helper position, and display competence.? (After all, how did I get here?)? You have to be ready to deal with fixed income, which? means your math skills have to be good.? As a bonus, you might have to deal with directly originated assets like mortgages, credit tenant leases, private placements, odd asset-backed securities, and more.? It is far more dynamic than most imagine, if you are working for an adventurous firm.? (I have only worked for adventurous firms, or at least adventurous divisions of firms.)? Getting the CFA credential is quite useful.
  10. Administrators — the best administrators have a bit of all the skills.? They have to if they are managing the company aright.? Most of them are marketers, and? a few are actuaries, accountants,or lawyers.? Marketing has an advantage, because it is the main constraint that insurance companies face.? It is a competitive market, and those who make good sales prosper.? VIrtually all administrators are college educated, and most have done additional credentialing.? Good administrators can do project, people and data management.? it is not easy, and personally, few of the administrators I have known were truly competent.? If you have the skills, who knows?? You could be a real success.

Please understand that I have my biases, and talk to others in the field before you pursue this in depth.? Informational interviewing is wise in any job search, and helps you understand what you are really getting into, including corporate culture, which can make or break your career.? Some people thrive in ugly environments, and some die.??Some people get bored to death in squeaky-clean environments, and some thrive.

So be wise, do your research, and if you think insurance would be an interesting career, pursue it assiduously.? Then, remember me when you are at the top, and you need my clever advice. 😉

 

On the Migration of Stock

On the Migration of Stock

Posted on by David Merkel

Photo Credit: ashokboghani

This should be a brief article.? I remember back in 1999 to early 2000 how P&C insurance stocks, and other boring slower-growth industries were falling in price despite growing net worth, and reasonable earnings.? I was working for The St. Paul at the time (a Property & Casualty Insurer), and for an investment actuary like me, who grew up in the life insurance business it was interesting to see the different philosophy of the industry.? Shorter-duration products make competition more obvious, making downturns uglier.

The market in 1999-2000 got narrow.? Few groups and few stocks were leading the rise.? Performance-conscious investors, amateur and professional, servants of the “Church of What’s Working Now,” sold their holdings in the slower growing companies to buy the shares of faster growing companies, with little attention to valuation differences.

I remember flipping the chart of the S&P 1500 Supercomposite for P&C Insurers, and laying it on top of an index of the dot-com stocks.? They looked like twins separated at birth, except one was upside down.

When shares are sold, they don’t just disappear.? Someone buys them.? In this case, P&C firms bought back their own stock, as did industry insiders, and value investors — what few remained.? When managed well, P&C insurance is a nice, predictable business that throws of reliable profits, and is just complex enough to scare away a decent number of potential investors.? The scare is partially due to the effect that it is not always well-managed, and not everyone can figure out who the good managers are.

So shares migrate.? Those that fall in the midst of a rally, despite decent economics, get bought by long-term investors.? The hot stocks get bought by shorter-term investors, who follow the momentum.? This continues until the gravitational effects of relative valuations gets too great — the cash flows of the hot stocks do not justify the valuations.

Then performance reverts, and what was bad becomes good, and good bad, but as with almost every investment strategy you have to survive until the turn, and if the assets run from the prior migration, it is cold comfort to be right eventually.

As an aside, this is part of what fuels dollar-weighted returns being lower than time-weighted returns.? The hot money migration buys high, and sells low.

Thus I say to value investors, “Persevere.? I can’t tell you when the turn will be, but it is getting closer.”

The Rules, Part LXIII

The Rules, Part LXIII

Posted on by David Merkel

Photo Credit: Pete Edgeler
Photo Credit: Pete Edgeler

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Onto the next rule:

“We pay disclosed compensation. ?We pay undisclosed compensation. ?We don’t pay both?disclosed compensation?and undisclosed compensation.”

I didn’t originate this rule, and I am not sure who did. ?I learned it at Provident Mutual from the Senior Executives of Pension Division when I worked there in the mid-’90s. ?There is a broader rule behind it that I will get to in a moment, but first I want to explain this.

