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I actually had a chat with a friend about prize indemnity insurance, he's a Lloyd's guy. In the end it's the law of large numbers, pretty much what a casino do

I actually had a chat with a friend about prize indemnity insurance, he's a Lloyd's guy. In the end it's the law of large numbers, pretty much what a casino does: take lots of small positive bets, don't let one bet dominate. If you do get something too big, syndicate it with some of your competitors to spread the risk. Of course also make sure everyone who comes for insurance is actually what you think, like the guy in the article says it's not necessarily a hugely detailed check but it is enough to stop the worst frauds. You want a model that's robust, and you only have so much data about how often some guy hits a hole in one or a half court shot, and there's only so much you can know about whether they are a pro and the distance to the hole. The big problem seemed to be competition. You only get to write the insurance if you're the best price but the best price is not necessarily one that makes sense for the business. If some guy is buying market share with a loss leader, what do you do? Every segment of the market could be affected by this at a given time.

danielmarkbruce 5y ago
This last part is true of any insurance. And it's not just buying market share which can cause it - pure stupidity can too.
- jaggederest 5y ago
  Even more subtly, if there is one insurance company that makes a lot of extra return on their "float" (the money that has been paid in premiums but not yet paid out in claims), they may actually sell insurance that is a "bad bet", i.e. is expected to have underwriting losses, but that the time value of money makes profitable for them. In that context other insurance companies can't compete unless they also are making huge returns on their float. It drives risky behavior by insurance companies in exactly the opposite way you'd prefer.
  - danielmarkbruce 5y ago
    I tend to put that in the stupid bucket too.
    - Spooky23 5y ago
      Pretty sure that’s the strategy that made Warren Buffet crazy rich.
      - danielmarkbruce 5y ago
        Probably want to be less sure on this one.
  - eru 5y ago
    In some sense, the two sides of the insurance business are decoupled. When insurance companies agree on a 'bad bet', that just means that they are essentially agreeing to pay a high interest rate on their float. A profit driven insurance company should only agree to such an expensive float if other funding sources are also expensive. And that's independent of the risk appetite of the investing managers of the insurance company. To be explicit: a profit driven insurance company should issue more equity or a bond to finance their investment, unless the float is cheaper for them. (Of course, this all goes out of the window, the moment you have legal rules that restrict insurance companies from issuing more bonds or equity. Then they might rationally agree to an expensive float.)
- throwaway2037 5y ago
  Warren Buffet talked about this extensively during the run-up to the 2008 Global Financial Crisis. A large part of his portfolio is insurance companies. Insurance premiums had fallen so much in 2007 (or became so competitive/stupid), that it was seriously affecting the revenues of his insurance companies.
  - danielmarkbruce 5y ago
    Yeah, he seems to have been complaining about it for 40 years...
robocat 5y ago
> and there's only so much you can know about whether they are a pro Like most insurance, the conditions are checked before paying the winner. Of course, there is still the possibility of fraud.
r00fus 5y ago
> The big problem seemed to be competition. You only get to write the insurance if you're the best price but the best price is not necessarily one that makes sense for the business. That's straightforward - your insurance product needs reputation. Sure you could go with "that other guy" but we're Lloyd's! You know we'll pay out if it's a legit prize winning. Also marketing - lowballer needs to spend to get visibility that would cut into margins. The market player that has the most data knows exactly how much to spend on marketing and how much to charge in premiums.
- phonon 5y ago
  Insurance is highly regulated--most products are reviewed by state regulators and will be denied if the pricing is too high OR too low.
  - eru 5y ago
    For general insurance, yet. But I am not so sure price indemnity insurance, like hole-in-one insurance, is quite as heavily regulated?
joosters 5y ago
The big problem seemed to be competition. You only get to write the insurance if you're the best price but the best price is not necessarily one that makes sense for the business. A friend of mine worked for an insurer, their job was to model the risks and calculate insurance costs for various things. The problem was, it didn't really matter how clever or detailed their modelling was. If their risk model came up with too large a premium, management demanded that the pricing be made more competitive. So they ended up overriding their calculations with a whole heap of 'fudge factors' to move their prices to be more in-line with the rest of the market. Kind of defeated the point of the modelling, really.
- mellavora 5y ago
  Well, except for the "all models are wrong, some are useful" thing. They knew where they had fudged, which meant (if management was smart) they had some clue on when a client was slipping into a risk area and the policy should be hedged.
bjackman 5y ago
> The big problem seemed to be competition. It seems like the more predictable something is, the more the market will squeeze insurers' margins on insuring that risk. Holes-in-one probably follow a pretty regular probability distribution, which makes me think this is probably a very tough market for smaller players, even without the loss leader thing you mentioned.

