Search Results for “insurers” – Page 3

The Rules, Part LXVIII

Posted on 7 November 20208 November 2020 by David Merkel

Picture Credit: m.robersonart || “When You Come to a Fork in the Road, Take It” attributed to Yogi Berra

Limit the timing of a person’s choice, and the person will think about choosing.

In 1992, I went to work in the Pension Division of Provident Mutual. It was a time of change as more and more pensions were being structured as defined contribution [DC] plans. Old products structured for defined benefit [DB] plans were being replaced at a slow rate. Immediate Participation Guarantee products were giving way to Guaranteed Investment Contracts, which would quickly give way to Synthetic Guaranteed Investment Contracts.

And for variable accounts, insurers were trotting out separate account products to try to challenge mutual fund companies as they competed for the business 401(k)s and other DC plans. Now old methods die hard. Many of the group annuities marketed to DC plans still had DB style features, which limited the number of times NAVs were calculated, and/or trading from one fund to another, which could only happen when NAVs were calculated.

As time went on NAVs were calculated with greater frequency, moving from annual, to quarterly, to monthly, to daily. Trading ability moved in lockstep, though some firms limited the total number of trades in a year that any participant could make.

And then a strange thing happened. When it was annual many people traded on the day it could be done. Moving to quarterly and monthly, not only did the percentage of people trading drop, the absolute amount dropped as well. Moving to daily, it was almost like people stopped trading. Because they could do it at any time, they stopped worrying about it and did not trade much until a panic hit. (Aside: when it moved to daily, a small group of people did trade frequently, but the grand majority would do nothing, or maybe do one rebalancing trade per year if they were disciplined.

Now, this applies in a number of other areas. Often companies want people to forget that they are paying them for service. This applies to many financial products where fees are paid on a daily basis. It’s tiny on any given day, but adds up over time. If a financial advisor offers direct billing, it is definitely more noticeable when you pay it quarterly.

Other companies want you to pay them on an auto-renewing basis. They may even offer a discount for doing it. I don’t like auto-renew, and so if I do it, I put a tickler note on my calendar to consider non-renewal one month before renewal.

Other companies want you to pay automatically from your credit card or bank account. They don’t want you to think about the money you are sending them. Even though it is a minor hassle to write checks for things, paying for them personally makes you think about the product or service, and whether you think you are getting value for your money.

Service contracts for HVAC equipment can be like that as well. Any sufficiently complex service has some stickiness to it, and you have to plan in advance to replace it. Notes in the tickler file help to get you ready for the renewal dates. This year, for the first time in 10 years, I bid out my E&O coverage. And as I have said before:

“For those that are short on time, my basic advice is this: bid out your auto, home, umbrella and other personal lines property & casualty insurance policies once every three years, or after every significant event that changes your premium significantly.”
Bid Out Your Personal Insurance Policies!

The insurance companies count on the fact that you are asleep to raise your rates at renewal. And, for those that buy deferred annuity products (don’t do it), I can tell you that agents keep their own tickler file of the date that the surrender charge goes to zero. Then they call the policyholder up, saying they have a much better policy for them. I can tell you that the single most important factor in annuity surrender is the end of the surrender charge period. In the two years following it going to zero, 30-40% will surrender, and go to a new annuity, where they are locked in for another surrender charge period. The only winner is the agent. Both the policyholder and company would be better off if they didn’t surrender.

But life insurance products are sold, not bought, for the most part. The policyholder is probably better off saving something, rather than not saving.

My simple advice to you is take a look at your finances, and think about the places where you money is leaving you quietly. Then make a plan to evaluate every every product and service that is auto-paid, and ask whether you can do better — lower cost, better quality, or even “I don’t need that anymore.” Sometimes you might even find fraud. If you aren’t thinking, and defending your finances, product and service providers will find ways to quietly take advantage of you. Don’t be an easy target.

Mad Bombers

Posted on 8 October 2020 by David Merkel

Photo Credit: vaXzine || It’s da Bomb. man…

Some securities I own are illiquid. A few are very illiquid. When I wrote for theStreet.com, we had a warning that we posted for every security mentioned where the market cap was less than half a billion dollars, because what we wrote could budge the market, and sometimes it did. I remember when I wrote a post about personal lines P&C insurers, and I mentioned Safety Insurance [SAFT], which was definitely small, as one of the companies that I thought was worth owning, and we did own it at the firm that I worked for. The stock popped about 5% before settling down.