There are many efforts in business, particularly in sales, where some?want to hide what they are truly making, so that they can make an above average income off of the unsuspecting. ?At the Pension Division of Provident Mutual, the sales chain worked like this: our representatives would try to sell our investment products to pension plans, both municipal and corporate. ?We preferred going direct if we could, but often there would be some fellow who had ingratiated himself with the plan sponsor, perhaps by providing other services to the pension plan, and he would become a gateway to the pension plan. ?His recommendation would play a large role in whether we made the sale or not.

Naturally, he wanted a commission. ?That’s where the rule came in, and from what I?remember at the time, many companies similar to us did not play by the rule. ?When the sale was made, the client would see a breakdown of what he was going to be charged. ?If we were paying disclosed compensation to the “gatekeeper,” we would point it out and mention that that was *all* the gatekeeper was making. ?If the compensation was not disclosed, the client would see the bottom line total charge, and he would have to evaluate if that was good or bad deal for plan participants.

Our logic was this: the plan sponsor would have to analyze the total cost anyway for a bundled service against other possible bundled and unbundled services. ?We would bundle or unbundle, depending on what the gatekeeper and client wanted. ?If either wanted everything spelled out we would do it. If neither wanted it spelled out, we would only provide the bottom line.

What we would never do is provide a breakdown that was incomplete, hiding the amount that the gatekeeper was truly earning, such that client would see the disclosed compensation, and think that it was the entire compensation of the gatekeeper.

We were the smallest player in the industry as far as life insurers went, but we were more profitable than our peers, and growing faster also. ?Our business retention was better because compensation surprises did not rise up to bite us, among other reasons.

Here’s the broader rule:

“Don’t be a Pig.”

Some of us?had a saying in the Pension Division, “We’re the good guys. ?We are trying to save the world for a gross margin of 0.25%/year on assets, plus postage and handling.” ?Given that what we did had almost no capital requirements, that was pretty good.

Most scandals over pricing involve some type of hiding. ?Consider the pricing of pharmaceuticals. ?Given the opaqueness is difficult to tell who is making what. ?Here is another?article on the same topic?from the past week.

In situations like this, it is better to take the high road, and make make your pricing more transparent than your competitors, if not totally transparent. ?In this world where so much data is shared, it is only a matter of time before someone connects the dots on what is hidden. ?Or, one farsighted competitor (usually the low cost provider) decides to lay it bare, and begins winning business, cutting into your margins.

I’ll give you an example from my own industry. ?My fees may not be the lowest, but they are totally transparent. ?The only money I make comes from a simple assets under management fee. ?I don’t take soft dollars. ?I make money off of asset management that is?aligned with what I myself own. ?(50%+ of my total assets and 80%+ of my liquid assets are invested exactly the same as my clients.)

Why should I muck that up to make a pittance more? ?It’s a nice model; one that is easy to defend to the regulators, and explain to clients.

We probably would not have the fuss over the fiduciary rule if total and prominent disclosure of fees were done. ?That said, how would the brokers have lived under total transparency? ?How would life insurance salesmen live? ?They would still live, but there would be fewer of them, and they would probably provide more services to justify their compensation.

Even as a bond trader, I learned not to overpress my edge. ?I did not want to do “one amazing trade,” leaving the other side wounded. ?I wanted a stream of “pretty good” trades. ?An occasional tip to a broker that did not know what he was doing would make a “friend for life,” which on Wall Street could last at least a month!

You only get one reputation. ?As Buffett said to the Subcommittee on Telecommunications and Finance of the Energy and Commerce Committee of the U.S. House of Representatives back in 1991 regarding Salomon Brothers:

I want the right words and I want the full range of internal controls. But I also have asked every Salomon employee to be his or her own compliance officer. After they first obey all rules, I then want employees to ask themselves whether they are willing to have any contemplated act appear the next day on the front page of their local paper, to be read by their spouses, children, and friends, with the reporting done by an informed and critical reporter. If they follow this test, they need not fear my other message to them: Lose money for the firm, and I will be understanding; lose a shred of reputation for the firm, and I will be ruthless.

