Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Nvidia Numero Uno in Count Down to President Donald Pump Election Victory - 5th Nov 24
Trump or Harris - Who Wins US Presidential Election 2024 Forecast Prediction - 5th Nov 24
Stock Market Brief in Count Down to US Election Result 2024 - 3rd Nov 24
Gold Stocks’ Winter Rally 2024 - 3rd Nov 24
Why Countdown to U.S. Recession is Underway - 3rd Nov 24
Stock Market Trend Forecast to Jan 2025 - 2nd Nov 24
President Donald PUMP Forecast to Win US Presidential Election 2024 - 1st Nov 24
At These Levels, Buying Silver Is Like Getting It At $5 In 2003 - 28th Oct 24
Nvidia Numero Uno Selling Shovels in the AI Gold Rush - 28th Oct 24
The Future of Online Casinos - 28th Oct 24
Panic in the Air As Stock Market Correction Delivers Deep Opps in AI Tech Stocks - 27th Oct 24
Stocks, Bitcoin, Crypto's Counting Down to President Donald Pump! - 27th Oct 24
UK Budget 2024 - What to do Before 30th Oct - Pensions and ISA's - 27th Oct 24
7 Days of Crypto Opportunities Starts NOW - 27th Oct 24
The Power Law in Venture Capital: How Visionary Investors Like Yuri Milner Have Shaped the Future - 27th Oct 24
This Points To Significantly Higher Silver Prices - 27th Oct 24
US House Prices Trend Forecast 2024 to 2026 - 11th Oct 24
US Housing Market Analysis - Immigration Drives House Prices Higher - 30th Sep 24
Stock Market October Correction - 30th Sep 24
The Folly of Tariffs and Trade Wars - 30th Sep 24
Gold: 5 principles to help you stay ahead of price turns - 30th Sep 24
The Everything Rally will Spark multi year Bull Market - 30th Sep 24
US FIXED MORTGAGES LIMITING SUPPLY - 23rd Sep 24
US Housing Market Free Equity - 23rd Sep 24
US Rate Cut FOMO In Stock Market Correction Window - 22nd Sep 24
US State Demographics - 22nd Sep 24
Gold and Silver Shine as the Fed Cuts Rates: What’s Next? - 22nd Sep 24
Stock Market Sentiment Speaks:Nothing Can Topple This Market - 22nd Sep 24
US Population Growth Rate - 17th Sep 24
Are Stocks Overheating? - 17th Sep 24
Sentiment Speaks: Silver Is At A Major Turning Point - 17th Sep 24
If The Stock Market Turn Quickly, How Bad Can Things Get? - 17th Sep 24
IMMIGRATION DRIVES HOUSE PRICES HIGHER - 12th Sep 24
Global Debt Bubble - 12th Sep 24
Gold’s Outlook CPI Data - 12th Sep 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Japan Disaster Means Investors Should Beware of Insurance Stocks

Companies / Sector Analysis Mar 24, 2011 - 07:27 AM GMT

By: Money_Morning

Companies

Best Financial Markets Analysis ArticleMartin Hutchinson writes: The catastrophe-modeling company AIR Worldwide Corp. has estimated that insurance company losses from the Japanese earthquake and tsunami could reach $35 billion.

That has insurance analysts feeling bullish about insurance stocks: In their view, losses are good because it enables the insurers to ratchet up their premiums.


Personally, I don't see it that way. While I like life-insurance and domestic-insurance companies as investments for ordinary investors, I think the big-ticket insurance market is too opaque, too insider dominated, and much too unlikely to deliver decent returns to its outside shareholders.

In short, here in the aftermath of the deadly Japan disaster, investors need to beware of global insurance stocks.

A Casualty of Insurance Investments
Before proceeding, I should explain a bias here: I had a number of friends who were unfortunate enough to be "names" at Lloyds of London. These people, often quite unsophisticated but generally fairly wealthy (before they invested in Lloyds), were encouraged to put up a minimum of about $100,000 - maybe $250,000 in today's money - to become a "name," which was considereda fairly safe and socially smart thing to do (fortunately I never had that kind of money in those days, or I might have done it).

As a "name," they would participate in the insurance business of a Lloyds "syndicate," receiving the profits but - crucially - bearing unlimited liability for the losses.

Prior to about 1970, the global insurance market was not particularly competitive, Lloyds of London brokers were generally scrupulous in their honesty, syndicate moneys were invested conservatively, and the "names" made a decent return - although probably less than they should have made, given the profitability of the business.

Then came the 1970s.

During that decade, the number of "names" was expanded and the global insurance business became much more competitive and aggressive. Ethical standards declined, syndicate moneys were invested in speculations and the "names" were treated as cannon fodder, to be milked for extra payments if things went wrong.

