Gaby Lapera: Talking about risk, a lot of
people when they think about insurance, they think about this stodgy, sweaty accountant
with giant glasses who are a little bit nervous and constantly writing things down. They think
of insurance as pretty much the opposite of risk, but insurance companies actually have
some very interesting risks that other companies might not face necessarily. What kind of risks
are there when you invest in an insurance company?
Jordan Wathen: There’s a lot of risks you wouldn’t think about. This year a big one
with property and casualty insurers, more specifically car insurers, is that people
are driving more because gas prices are low. Because of that they’re getting in much more
accidents, and actually the cost with each accident has been going up this year too.
Geico reported, which obviously is a subsidiary of Berkshire Hathaway, they reported that
the severity of claim, how much they pay out, is going up, as well as the frequency, because
people are driving more. Lapera: That’s something that you wouldn’t
about, right? The price of oil dropping, what does that have to do anything with insurance.
But if you’re an auto insurer, it’s a big deal. If you’re a health insurer that’s insured
all these people that are in accidents, it’s a big deal.
Wathen: Right exactly. I would have never … It’s not something that when you look
at a car insurance company you think, “Oh man, I’d better worry about the price of oil,”
but the lower it goes, the more people tend to drive, and it makes sense.
Lapera: Yeah. Another one that people don’t really think about it, because I think most
people don’t think about reinsurance, which is again those insurance companies that insure
insurers, is natural disasters. I think, I want to say was it 2014? Was that the year
of the tsunami? I can’t remember. There was a year that there was a ton of natural disasters,
and there were a few reinsurers that just went out of business. They couldn’t handle
the claims. Wathen: Right exactly. It goes so deep too.
You could go and look, there’s a small insurance company based out of Massachusetts, Safety
Insurance, that for years has had absolutely stellar underwriting record. They do great
in car and home insurance, but then they had something like 7 or 8 feet of snow fall in
Boston. What can you do? There’s nothing you can do about it, it’s just bad luck. But for
an insurer bad luck isn’t a very good thing. Lapera: No, and they do the best they can
to mitigate these risks with actuaries, but especially when you are gambling on something
like good weather, that’s when you have to assess what you risk tolerance is, as hilarious
as it is to say for insurers. Wathen: Right, yeah exactly. No it’s not fun.
I’m kind of glad that’s not my job, because at the end of the day, weathermen can’t predict
the weather 10 days out, predicting it a year out or 10 years out, I can only imagine the
difficulty in doing that. Lapera: Yeah. Let’s talk a little bit about
risks that are more common I guess across different companies for insurers. Insurers
can go one of two paths. They can either choose to specialize in one thing, like maybe auto
and RV and boat insurance, modes of transportation, or they could choose to specialize in a lot
of different things. Are there advantages or disadvantages to either of these?
Wathen: I think there’s advantages and disadvantages to both. If you think about a very specialized
insurer, going back to Safety for instance, the danger with them is that most of their
premiums are written in New England. If it snows in New England, that’s a bad year for
them. If they have a lot of snow fall they have a lot of losses. There’s geographic risk
there. On the other hand if it doesn’t snow or winter is very mild, then it’s a great
year and they’re partying hard like it’s 1999, because no one’s getting in car accidents,
it’s beautiful weather, it’s fantastic. They’re just printing money. Then to some extent,
being more diversified it can be good obviously because one risk won’t put you under, won’t
put an insurance company under, but in the same token it’s very hard to get the incentives
right when you have multiple lines of insurance under one business.
Lapera: Right. Wathen: If you think about it, let’s say there’s
a company, say a car insurance company and a health insurance company together, and you
have executives leading both sides of it. How are you going to compensate them for underwriting
performance at one when they’re only responsible … How are you going to compensate for underwriting
performance at the car insurance unit, when they’re only responsible for the health and
life unit for instance?