But frenzies to buy are usually tame compared with frenzies to sell. There is an urgency to preserving value that makes the seller particularly zealous in getting out rapidly.

In the last three weeks, I’ve experienced this twice with two securities that I own. In both cases I bought moreas the seller got aggressive. Let me show you what happened.

This is a graph of National Western Life Insurance over the last three weeks. It’s my largest holding in one of my strategies. On September 23rd, near the close, an aggressive seller, on no news, sold a large block of stock, driving down the price temporarily. I was one of those buying from him, but by no means the biggest buyer.

Then there is TCW Strategic Income Fund [TSI], which is the second-largest holding as bond funds go for my clients, behind PIMCO Enhanced Short Maturity Active ETF [MINT] which I use for liquidity. Yesterday, someone was aggressively selling until 2PM or so, and then they seemed to be done. They may have been selling for three days prior to that. In this case also, I was buying as they were selling, and in this case I caught the bottom tick. Again, there was no news, but when is there ever news for a bond fund?

My main point is this: be willing to be a buyer on days when there is no news, an it is not a sector effect, when a security that you know well is getting thrown out the window for no good reason. Occasionally mad bombers show up and they have to sell down to the last share. Having known some institutional traders, that last sale can be quite aggressive because they want to be DONE!

THere was a guy at theStreet.com, I think his name was Ken Wolff who often talked about “dumpers.” Stocks where a bad event happens, and everyone runs to sell, and there is a climax of volatility where the aggressive sellers have sold their last shares. You see the spike up in volume, and the spike down in the price. His idea was that it was simple to buy then, and close out the trade at the end of the day. On that front, I thought he was pretty clever.

Panic never leads to good results. Understand what you own very well, and be willing to buy when other market participants are irrational.

Full disclosure: long NWLI TSI MINT

The Rules, Part LXVI

Posted on 9 May 202010 May 2020 by David Merkel

Photo Credit: Heather R || Round and round it goes, where it stops, nobody knows

Don’t bet the firm.
Attributed to the best boss I ever had, Mike Cioffi. I learned so much from him.

I was surprised to see how many times I mentioned at this blog how I considered and dropped the idea of writing floating rate Guaranteed Investment Contracts [GICs]. A lot of effort went into that decision, and unlike most decisions like that, the failures of competitors with a different view happened quite rapidly.

Also, this blog highlighted those that wrote terminable floating rate GICs later, and insurers that wrote contracts that had clauses allowing for termination upon ratings downgrades.

But that’s my own story. What of others?

The best recent example that I can give is oil producers both in 2015-6 and today. When oil prices plunged, many smaller marginal oil producers went broke. Why didn’t they take a more cautious view of their industry, and run with stronger balance sheets that could endure low crude oil prices for two years?

If you are managing for the price of your stock, maximizing the return on equity is a basic goal for many. That means shrinking your equity capital base, and living with the risk that your company could go broke with many others if the price of crude oil drops significantly. Of course, you could try to hedge your production, but at the risk of capping your returns.

==============================

The main idea here is to have a strategy where you stay in the game. This means running with a thicker balance sheet, and hedging material risks. What stands in the way of doing that?

Having a thicker balance sheet might give a firm a lower valuation, and attract activists that will attempt to buy up the firm, partially using the excess capital that aided safety. The antidote to this is to actively sell shareholders on the idea that the firm is doing this to preserve the firm from the risk of failure, much as Berkshire Hathaway keeps excess assets around for reasons of avoiding risk and allowing for the possibility of gaining significant returns in a crisis.

==============================

If you work for a single firm, most would say, “Of course! Don’t bet the firm! What, are you nuts!?”

But incentives matter. Where there are bonuses based on sales growth, sales will happen, regardless of the quality of them. Where there are bonuses based off of asset returns over a short period, you will have managers swinging for the fences. Where there are annual profit goals, there may be aggressive accounting and aggressive sales practices. But who cares about next year, much less the distant future? Who cares for the long-term interests of all who are affected by the firm?

Corporate culture matters. Excellent corporate cultures balance the short- and long-runs. They strive for excellent results while protecting against the worst scenarios. If the firm is able to survive, it can potentially do great things. Not so for the firm that dies.

