4 ms·

Payouts and premiums aren't where the money is in insurance. It's in the return on investments the insurer makes with the money they hold in trust. From an insu

by joshAg 5y ago

Payouts and premiums aren't where the money is in insurance. It's in the return on investments the insurer makes with the money they hold in trust. From an insurer's point of view, the best market isn't one with no payouts, but one where there is a highly predictable amount of payouts, because the better they can predict how much they need to payout, the more aggressive they can be with their investments. Yeah, there's a decent amount of regulation around payouts to protect the consumer, but it pales in comparison to the regulations around making sure that the insurer has enough liquid assets on hand, that the total valuation of their assets (ie investments) remains large enough, and that they're charging a minimum amount of premium for the risk that they're taking on.

monocasa 5y ago
> It's in the return on investments the insurer makes with the money they hold in trust ...sourced from the premiums. When they pull in more premiums, they have more money to invest.
- deleted 5y ago
  [deleted]
- joshAg 5y ago
  No, it's sourced from the initial capitalization of the firm and then realized returns that are reinvested. You can't offer insurance until you're capitalized enough to handle claims on the same day the policy takes effect. Ideally the premiums will cover payouts and day-to-day business expenses, so the invested money can just keep being reinvested, hopefully into longer term and more aggressive investments. The premiums and payouts get rolled into underwriting profit/income. And that can eventually get rolled into new investments. Here, look at state farm for 2019[1]. Their underwriting gain was $777 million on $65.2 billion in total premium. Their investment income was $5 billion with a net worth of over $100 billion, which is more than 6 times larger their underwriting premiums. Their profit ratio for underwriting is like 1.2% because they're not trying to maximize that profit. A large reason they're not trying to maximize it is that for admitted policies, there's usually an upper limit to how much aggregate premium can go to anything other than paying out claims (eg: [2] and [3]). So for an insurer, they don't want to set themselves up to depend on premiums to fund the investment arm because 1) there's an upper limit on how much aggregate premium can go towards anything other than claims 2) there's no limit on how much aggregate premium can go towards claims, 3) growing premium haphazardly can result in less money available for investing due to other regulations that limit risk and require a certain amount of liquidity for claims. [1]: https://newsroom.statefarm.com/2019-state-farm-financial-results/ https://newsroom.statefarm.com/2019-state-farm-financial-res... [2]: https://www.law.cornell.edu/regulations/california/10-CCR-Sec-2644-12 https://www.law.cornell.edu/regulations/california/10-CCR-Se... [3]: https://consumerfed.org/press_release/auto-insurers-reaped-nearly-30-billion-pandemic-windfall-profit-in-2020-as-state-insurance-regulators-fail-to-protect-consumers/ https://consumerfed.org/press_release/auto-insurers-reaped-n...
  - monocasa 5y ago
    The seed comes from initial investment, but if premiums weren't a major component of growth they'd just be an investment firm. They don't have control over investment returns for the most part, so premiums are the only avenue for growth that they can do something about.
jjoonathan 5y ago
Yes, in a well-regulated insurance market the winning business model isn't deceit. That's the point of the regulations. Deceit can take many forms, and I'd argue that undercapitalization is actually one of them. "There's a trap clause on page 23 of the telephone book contract" is only the simplest strategy an insurance company can use to lemon-drop. "We ask our customers to do an impossible information wrangling task and only review the paperwork if they get cancer, so that we have an excuse to drop them" is a slightly more evolved form. Loading up sacrificial business vehicles with risk and using bankruptcy to discharge obligations is the most advanced form of deceit-based insurance business models, because it provides plausible deniability. "We just tried to compete a bit too hard!" they can claim, even if they knew in their hearts exactly what they were doing: the age old practice of selling insurance that you had no intent of making good on. Fortunately, we have a long record of historical evil tricks to draw on when crafting legislation, because I absolutely stand by my claim that the natural incentives (the ones that happen without careful legislation) in the insurance industry are overwhelmingly bleak, both on an absolute scale and relative to other industries.
- joshAg 5y ago
  I'm not saying it's not because of regulations. I'm saying it's not just the regulations on payouts and the regulations on payouts probably aren't even the most important, because all the regulation in the world around ensuring the insurer can't skip out on payouts will do nothing for "Oops we invested badly and have literally no money with which to pay your completely valid claim". The payouts regulations are still good and necessary because that's way better than requiring people to find out the hard way through shitty claims processes and denials and word-of-mouth reputation, but they're in no way sufficient.
  - jjoonathan 5y ago
    I'm not sure we disagree. We just allocate the benefit of the doubt differently. > "Oops we invested badly and have literally no money with which to pay your completely valid claim". It's 100% possible for this to be a genuine mistake. I'm sure that it happened as a genuine mistake more than once! However, it is also possible to do this on purpose: load up a business vehicle with increasing amounts of risk and extract as much of the premiums as one possibly can before it explodes. If this is done intentionally, it is exactly the same hustle as selling policies that one doesn't intend to make good on, it just uses a different mechanism to shirk the obligation. Every company that does it on purpose will say that it happened by mistake, of course, and just as I am certain that it has happened multiple times as a genuine mistake, I am certain that it has happened multiple times on purpose. Undercapitalization is the evolved form of the "sell a trash policy" hustle because it provides almost perfect plausible deniability. It makes sense that the greatest legislative effort would be spent heading it off.
TeMPOraL 5y ago
> From an insurer's point of view, the best market isn't one with no payouts, but one where there is a highly predictable amount of payouts, because the better they can predict how much they need to payout, the more aggressive they can be with their investments. Isn't the latter a strict superset of the former? No payouts is an easily predictable number. And for nonzero amount of payouts, the less those payouts sum to, the more money remains for continuous investing.
- joshAg 5y ago
  No, they're not a superset. You can have events with a very low probability and very little variance, events with very low probability and very high probability, higher probability with low variance, and high probability with very high variance. Here's some random numbers,say for a hypothetical 100,000 hypothetical year long policies low probability, low variance: E(total claims) := 20, V(total claims) := 1 low probability, high variance: E(total claims) := 20, V(total claims) := 20 higher probability, low variance: E(total claims) := 20,000, V(total claims) := 10 higer probability, high variance: E(total claims):= 20,000, V(total claims): 10,000 Premiums don't usually make their way into investing for a bit. They're used to cover claims and then business overheads and then even dividends first. First they go to claims, because there's usually regulations to prevent price gouging that require insurers to refund premium if the ratio of aggregate premium : aggregate claims gets too high (the regulation is on a state by state basis in the US). Then any remainder goes to any other outlay first, so that the invested money can be/stay invested into longer term investments. Only if those outlays can be completely covered by the premium (and i'm skipping over a few things like regulations regarding various levels of liquidity for different risk levels and other stuff) then yeah it can make its way over to the actual investment fund. But in general the business model for insurers is that underwriting profit, limited as it is by regulations, is primarily used for actually running day to day operations and isn't a reliable source for being turned over to the investing side. The investing side is primarily using the initial capitalization of the insurer and the returns from earlier investments. One way of looking at insurance is that the insured is actually buying an option against the insured's capitalization with very limited exercise clauses, but the the insurer pays out exercised options with the money from other purchased options contracts.

