Speaker 1: Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2: Hello and welcome to another episode of the Odd Lots Podcast.
Speaker 3: I'm Joe Wisenthal and I'm Tracy Alloway.
Speaker 2: Tracy, it's funny that, like in all the coverage of
Speaker 2: finance generally, you know, we talk about banking, we talk
Speaker 2: about brokerage, we talk about deals, there's not a lot
Speaker 2: of talk about insurance.
Speaker 3: I know, it's so weird. I feel like it's kind
Speaker 3: of a blind spot for financial journalism. And I'm sure
Speaker 3: I'm gonna get a lot of tweets and emails from
Speaker 3: dedicated insurance correspond yes, but there should be more of them. Yes,
Speaker 3: that's basically what we're saying. It's a huge pool of capital,
Speaker 3: and also it has real life consequences, right, I think
Speaker 3: those aren't discussed enough. Like there's a sort of feedback
Speaker 3: loop where insurers are often deciding what is economically acceptable
Speaker 3: in terms of risk, and so their decisions have actual
Speaker 3: impact on you know, people's lives and the way we
Speaker 3: behave where we live. Things like that.
Speaker 2: It's interesting to think about, like the similarities between insurance
Speaker 2: and deposit banking, because both industries are basically, I give
Speaker 2: an institution an amount of money, and I expect at
Speaker 2: some point to get it all back, and in the
Speaker 2: meantime that company that I gave it to gets to
Speaker 2: lend it out or invest it or something like that.
Speaker 2: The difference is with banking, you sort of like get
Speaker 2: the money back whenever you want it. With insurance, on
Speaker 2: the other.
Speaker 3: Hand, when something bad happens.
Speaker 2: It'll probably happen at some point in your life. You
Speaker 2: just have no idea when it'll unfortunately almost always be
Speaker 2: when a very bad incident that you want to ensure against.
Speaker 2: But yeah, it really is interesting how there's this huge
Speaker 2: thing and as you say, it touches every aspect of
Speaker 2: life in many cases dictates even what people can and
Speaker 2: can't do. But it's like we know so little about
Speaker 2: like there's so little talk about it.
Speaker 3: It's the lesser known supply shock, let's put it that way. Recently,
Speaker 3: we did that episode on the Fed's Preferred measure of inflation,
Speaker 3: and we were talking in that about the insurance component
Speaker 3: and the impact that's been having on the headline number.
Speaker 2: Right, So this is the one aspect of insurance that
Speaker 2: has gotten a fair amount of coverage over the last
Speaker 2: several years, which is that in certain states, particularly California
Speaker 2: and Florida and maybe some others, there have been these
Speaker 2: huge upward shocks to the cost of covering your home.
Speaker 2: We actually talked about this with the Howard Hughes CEO
Speaker 2: last autumn, where he was talking about their insurance surge.
Speaker 2: But I have to say, like, in my head, like
Speaker 2: I still don't totally understand what's driven these huge spikes
Speaker 2: in premiums, particularly for homeowner's insurance.
Speaker 3: So I think what's confusing about this whole discussion is
Speaker 3: you see two very different headlines. So on the inflation side,
Speaker 3: you see things like, oh, the cost of insurance is
Speaker 3: surging in Florida and California, it's unaffordable to live in
Speaker 3: those specific places or specific areas within those states. But
Speaker 3: on the other hand, you also see headlines that say
Speaker 3: things like insurers are sixty percent behind in terms of
Speaker 3: pricing from where they need to be, and insurers say
Speaker 3: the market is uneconomic, they can't make the numbers work,
Speaker 3: And so you're left kind of head scratching, Well, is
Speaker 3: this about insurers trying to cover extra costs? Is it
Speaker 3: price gouging? Is it that there's something fundamentally too risky
Speaker 3: about this particular line of business. Is it political posturing?
Speaker 3: This is the other thing that happens here in California
Speaker 3: and Florida. They have very particular regulatory systems around insurance.
Speaker 3: It's really hard to disentangle it's actually going on completely.
Speaker 2: And there's always this question anytime you see an insurer
Speaker 2: like pull out of a state, like I never understand that, Like,
Speaker 2: why not just price it higher where it's like, oh,
Speaker 2: this is uninsurable. Yeah, no, certainly, like there's some risk
Speaker 2: that someone will desire to be compensated for. But yet
Speaker 2: you see this line uninsurable. I do think obviously, in
Speaker 2: the case of Florida and California, we've seen disasters. Of course,
Speaker 2: we've seen various wildfires over the last several years in California,
Speaker 2: Florida hit by a number of hurricanes, so there's a
Speaker 2: climate change element. But in my mind, I do not
Speaker 2: feel like I understand the whole story of why. At
Speaker 2: least in a handful of states, homeowner insurance premiums have
Speaker 2: spiked at levels that like basically it feels like no
Speaker 2: one has seen before in history.