To that end, incentives should be balanced. Those that play offense, like salesmen, should have a realized profitability component to their bonus. Investment departments should be judged on safety as well as returns. Conversely, defensive areas need to have some of their bonuses based on profits, and profit growth. It’s good to get all of a firm onto the same page nd be moderate, prudent risk-takers.

In closing, the main point here is that there is no reward so large that it is worth risking the future of the firm. Take moderate and prudent risks, but don’t take any risk where you and all of your colleagues may end up searching for new work. It’s not worth it.

Beyond that, to those that structure bonus pay, be balanced in the incentives that you give. Let them benefit from their individual efforts, but also benefit from the long-run safety and profitability of the firm as a whole. That will result in the greatest benefit for all.

What Makes An Asset Safe?

Posted on 14 February 2020 by David Merkel

Photo Credit: acciarini ||Sometimes a good conversation elucidates a matter…

Q: What defines a safe asset?

A: My, but that is a broad question. Do you have something more specific that you are trying to answer?

Q: Well, I’ve heard that the wealthy often invest their excess assets in real estate. It seems perfect. As Twain said, “Buy land, they aren’t making any more of it.” It provides income, and protects against inflation.

A: Do you own the land free and clear, or did you have to borrow to own it?

Q: I don’t own any land, aside from my house, and yes, I have a mortgage there. Why are you asking this?

A: Do you remember the financial crisis 2008-2011?

Q: Yes, but why does that matter?

A: Many people had paid a lot for their homes, and were stretched in making mortgage payments. Then one of the Ds hit.

Q: Ds?

A: As written by one wordy blogger:

3) As housing prices fall, which they should because housing is in oversupply, more homeowners find themselves in trouble. Remember, defaults occur because a property is underwater, and one of the five Ds hits:

Divorce
Disability
Death
Disaster
Dismissed from employment

Q: My, but he is a piece of work. So, houses aren’t a safe asset?

A: Well, most of the time they are, particularly if don’t have any debt on them. But there are situations where housing prices have been bid up to where the prices don’t justify the cash flows if you are borrowing to own it and are renting it out.

Q: What do you mean?

A: No asset’s price can survive if the implicit net rent is negative. I.e., if you have to feed the property to hold it.

Q: Huh?

A: Imagine that instead of living in your home, you borrowed money to buy the house, and have rented it out. What I am saying is that when those that do this are losing money, the price of the house is too high. They are relying on price appreciation to bail them out, and no one can control that.

Q: Is there a simpler way to say this?

A: When you have to give up money to hold onto an asset, you are in a weak position, and it means you should sell, particularly if many people are having to do the same thing. Properly priced assets produce cash; they don’t consume cash. If on net it is cheaper to rent than borrow and own, then it is probably better to rent.

Q: Are you just saying that risk is a function of the price of the asset? An overpriced asset is risky, and an underpriced asset is not?

A: I am saying that, but there is more to say as well. An asset could be priced below its fair market value, and it could still be risky if it is misfinanced. Take for example the insurance company General American back in August 1999.

Q: Huh?

A: Old news, I know, and most people don’t follow insurers. But they had written a lot of floating rate GICs terminable at par in 7 days if they got a ratings downgrade. What was safe if it had only been 5% of their assets became toxic at 25% of their assets. The amount they were selling ballooned because money market funds could treat the assets as short-term paper.

Once the downgrade came, there was no way to raise that much money so fast. They ended up selling out to MetLife for 50% of their net worth. MetLife picked up control of one of their subsidiaries, RGA, in the process. They made exceptionally good money on that purchase.

It’s like crossing a stream that is 3 feet deep on average, but there is a spot in the middle that is 20 feet deep. If you can’t swim, don’t cross it.

Q: I heard you wrote to Cramer about General American at the time.

A: Yes, that was my first email to him, and I explained the situation in such detail that he republished the email for readers. That was my introduction to Cramer.

Q: So, you are saying there are two things to safety — price and financing?

A: That’s all I’ve said so far, but there are a few other things. The character of management matters. Remember my piece, Dead as a Severed Horse?s Head?

Q: Oh, the zinc miner that sided with the bondholders against the shareholders?

A: Exactly. With better management, they could have skated through the troubles, and perhaps sold the company to a larger base metals miner like BHP.

Q: Is any of this similar to the losses you took on Scottish Re or National Atlantic?

A: Yes. I thought you were my friend, though.

Q: Well, I read your confession pieces on both of them.

A: It still hurts, but faithful are the wounds of a friend.

Q: Proverbs 27:6, I like it.