by joshAg 5y ago

monocasa 5y ago

> It's in the return on investments the insurer makes with the money they hold in trust ...sourced from the premiums. When they pull in more premiums, they have more money to invest.

deleted 5y ago
[deleted]
joshAg 5y ago
No, it's sourced from the initial capitalization of the firm and then realized returns that are reinvested. You can't offer insurance until you're capitalized enough to handle claims on the same day the policy takes effect. Ideally the premiums will cover payouts and day-to-day business expenses, so the invested money can just keep being reinvested, hopefully into longer term and more aggressive investments. The premiums and payouts get rolled into underwriting profit/income. And that can eventually get rolled into new investments. Here, look at state farm for 2019[1]. Their underwriting gain was $777 million on $65.2 billion in total premium. Their investment income was $5 billion with a net worth of over $100 billion, which is more than 6 times larger their underwriting premiums. Their profit ratio for underwriting is like 1.2% because they're not trying to maximize that profit. A large reason they're not trying to maximize it is that for admitted policies, there's usually an upper limit to how much aggregate premium can go to anything other than paying out claims (eg: [2] and [3]). So for an insurer, they don't want to set themselves up to depend on premiums to fund the investment arm because 1) there's an upper limit on how much aggregate premium can go towards anything other than claims 2) there's no limit on how much aggregate premium can go towards claims, 3) growing premium haphazardly can result in less money available for investing due to other regulations that limit risk and require a certain amount of liquidity for claims. [1]: https://newsroom.statefarm.com/2019-state-farm-financial-results/ https://newsroom.statefarm.com/2019-state-farm-financial-res... [2]: https://www.law.cornell.edu/regulations/california/10-CCR-Sec-2644-12 https://www.law.cornell.edu/regulations/california/10-CCR-Se... [3]: https://consumerfed.org/press_release/auto-insurers-reaped-nearly-30-billion-pandemic-windfall-profit-in-2020-as-state-insurance-regulators-fail-to-protect-consumers/ https://consumerfed.org/press_release/auto-insurers-reaped-n...
- monocasa 5y ago
  The seed comes from initial investment, but if premiums weren't a major component of growth they'd just be an investment firm. They don't have control over investment returns for the most part, so premiums are the only avenue for growth that they can do something about.