This is a smell test much like the Golden Rule. ?As Jesus said, “Therefore, whatever you want men to do to you, do also to them, for this is the Law and the Prophets.” (Matthew 7:12)

That said, Buffett’s rule has more immediate teeth (if the CEO means it, and Buffett did), and will probably get more people to comply than God who only threatens the Last Judgment, which seems so far away. ?But I digress.

Many industries today are having their pricing increasingly disclosed by everything that is revealed on the Internet. ?In many cases, clients are asking for a greater justification of what is charged, or, are looking to do price and quality comparison where they could not do so previously, because they did not have the data.

Whether in financial product prices, healthcare prices, or other places where pricing has been bundled and secretive, the ability to hide is diminishing. ?For those who do hide their pricing, I will offer you one final selfish argument as to why you should change: given present trends, in the long-run, you are fighting a losing battle. ?Better to earn less per sale with happier clients, than to rip off clients now, and lose then forever, together with your reputation.

 

Everyone Needs Good Advice

Everyone Needs Good Advice

Posted on by David Merkel

Picture Credit: jen collins

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I am a fiduciary in my work that I do for my clients. I am also the largest investor in my own strategies, promising to keep a minimum of 80% of my liquid net worth in my strategies, and 50% of my total net worth in them (including my house, etc.).

I believe in eating my own cooking. ?I also believe in treating my clients well. ?I’ve treated part of this in an earlier post called?It?s Their Money, where I describe how I try to give exiting clients a pleasant time on the way out. ?For existing clients, I will also help them with situations where others are managing the money at no charge, no payment from another party, and no request that I manage any of those assets. ?I do that because I want them to be treated well by me, and I know that getting good advice is hard. ?As I wrote in a prior article?The Problem of Small Accounts:

We all want financial advice.? Good advice.? And we want it for free.? That?s why we come to the Aleph Blog, where advice is regularly dispensed, and at no cost.

But? I can?t be personal, and give you advice that is tailored to your situation.? And in my writing here, much as I try to be highly honest, I am not acting as a fiduciary, even though I still make my writings hold to such a standard.

Ugh.? Here?s the problem.? Good advice costs money.? Really good advice costs a lot of money, and is worth it, if you have enough money to spread the cost over.

But when you have a small account, you have a problem in getting advice.? There is no way for someone who is fiduciary (like me) to make money addressing your concerns.? That is why I have a high minimum for investing: $100,000.? With that, I can spend time on clients, even helping them with assets from which I make no money.

What extra things have I done for clients over time? ?I have:

  • Analyzed asset allocations.
  • Analyzed the performance of other managers.
  • Advised on changing jobs, negotiating salary, etc.
  • Explained the good and bad points of certain insurance companies and their policies, and suggested alternatives.
  • Analyzed chunky assets that they own elsewhere, aiding them in whether they keep, sell, or sell part of the asset.
  • Analyzed a variety of funky and normal investment strategies.
  • Advised on buying a building, and future business plans.
  • Told a client he was better off reinvesting the slack funds in his business that needed?financing, rather than borrow and invest the funds with me.
  • Told a client to stop sending me money, and pay down his mortgage. ?(He has since resumed sending money, but he is now debt-free.)

I take the fiduciary side of this seriously, and will?tell clients that want to put a?lot of their money in my stock?strategy that they need less risk, and should put funds in my bond strategy, where I earn less.

I’ve got a lot already. ?I don’t need to feather my nest at the expense of the best interests of my clients.

Over the last six years, around half of my clients have availed themselves of this help. ?If you’ve read Aleph Blog for awhile, you know that I have analyzed a wide number of things. ?Helping my clients also sharpens me for understanding the market as a whole, because issues come into focus when the situation of a family makes them concrete.