A: I still remember the stress and the losses.

Q: Then is that all? Price, leverage, and management?

A: Pretty much. There are some secondary matters to those who do not want to do the hard work. Companies that pay dividends and buy back stock are shareholder friendly, and that is good so long as they don’t borrow too much to do that.

Also, there are the issues of operating leverage — companies with low fixed costs are safer. But that’s about it, unless you want to talk about investments other than stocks.

Q: Can we take this up later?

A: Sure, let’s take this up in part 2.

Dissent on Triple-S Management II

Posted on 15 November 201915 November 2019 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.

Industry Ranks November 2019

Posted on 8 November 20198 November 2019 by David Merkel

Photo Credit: Kailash Giri || I used to live near a crude oil refinery. Got soot on my car, but it provided a lot of jobs for people in the area.

Data from Value Line, Calculations by me

Remember when I used to do posts like these? The last full time was May 2014. I lost access to the data, and eventually I gave up.

Recently, I got access to the data back, and I rebuilt the model. I’ll do a post like this every now and then.

My main industry model is illustrated in the graphic. Green industries are cold. Red industries are hot. If you like to play momentum, look at the red zone, and ask the question, ?Where are trends under-discounted?? Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted. Yes, things are bad, but are they all that bad? Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled ?Dig through.?

You might notice that I have no industries from the red zone. That is because the market is so high. I only want to play in cold industries. They won?t get so badly hit in a decline, and they might have some positive surprises.

If you use any of this, choose what you use off of your own trading style. If you trade frequently, stay in the red zone. Trading infrequently, play in the green zone ? don?t look for momentum, look for mean reversion. I generally play in the green zone because I hold stocks for 3 years on average.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh? Why change if things are working well? I?m not saying to change if things are working well. I?m saying don?t change if things are working badly. Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes. Maximum pain drives changes for most people, which is why average investors don?t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy ? no one thinks of changing then. This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year. It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology stocks here, some industrials, some retail stocks, particularly those that are strongly capitalized.

I?m looking for undervalued industries. I?m not saying that there is always a bull market out there, and I will find it for you. But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive. I don?t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting.

The Red Zone has tech, financials, communications, and areas geared to home building and improvement. I don’t own much in the way of financials, aside from a few beaten-up life insurers. Really, I don’t own much in the red zone at all.

In the green zone, I picked almost all of the industries. I don’t like retail much, and I am not a fan of E&P here. That still leaves me with a bunch of cyclicals in industries that have lagged the market, and a melange of other things.

The questions is: how well will the economy continue to do? This recovery is pretty long in the tooth. If it doesn’t do well, how much protection does a low valuation carry?

What would the model suggest? Ah, there I have something for you, and so long as Value Line does not object, I will provide that for you. I looked for companies in the industries listed, but in the top 4 of 9 balance sheet safety categories, and with returns estimated over 12%/year over the next 3-5 years. The latter category does the value/growth tradeoff automatically. I don?t care if returns come from mean reversion or growth.

Also, I wanted firms selling at a low-ish forward EV/EBITDA multiple (in relative terms to each industry), and having grown book value after dividends are reinvested over the past seven years.

But anyway, as a bonus here are the names that are candidates for purchase given this screen. Remember, this is a launching pad for due diligence, not hot names to buy.

Data is a mix from AAII Stock Investor, Value Line and Sentieo || Calculations are mine

Full Disclosure: Clients and I own shares in DLX, SLB, GPC & MGA

Dissent on Triple-S Management

Posted on 17 September 201917 September 2019 by David Merkel

Dear Friends,

After a year off, it’s time for me to get back in the saddle and blog again.? I’m going to restart in a way similar to the way that I began — writing shorter posts, and being light on graphics.? I’ll go into what I did during my time off bit-by-bit as I go on. But for now, here is today’s post:

===========================================

Yesterday there was an article published on Triple-S Management which I found to be poorly done in some ways.? That said, GTS has its share of negatives:

There are a lot of claims outstanding from Hurricane Maria on GTS, though there may be some good reasons why the claim settlement is slow.? That said, in my own investing on Katrina, I was able to find and short reinsurers that had understated their claim exposure — that happens.? In that case, though, the errors were realized within two months, not two years.
Triple-S management is not a great management team, but paraphrasing Buffett, I’d rather have a mediocre management team in a great business, than a great management team in a mediocre business.
That great business is health care insurance in Puerto Rico, where GTS has a leading position.? Cutting against that are their other insurance businesses, which I think they might be better off exiting.? Most insurance management teams don’t do well managing multiple lines of business. Focus is a plus in insurance.
AM Best did downgrade the P&C sub of GTS?(Triple-S Propiedad) pretty severely after the Maria claims were revealed, which *did* take a long time to surface.? But AM Best is “inside the wall” and has a lot of data that is nonpublic.? They would have asked the questions regarding large claims posed by the article above.? Since that time AM Best has become more positive on the creditworthiness of the entire GTS enterprise, inding Propiedad.? None of GTS’s entities are “under review with negative implications anymore.”
All of the significant exposure to loss for Propiedad is in Commercial Multiperil.? I confirmed that from the year-end Statutory statements, which are not public documents, but should be.? (NAIC, let the data be free!)

Here are my main difficulties with the article:

After a major disaster, everything moves slower in insurance, and insurers play hardball to a higher degree.? That’s normal business.? There are reasons why a claim may paid out at lower values or not at all — terms or conditions of the contract were violated, damage happened for reasons not covered in the insurance, negligence of the insured, the cost estimates are wrong, etc.
The writers say that GTS only has the amount of its market capitalization to play with to make claim payments after its reinsurance is exhausted.? GTS trades at at a price-to-tangible book ratio of 43%.? The net worth of GTS, though not entirely available to pay claims, is around $900 million.
And, I looked around to see if GTS parent company is on the hook to provide capital support for Propiedad.? They have promised another $10 million, but looking through some of the filings at the SEC, and the 2018 year-end statutory statements for Propiedad, I saw no guarantee listed.? AM Best identified such a guarantee for the Triple-S Blue subsidiary in the most recent press release, but did not say something similar about Propiedad in the November 2018 press release, which would have been a material factor in both the ratings of Propiedad and GTS as a whole if it had existed after the release of the Maria claims.? As such, in a pinch, GTS could send Propiedad into insolvency/runoff, or, play a political game with losses if necessary.
As it is, the expected remaining losses for P&C in Puerto Rico is in the $2 billion range.? That makes the estimate that Propiedad has $1 billion remaining to pay unlikely, and makes the $309 million seem reasonable compared to its market share (9-21% depending on how you measure it).
Insurers in setting initial reserves, are supposed to put out their best estimates.? That may be considerably lower than what insureds are asking for — it’s a negotiation, after all.? If claims as they are processed are paid out at higher rates than the estimates, it will show up as an increase in “claims incurred in prior years.”? That hasn’t been happening in the GAAP or Statutory statements so far, but who can tell for sure — maybe the article is right, and there are some big bombs remaining.
But the three claims mentioned in the article totalling $170 million will likely be settled for less.? The other alleged $900 million of claims are difficult to analyze or verify.? It’s just scuttlebutt, which could be right, but who can tell?? It doesn’t fit with the total likely remaining claims in Puerto Rico of $2 billion, or, maybe the $2 billion estimate is wrong.? (By this point, those estimates should be good.)
The article briefly questions the retroactive reinsurance cover for Propiedad, but it’s really pretty simple.? After a disaster, getting insurance for claims is tough and expensive.? Typically, the policy names a total claims attachment point for when claims will start being paid that seems unlikely to be hit, and the reinsurer pays proportion of the claims above that point up to a limit.? (Buffett has done a lot of these deals on reinsurance of asbestos claims.)? What it does mean is that another insurance company had to get enough confidence on the total claim level? to write the business.? They probably got to look through all of the claim files, settled and pending.? (The reinsurer in question is a very large and well-known one, one with very high-quality underwriting processes.? I think it would break confidentiality from downloading the documents from the NAIC if I revealed its name. The answer is at the top of? page 14.17 of the annual statutory statement of Propiedad.)
Finally, the writers of the article allege all manner bad things that will happen to the health business of GTS either from a scandal, or what will happen from lack of full payment of claims on damaged Puerto Rico government buildings.? Puerto Rico does not likely want Propiedad to go insolvent.? They would rather work out some sort of deal that extracts the most it can out of the GTS parent company without leading them to send the company into runoff/insolvency.? The Puerto Rican government could indeed threaten GTS with the loss of some or all healthcare business, but they could not seize the healthcare company.? In the worst case scenario, if Puerto Rico ended up with an insolvent Propiedad, and told GTS that they would never get healthcare business again, GTS would go into runoff, and the dividends paid by the company as it went out of business would exceed the current stock price.? In the meantime, GTS is a large employer in Puerto Rico, and they would have to deal with all of the layoffs.? I don’t think this scenario is likely to happen.? If claims from government entities are too high for Propiedad to deal with, the Puerto Rican government would likely work out some sort of deal.