jjoonathan 5y ago

Yes, in a well-regulated insurance market the winning business model isn't deceit. That's the point of the regulations. Deceit can take many forms, and I'd argue that undercapitalization is actually one of them. "There's a trap clause on page 23 of the telephone book contract" is only the simplest strategy an insurance company can use to lemon-drop. "We ask our customers to do an impossible information wrangling task and only review the paperwork if they get cancer, so that we have an excuse to drop them" is a slightly more evolved form. Loading up sacrificial business vehicles with risk and using bankruptcy to discharge obligations is the most advanced form of deceit-based insurance business models, because it provides plausible deniability. "We just tried to compete a bit too hard!" they can claim, even if they knew in their hearts exactly what they were doing: the age old practice of selling insurance that you had no intent of making good on. Fortunately, we have a long record of historical evil tricks to draw on when crafting legislation, because I absolutely stand by my claim that the natural incentives (the ones that happen without careful legislation) in the insurance industry are overwhelmingly bleak, both on an absolute scale and relative to other industries.

joshAg 5y ago
I'm not saying it's not because of regulations. I'm saying it's not just the regulations on payouts and the regulations on payouts probably aren't even the most important, because all the regulation in the world around ensuring the insurer can't skip out on payouts will do nothing for "Oops we invested badly and have literally no money with which to pay your completely valid claim". The payouts regulations are still good and necessary because that's way better than requiring people to find out the hard way through shitty claims processes and denials and word-of-mouth reputation, but they're in no way sufficient.
- jjoonathan 5y ago
  I'm not sure we disagree. We just allocate the benefit of the doubt differently. > "Oops we invested badly and have literally no money with which to pay your completely valid claim". It's 100% possible for this to be a genuine mistake. I'm sure that it happened as a genuine mistake more than once! However, it is also possible to do this on purpose: load up a business vehicle with increasing amounts of risk and extract as much of the premiums as one possibly can before it explodes. If this is done intentionally, it is exactly the same hustle as selling policies that one doesn't intend to make good on, it just uses a different mechanism to shirk the obligation. Every company that does it on purpose will say that it happened by mistake, of course, and just as I am certain that it has happened multiple times as a genuine mistake, I am certain that it has happened multiple times on purpose. Undercapitalization is the evolved form of the "sell a trash policy" hustle because it provides almost perfect plausible deniability. It makes sense that the greatest legislative effort would be spent heading it off.

TeMPOraL 5y ago

> From an insurer's point of view, the best market isn't one with no payouts, but one where there is a highly predictable amount of payouts, because the better they can predict how much they need to payout, the more aggressive they can be with their investments. Isn't the latter a strict superset of the former? No payouts is an easily predictable number. And for nonzero amount of payouts, the less those payouts sum to, the more money remains for continuous investing.

joshAg 5y ago
No, they're not a superset. You can have events with a very low probability and very little variance, events with very low probability and very high probability, higher probability with low variance, and high probability with very high variance. Here's some random numbers,say for a hypothetical 100,000 hypothetical year long policies low probability, low variance: E(total claims) := 20, V(total claims) := 1 low probability, high variance: E(total claims) := 20, V(total claims) := 20 higher probability, low variance: E(total claims) := 20,000, V(total claims) := 10 higer probability, high variance: E(total claims):= 20,000, V(total claims): 10,000 Premiums don't usually make their way into investing for a bit. They're used to cover claims and then business overheads and then even dividends first. First they go to claims, because there's usually regulations to prevent price gouging that require insurers to refund premium if the ratio of aggregate premium : aggregate claims gets too high (the regulation is on a state by state basis in the US). Then any remainder goes to any other outlay first, so that the invested money can be/stay invested into longer term investments. Only if those outlays can be completely covered by the premium (and i'm skipping over a few things like regulations regarding various levels of liquidity for different risk levels and other stuff) then yeah it can make its way over to the actual investment fund. But in general the business model for insurers is that underwriting profit, limited as it is by regulations, is primarily used for actually running day to day operations and isn't a reliable source for being turned over to the investing side. The investing side is primarily using the initial capitalization of the insurer and the returns from earlier investments. One way of looking at insurance is that the insured is actually buying an option against the insured's capitalization with very limited exercise clauses, but the the insurer pays out exercised options with the money from other purchased options contracts.