So informally, I am more than an “investments only” RIA [Registered Investment Advisor], but I only earn money off of my investment fees, and no other way. ?Personally, I think that other “investments only” RIAs would mutually benefit their clients if they did this as well — it would help them understand the struggles that they go through, and inform their view of the economy.

Thus I say to my competitors: do you want to justify your fees? ?This is a way to do it; perhaps you should consider it.

Postscript

Having some people in an “investment only” shop that understand the basic questions that most clients face also has some crossover advantages when it comes to understanding financial companies, and different places that institutional money gets managed. ?It gives you a better idea of the investment ecosystem that you live and work in.

Call Me When You Have A Real Insurance Company!

Call Me When You Have A Real Insurance Company!

Posted on by David Merkel

Photo Credit: eflon?|| The?title of the article comes from a comment Greenberg supposedly made to Buffett when AIG was much bigger than Berkshire Hathaway — times change…

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The?title of the article comes from a comment Greenberg supposedly made to Buffett when AIG was much bigger than Berkshire Hathaway [BRK] — times change…

It’s come to this: AIG has sought out reinsurance from BRK to cap the amount of losses they will pay for prior business written. ?It’s quite a statement when you are willing to pay $10 billion in order to have BRK pay 80% of claims over $25 billion, up to $20 billion in total. ?At $50 Billion in claims AIG is on its own again.

So what business was covered? ?A lot. ?This is the one of the biggest deals of its type, ever:

The agreement covers 80% of substantially all of AIG?s U.S. Commercial long-tail exposures for accident years 2015 and prior, which includes the largest part of AIG?s U.S. casualty exposures during that period. AIG will retain sole authority to handle and resolve claims, and NICO has various access, association and consultation rights.

Or as was said in the Wall Street Journal article:

The pact covers such product lines as workers? compensation, directors? and officers? liability, professional indemnity, medical malpractice, commercial automobile and some other liability policies.

Now, AIG is not among the better P&C insurance companies for reserving out there. ?2.5 years ago, they made the Aleph Blog Hall of Shame for P&C reserving. ?Now if you would have looked on the last 10-K on page 296 for item 8, note 12, you would note that AIG’s reserving remained weak for?2014 and 2015 as losses and loss adjustment expenses incurred for the business of prior years continued positive.

For AIG, this puts a lot of its troubles behind it, after the upcoming writeoff (from the WSJ article):

AIG, one of the biggest sellers of insurance by volume to businesses around the globe, also said it expects a material fourth-quarter charge to boost its claims reserves. AIG declined to comment on the possible size. Its fourth-quarter earnings will be released next month.

For BRK, this is an opportunity to make money investing the $10 billion as claims on the long-tail business get paid out slowly. ?It’s called float, which isn’t magic, but Buffett has done better than most at investing the float, and choosing insurance business to write and reinsure that doesn’t result in large losses for BRK.

I expect BRK to make an underwriting profit on this, but let’s assume the worst, that BRK pays out the full $20 billion. ?Say the claims come at a rate of $5 billion/year. ?The average payout period would be 7.5 years, and BRK would have to earn 9.2% on the float to break even. ?At $3.75B/yr, the figures would be 10 years and 6.9%. ?At $2.5B/yr, 15 years and 4.6%.

This doesn’t seem so bad to me — now I don’t know how bad reserve development will be for AIG, but BRK is usually pretty careful about underwriting this sort of thing. That said BRK has a lot of excess cash sitting around already, and desirable targets for large investments are few. ?This had better make an underwriting profit, or a small loss, or maybe Buffett is ready for the market to fall apart, and thus the rate he can earn goes up.

All that said, it is an interesting chapter in the relationship between the two companies. ?If BRK wasn’t the dominant insurance company of the US after the 2008 financial crisis, it definitely is now.

Full disclosure: long BRK/B for myself and clients

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