I have a personal story that ably illustrates the point.

A friend of mine was married to that 19th Century English melodrama villain, a Bad Baronet (baronets were hereditary knights, generally awarded for large donations to James I, or, eventually, to political-party funds).

My friend had inherited quite a considerable fortune, some of which her husband - the Bad Baronet - then invested in Lloyds syndicates, through an assortment of his "contacts." In the 1980s, needless to say, those syndicates all went bad, partly because they had operated at the dodgy end of the U.S. market, where the trial lawyers for a time made insurance fraud against Lloyds a national sport.

Lloyds then presented my friend with a bill for about $10 million, an amount that was far more than she had invested, but one that was her share of the losses on the insurance the syndicate had written.

That wiped her, while the Bad Baronet - who, by then, wanted to turn her in for a newer model - divorced her hurriedly, while she still theoretically had money and couldn't get much of a divorce settlement out of him.

The lessons of this sorry tale are obvious:

•Don't put your money into insurance operations controlled by somebody else.
•And never play cards with a man called Sir Rupert (the Bad Baronet).

A Look Behind the Curtain
The insurance business is intrinsically cyclical. Since the service being offered is hard to differentiate, when the business appears profitable, investors view it as "easy money" and new pools of money flood in.

This money flow is made easier by the fact that such new pools can act as "reinsurers," meaning they can bypass the whole "dealing with the public" facet of the insurance business. They can forgo the expense of agents, advertising, staffing, processing - which makes reinsurance a low-overhead portion of the insurance sector.

That's why disasters such as the Japanese, New Zealand and Chilean earthquakes are seen as positive developments by the insurance industry (provided they are not large enough to send the whole shebang into bankruptcy).

By draining the profitability from marginal reinsurance operations, these catastrophes make it less attractive for new money to enter the business. This, in turn, enables the stronger companies to raise premiums, increasing their profitability. Of course, once this newer, higher profitability is noticed, new money floods in again. But for the short-term, at least, profitability is increased.

For outside investors, this cycle is very difficult to spot, What's more, the losses happen before the profits, which makes the whole enterprise rather more risky than one would like.

There is, however, another factor driving the insurance business, which makes it even more difficult to get right, and that is the investment side of the business. Since premiums are received several years before claims are paid, the actual insurance does not need to make money at all, as companies can make adequate returns through investing the premium surplus. Thus, the "underwriting ratios" (ratio of losses to premiums) of large companies are often above 100%, even while the companies themselves make good profits on the investment side.

The problem here is that, over the past 10 years, investment returns have been lousy. The stock markets really haven't gone anywhere, and bond yields have descended to minuscule levels.

Insurance companies try to make up for this through diversification into such "alternative assets" as hedge funds, private equity funds and commodities.

However, the returns on most alternative assets are very non-transparent, the liquidity is low (so they can't be sold when a big claim occurs) and the fees on funds are high. Also, as American International Group Inc. (NYSE: AIG) spectacularly demonstrated with its credit-default-swap business, some of the bright ideas insurance companies have on the investment side can turn horribly wrong. And when that happens, those bad ideas can transform a once-viable company into a bankrupt shell - and virtually overnight, as we saw with AIG (which we ... as the American taxpayers ... bailed out to avoid such a fate, but you get the point).

With insurance underwriting depending on a cycle that is difficult for outsiders to predict, and an investment side that either produces very low returns or leads companies to take outlandish risks, I would have to say that the insurance business is pretty unattractive overall.

In fact, I would even say that the insurance business is a lot like the airline business, which - for structural reasons - has produced an overall loss for its investors in the 108 years since the Wright Brothers took off.

Here in the aftermath of the Japan earthquake and tsunami, you're going to hear a lot of bullish sentiment about the insurance business - especially as analysts talk about the prospect of increased premiums.

As we've already explained, that could actually help some of the insurers. But, as we've also seen, that doesn't mean the shareholders will benefit.

So don't be seduced into putting a lot of money into insurance stocks - even if the company you invest in is not run by a Bad Baronet!

[Editor's Note: There's a segment of the stock market whose investment returns are five times that of the typical stock.

But here's the problem: Only 1% of investors know about it.

Fortunately, Money Morning Contributing Editor Martin Hutchinson is among that 1%. The 37 years he spent as an international merchant banker gave him that knowledge, and that insight.

Now you can access that insight.

With Hutchinson's The Merchant Banker Alert advisory service, you can crack this "rich-man's market," discover the identities of those stocks - and reap those massive gains yourself.

Click here for a report that shows you how to get started.]

Source : http://moneymorning.com/2011/03/24/...

Money Morning/The Money Map Report

©2011 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in