If you think this is unlikely, remember that in the financial crisis, all sorts of large entities got special treatment when they teetered near bankruptcy.? I am not saying that is the case here.? I think GTS, AM Best and the retroactive reinsurer are correct, and the writers of the article are wrong regarding the claims exposure.

Am I certain of this?? Of course not.? Though I made money speculating on Katrina’s effects on Montpelier and Ren Re, I lost money on Scottish Re.? I am fallible.? I am making considerable surmises in this piece I am writing now, as are the writers of the piece I am criticizing.

Last point: I would be almost certain they have more money on the line for this one than my clients and I do, for whatever that is worth.

==========================

Disclaimer: There are a lot of things that I don’t know here, so I could be wrong.? As with anything I write, do your own due diligence.??

Full disclosure: long GTS for clients and me

(And, oh yeah, this didn’t end up short, now did it?)

What Caused the Financial Crisis?

Posted on 15 September 201816 September 2018 by David Merkel

Photo Credit: Alane Golden || Sad but true — the crisis was all about bad monetary policy, a housing bubble, and poor bank risk management======================

There are a lot of opinions being trotted around ten years after the financial crisis.? A lot of them are self-serving, to deflect blame from areas that they want to protect.? What you are going to read here are my opinions.? You can fault me for this: I will defend my opinions here, which haven?t changed much since the financial crisis.? That said, I will simplify my opinions down to a few categories to make it simpler to remember, because there were a LOT of causes for the crisis.

Thus, here are the causes:

1) The Federal Reserve and the People?s Bank of China

For different reasons, these two central banks kept interest rates too low, touching off a boom in risk assets in the USA.? The Fed kept interest rates too low for too long 2001-2004. The Fed explicitly wanted to juice the economy via the housing sector after the dot-com bust, and the withdrawal of liquidity post-Y2K.? Also, the slow, predictable way that they tightened rates did little to end speculation, because long rates did not rise, and in some cases even fell.

The Chinese Central Bank had a different agenda.? It wanted to keep the Yuan cheap to continue growing via exporting to the US.? In order to do that, it needed to buy US assets, typically US Treasuries, which balanced the books ? trading US bonds for Chinese goods ? and kept longer US interest rates lower.

Both of these supported the:

2) Housing Bubble

This is the place where there are many culprits.? You needed lower mortgage underwriting standards. This happened through many routes:

US policy pushing home ownership at all costs, including tax-deductibility of mortgage interest.
GSEs guaranteeing increasingly marginal loans, and buying lower-rated tranches of subprime RMBS. They ran on such a thin capital base that it was astounding.? Don?t forget the FHLBs as well.
Politicians and regulators refused to rein in banks when they had the power and tools to do so.
Securitization of private loans separated origination from risk-bearing, allowing underwriting standards to deteriorate. Volume was rewarded, not quality.
Mortgage insurers and home equity loans allow people to borrow a far greater percentage of the value of the home than before, for conforming loans.
Appraisers went along with the game, as did regulators, which could have stopped the banks from lowering credit standards. Part of the fault for the regulatory mess was due to the Bush Administration downplaying financial regulation.
The Rating Agencies gave far too favorable ratings to untried asset classes, like ABS and private RMBS securitizations. This is for two reasons: financial regulators required that the companies they oversaw must use ratings for assessing capital needed to cover credit risk, and did not rule out asset classes that were unproven, as prior regulators had done.? Second, CDOs and similar structures needed the assets they bought to have ratings for the same reason.
There was a bid for yieldy assets on the part of US Hedge funds and foreign financial firms. Without the yield hogs who bid for CDO paper, and other yieldy assets, the bubble would not have grown so big.
Financial guarantors insured mortgage paper without having good models to understand the real risk.
People were stupid enough to borrow too much, assuming that somehow they would be able to handle it.? As with most bubbles, there were stupid writers pushing the idea that investing in housing was “free money.”

