The Intelligent Quarterly from the publishers of The Insurance Insider

Spring 2012

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Mark Geoghegan The time to call a stock market top is when the last prominent unbeliever gets religion.

There always comes a moment in a market cycle when the last sceptic's heart is melted, doubts get the better of him and he succumbs to the seductive hysteria of the madding crowd.

He then throws himself into the mêlée with a convert's zeal, buying up every faddish stock with wild abandon.

He is just in time for the inevitable crash - the one that he has been predicting for so many years and for which now he is the least financially prepared.

The moral of the story is that fully paid-up members of the awkward squad need to stick to their guns lest they end up doing something very foolish - but this means standing alone with very few or no friends.

What, then, should a self-respecting diehard contrarian make of this year's crop of global P&C (re)insurance results?

One would not normally equate running a slightly above average catastrophe year with a widespread sub-90 percent combined ratio, although one swollen by substantial reserve releases.

To then throw one of the poorest non-crisis investment performances on record into the mix and come up with a reasonable profit is, on the face of it, a creditable performance indeed.

It is also irrefutable that the market is behaving with reasonable discipline, with few of the suicidal tendencies exhibited near the bottom of previous market turns in evidence.

What's more, all economic indicators point to a slow return to honest money, at least in the US.

But the key question for the true contrarian to ask himself is whether to believe that the reserve releases are real and can continue without reversal.

Many CEOs protest that they always reserve prudently and that reserve releases should be a feature of all combined ratios, no matter what year it is.

This optimistic breed is missing the point - everyone but the out-and-out fraudster always believes they are reserving prudently.

But the latest batch of figures proves that years of good results always eventually feed into more optimistic initial loss and IBNR assumptions.

Confirmation bias always wins in the end and the industry ends up pricing its business on past performance and not on realistic assumptions for the future.

Just look at UK motor for an example of how quickly and how spectacularly wrong this can go. The UK game changed - no-win no-fee, and claims farming all boomed - but the motor market carried on as normal, even as the average number of affected people per accident almost doubled.
The prudent cushion for a reserving shock was not there when it was needed - it had been released. The result has been a whole heap of pain.

So why are we deflating our reserve cushion, just as some of the fundamental reserving risk trends are turning upwards: in particular, as the last tort reform runs its course through the political cycle, compounded by the real risk of price inflation returning with a vengeance?

The biggest additional worry must be that, on top of this, capital is being returned.

The old pros in our business always prefer having patently too much capital over too little. Time and again they have been proven right that "too much" capital means survival and survival means prosperity.

Too little capital may mean superior returns for a while, but in the long run it always means death.

Old market hands also quietly believe that the only people who really think there is an easy or safe way of making returns that exceed 15 percent per annum are invariably on their third divorce, wear shiny suits and drive flashy sports cars, usually very badly.

Aggressive capital returns are like crash diets. You may end up looking good for a summer on the beach, but you end up putting it all back on and more as soon as the chill autumn comes. The wider investment community is right to shun our sector as one likely to destroy value in the near future.
The recent uplift in sector stock valuations is a suckers' rally driven by the barbarians in shiny suits and their M&A advisers.

Those that change their minds now may soon have cause for regret. When the reserving "shock" comes, it really ought not come as a surprise to many who should know much, much better.

So let's please keep the lack of faith, stick to our curmudgeonly contrarian instincts and let the barbarians take the hit for once!

Yours sincerely,

Mark Geoghegan,
Editor