danielmarkbruce 5y ago

This last part is true of any insurance. And it's not just buying market share which can cause it - pure stupidity can too.

jaggederest 5y ago
Even more subtly, if there is one insurance company that makes a lot of extra return on their "float" (the money that has been paid in premiums but not yet paid out in claims), they may actually sell insurance that is a "bad bet", i.e. is expected to have underwriting losses, but that the time value of money makes profitable for them. In that context other insurance companies can't compete unless they also are making huge returns on their float. It drives risky behavior by insurance companies in exactly the opposite way you'd prefer.
- danielmarkbruce 5y ago
  I tend to put that in the stupid bucket too.
  - Spooky23 5y ago
    Pretty sure that’s the strategy that made Warren Buffet crazy rich.
    - danielmarkbruce 5y ago
      Probably want to be less sure on this one.
- eru 5y ago
  In some sense, the two sides of the insurance business are decoupled. When insurance companies agree on a 'bad bet', that just means that they are essentially agreeing to pay a high interest rate on their float. A profit driven insurance company should only agree to such an expensive float if other funding sources are also expensive. And that's independent of the risk appetite of the investing managers of the insurance company. To be explicit: a profit driven insurance company should issue more equity or a bond to finance their investment, unless the float is cheaper for them. (Of course, this all goes out of the window, the moment you have legal rules that restrict insurance companies from issuing more bonds or equity. Then they might rationally agree to an expensive float.)
throwaway2037 5y ago
Warren Buffet talked about this extensively during the run-up to the 2008 Global Financial Crisis. A large part of his portfolio is insurance companies. Insurance premiums had fallen so much in 2007 (or became so competitive/stupid), that it was seriously affecting the revenues of his insurance companies.
- danielmarkbruce 5y ago
  Yeah, he seems to have been complaining about it for 40 years...

robocat 5y ago

> and there's only so much you can know about whether they are a pro Like most insurance, the conditions are checked before paying the winner. Of course, there is still the possibility of fraud.

r00fus 5y ago

> The big problem seemed to be competition. You only get to write the insurance if you're the best price but the best price is not necessarily one that makes sense for the business. That's straightforward - your insurance product needs reputation. Sure you could go with "that other guy" but we're Lloyd's! You know we'll pay out if it's a legit prize winning. Also marketing - lowballer needs to spend to get visibility that would cut into margins. The market player that has the most data knows exactly how much to spend on marketing and how much to charge in premiums.

phonon 5y ago
Insurance is highly regulated--most products are reviewed by state regulators and will be denied if the pricing is too high OR too low.
- eru 5y ago
  For general insurance, yet. But I am not so sure price indemnity insurance, like hole-in-one insurance, is quite as heavily regulated?

joosters 5y ago

The big problem seemed to be competition. You only get to write the insurance if you're the best price but the best price is not necessarily one that makes sense for the business. A friend of mine worked for an insurer, their job was to model the risks and calculate insurance costs for various things. The problem was, it didn't really matter how clever or detailed their modelling was. If their risk model came up with too large a premium, management demanded that the pricing be made more competitive. So they ended up overriding their calculations with a whole heap of 'fudge factors' to move their prices to be more in-line with the rest of the market. Kind of defeated the point of the modelling, really.

mellavora 5y ago
Well, except for the "all models are wrong, some are useful" thing. They knew where they had fudged, which meant (if management was smart) they had some clue on when a client was slipping into a risk area and the policy should be hedged.

bjackman 5y ago

> The big problem seemed to be competition. It seems like the more predictable something is, the more the market will squeeze insurers' margins on insuring that risk. Holes-in-one probably follow a pretty regular probability distribution, which makes me think this is probably a very tough market for smaller players, even without the loss leader thing you mentioned.