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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
by 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 agoI tend to put that in the stupid bucket too.
- Spooky23 5y agoPretty sure that’s the strategy that made Warren Buffet crazy rich.
- danielmarkbruce 5y agoProbably want to be less sure on this one.
- eru 5y agoIn 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.)