3) Bank Asset-liability management [ALM] for large commercial and investment banks was deeply flawed. ?It resulted in liquid liabilities funding illiquid assets.? The difference in liquidity was twofold: duration and credit.? As for duration, the assets purchased were longer than the bank?s funding structures.? Some of that was hidden in repo transactions, where long assets were financed overnight, and it was counted as a short-term asset, rather than a short-term loan collateralized by a long-term asset.

Also, portfolio margining was another weak spot, because as derivative positions moved against the banks, some banks did not have enough free assets to cover the demands for security on the loans extended.

As for credit, many of the assets were not easily saleable, because of the degree of research needed to understand them.? They may have possessed investment grade credit ratings, but that was not enough; it was impossible to tell if they were ?money good.?? Would the principal and interest eventually be paid in full?

The regulatory standards let the banks take too much credit risk, and ignored the possibility that short-term lending, like repos and portfolio margining could lead to a ?run on the bank.?

4) Accounting standards were not adequate to show the risks of repo lending, securitizations, or derivatives.? Auditors signed off on statements that they did not understand.

===============

That?s all, I wanted to keep this simple.? I do want to say that Money Market Funds were not a major cause of the crisis.? The reaction to the failure of Reserve Primary was overdone.? Because of how short the loans in money market funds are, the losses from money market funds as a whole would have been less than two cents on the dollar, and probably a lot smaller.

Also, bailing out the banks sent the wrong message, which will lead to more risk later.? No bailouts were needed.? Deposits were protected, and there is no reason to protect bank stock or bondholders.? As it was, the bailouts were the worst possible, protecting the assets of the rich, while not protecting the poor, who still needed to pay on their loans.? Better that the bailouts should have gone to reduce the principal of loans of those less-well-off, rather than protect the rich.? It is no surprise that we have the politics? we have today as a result.? Fairness is more important than aggregate prosperity.

PS — the worst of all worlds is where the government regulates and gives you the illusion of protecting you when it does not protect you much at all.? That tricks people into taking risks that they should not take, and leaves individuals to hold the bag when bad economic and regulatory policies fail.

The Balance: Short Selling Stocks- Not for the Faint Hearted

Posted on 5 September 2018 by David Merkel

Photo Credit: Heather Wizell || Ah, Wallstrip with Lindsay Campbell (look at the microphone…)

===========================================

Here’s another article that I edited at The Balance:?Short Selling Stocks- Not for the Faint Hearted.? The original author started out conservative on the topic, and I took it up another notch.

For this article, I:

added the information about changes to the uptick rule (which did not reflect anything post-2006),
corrected a small math error,
made the example more realistic as to how margin works in this situation,
added almost all of the section on risks
totally rewrote the section on picking shorts (if you dare to do it), and,
added the famous comment by Daniel Drew.

I have shorted stock in my life at the hedge fund I worked at, hedging in arbitrage situations, and very rarely to speculate.? Shorting is a form of speculation shorts don’t create economic value.? They do us a service by pruning places that pretend to have value and don’t really have it.

In general, I don’t recommend shorting unless you have a fundamentally strong insight about a company that is not generally shared.? That happens with me occasionally in insurance where I have spoken negatively about:

Penn Treaty
Tower Group
The various companies of the Karfunkels
The mortgage and financial guaranty insurers
Oh, and the GSEs… though they weren’t regulated as insurers… not that it would have mattered.

But I rarely get those insights, and I hate to short, because timing is crucial, and the upside is capped, where the downside is theoretically unlimited.? It is really a hard area to get right.

Last note, I didn’t say it in the article, and I haven’t said it in a while, remember that being short is not the opposite of being long — it is the opposite of being leveraged long.? If you just hold stocks, bonds, and cash, no one can ever force you out of your trade.? The moment you borrow money to buy assets, or sell short, under bad conditions the margin desk can force you to liquidate positions — and it could be at the worst possible moment.? Virtually every market bottom and top has some level of forced liquidations going on of investors that took on too much risk.

So be careful, and in general don’t short stock.? If you want more here, also read The Zero Short.? Fun!

Surprise! Return to RT Boom/Bust

Posted on 1 March 2018 by David Merkel

After almost three years, I returned to RT Boom/Bust on Tuesday.? There are many changes at RT.? Many new people, and a growing effort to put together an alternative channel that covers the world rather than just the US or just the developed world.? They are bursting at the seams, and their funding has doubled, so I was told.

I get surprised by who watches RT and sees me.? My? congregation is pretty conservative in every way, but I have some friends working in intelligence come up to me and say, “Hey, saw you on RT Boom/Bust.”? And then there is my friend from Central Africa who says, “The CIA has you on their list.? Watch out!”? He’s funny, hard-working, but very earnest.

I’ve never seen anything in what I have done where there is any hint of editorial control.? Maybe it is there, but I think I would be smart enough to see it.

Anyway, the topic at hand was alternative monetary systems, and the thing that kicked it off was the Vollgelt in Switzerland, where they are trying to create a monetary system where the banks can’t lend against deposits.? Here were my notes for the show, with a little more to fill in:

======================================

Mr. Merkel, what exactly is a sovereign money system?

The banks can?t lend against deposits.? Deposits are segregated, and wait for the depositor to use them.? The deposits no longer can be used by the bank but only the depositor.? There would be no need for deposit insurance, because deposits are off of the bank?s balance sheet.

What is the difference between a sovereign system and the way banks handle your money now?

You would have to pay for your transactional account, because the bank can?t make money off of lending against the deposits. Banks would no longer do ?maturity transformation? by lending long against short-term deposits.? Long-term lending would have to be other entities in the economy, such as insurance companies, pension funds, endowments, private individuals, foreign lenders, mortgage REITs, and banks funded by matching sources like CDs, bonds, and equity.

Switzerland is poised to vote on a sovereign money system, or Vollgeld in German. How likely is this vote to pass?

Not likely for three reasons.? First, the Swiss turned down a proposal to back the Swiss Franc with 20% gold.? Not one canton voted for it.? Only 22% of the electorate voted for it.? Second, things aren?t that bad now, and the financial system isn?t that levered.? ?If it ain?t broke, don?t fix it.?? Third, this is a total experiment with no real world precedents.? Many criticize economists for imagining what the world should be like and then proposing policy off their unrealistic idealized models.? This is another example of that.? We don?t know what the unintended consequences might be.

Some unintended consequences might be:

Transition would be difficult
Recession during the transition, because middle and small market lending would likely suffer
Pay for transactional accounts ? no interest even if inflation is high.
Increase in savings accounts, which might be short-dated enough to be transactional
Gives a lot of power to the SNB, which might be halfhearted about implementation (Regulators dislike change, and risk).
Could be subverted if Government becomes dependent on free money, leading to inflation
Moves monetary policy from rate targeting to permanent quantitative monetary adjustment. Unclear how the SNB would tighten policy; maybe issue central bank bonds to reduce money supply?

Could something like this rein in credit bubbles? Are we facing another credit bubble?

Yes, it could.? Most credit bubbles result from short-term lending funding long-term assets.? This would rein it in, in the short-run, but who could tell whether it might come back in another unintended way?? If some new class of lender became dominant, the threat could reappear.

We aren?t facing a credit bubble now, because the last crisis wiped away a lot of private debt, and replaced it with public debt.? Perhaps some weak nations with debts not in their own currency could be at risk, but right now, there aren?t any categories of private debt big enough and misfinanced enough to create a crisis.? That said, watch margin loans, student loans, and auto loans in the US.

Are there any modern day equivalents we can compare Vollgeld to?

None that are currently being used.? There are a lot of theoretical ideas still being tossed around, like 100% reserving, lowering bank leverage, strict asset-liability matching, disallowing banks from lending to financial companies, etc.? These ideas get a lot of press after crises, but fade away afterward.? Most of them would work, but all of them lower bank profits.? Concentrated interests tend to win against general interests, except in crises.

You mentioned there is a similar concept for derivatives that no one is talking about. How exactly would that work?

Derivatives are functionally equivalent to insurance contracts, but they are not regulated.? I believe they should be regulated like insurance contracts, and require that those seeking insurance have an ?insurable interest? that they are trying to hedge.? Only direct hedgers could initiate derivative transactions, and financial guaranty insurers would compete to fill the need.

This would prevent the unintended consequences of having multiples of protection written on a given risk, where a weak party like AIG is incapable of making good on all of the derivative contracts that they have written, which could lead to its own systemic risk if other derivative counterparties can?t absorb the losses.

======================================

I know that is over-simplified, but I read through the papers of both sides in the debate, and I thought both overstated their cases significantly.

I know fiat money has its problems, and so does fractional reserve banking, but if you are going to propose a solution, perhaps one that fits the basics of how a well-run bank at low leverage would work would be a good place to start.