Speaker 3: Yeah, And at the same time, the insurers say they
Speaker 3: can't make any money. I was just looking at a
Speaker 3: little article from credit site saying that the majority of
Speaker 3: the top twenty underwriters of Californian retail, home and auto
Speaker 3: insurance at this point have either entirely withdrawn or significantly
Speaker 3: curtailed their participation in the state given profitability challenges. So
Speaker 3: there's clearly something going on. The pool of available insurers
Speaker 3: seems to be dwindling. But the question is why.
Speaker 2: Yes, I think we really need to dig into this
Speaker 2: further and get a better handle on like how these markets,
Speaker 2: these heavily regulated markets, but at these markets, how they
Speaker 2: actually work, and how insurers think about managing risk, and
Speaker 2: how prices are determined and how capacity ebbs and flows.
Speaker 2: So time to give it the outlaws treatment.
Speaker 3: Yeah, this is an episode we've been meaning to do
Speaker 3: for a while, and to compensate for not doing it
Speaker 3: for months, we actually have two guests, two perfect guests
Speaker 3: for you.
Speaker 2: So we are going to be speaking with first someone
Speaker 2: who is on the business side of insurance, someone who's
Speaker 2: actually involved in regular operations and can talk about how
Speaker 2: prices are determined and how supply is determined. And then
Speaker 2: we're going to be speaking with someone who has a
Speaker 2: been a deeper understanding of the regulatory side. So we're
Speaker 2: going to first be speaking with Amias Garrity. He is
Speaker 2: a partner at QED Investors. It does a lot of
Speaker 2: fintech investing, and he is on the board of Kin,
Speaker 2: which is a direct household insurance company. So, Amias, thank
Speaker 2: you so much for coming on.
Speaker 4: Odd lots my pleasure.
Speaker 2: Why do you tell us first, like, what do you do,
Speaker 2: what's your background, and what do you do in this
Speaker 2: space of home insurance.
Speaker 4: So I'm on the board of a direct consumer home
Speaker 4: insurance company called Kin, and Kin really focuses on exactly
Speaker 4: this problem of what do we do in catastrophe affected areas?
Speaker 4: What do we do with the incredible change that we're
Speaker 4: dealing with in terms of hurricane and windstorms and ultimately fire.
Speaker 3: What's a direct to consumer insurer? How does that differ
Speaker 3: from a normal insurance model.
Speaker 4: So one of the really important elements of the structure
Speaker 4: of the insurance market is that almost everybody gets their
Speaker 4: insurance through an agent, and it actually really impacts the
Speaker 4: economics of the industry because agents are typically paid commissions
Speaker 4: around fifteen percent, and also because of that, all of
Speaker 4: the insurance company's access to information actually comes through agents.
Speaker 4: So with the Kin model, one of the reasons why
Speaker 4: we think this direct to consumer makes more sense is one,
Speaker 4: you get actually more economics to play with, so you
Speaker 4: can spend that money on data science, you can spend
Speaker 4: that money on aerial photography. And then also because the
Speaker 4: environment is changing so quickly and knowing what's going on
Speaker 4: in a house is so much more knowable now that
Speaker 4: you actually would prefer to get your information through data
Speaker 4: science than through an independent agent, like looking at a
Speaker 4: roof and saying, I don't know, roof looks pretty good.
Speaker 2: So big picture, we've all seen these stories, but oh,
Speaker 2: it's so hard to get insurance in a state like Florida,
Speaker 2: or people seeing their premiums jump thirty five or fifty
Speaker 2: or sixty percent. Just let's start a big picture, like
Speaker 2: how would you describe the problem or just the market
Speaker 2: environment of the last few years.
Speaker 4: Yeah, so the problem is pretty straightforward, which is insurance
Speaker 4: is there to protect people from losses that are gonna
Speaker 4: happen pretty infrequently. But if you just think about the math, right,
Speaker 4: so Hurricane Ian two years ago, right about twenty billion
Speaker 4: dollars of losses, So twenty five thousand claims ish, and
Speaker 4: you know, if that's gonna happen every twenty years, you're
Speaker 4: gonna need to pay just for that one storm probability
Speaker 4: twelve hundred.
Speaker 2: Bucks, okay. And this is twelve hundred bucks a year.
Speaker 2: Twelve hundred bucks a year, okay, Right.
Speaker 4: And so what we're dealing with is a pretty and
Speaker 4: we all know that climate change is real. So if
Speaker 4: you go back in history, typically our last forty years
Speaker 4: or so, they were about eight billion dollar events per year.
Speaker 4: So where the insurance industry deals with a billion dollars
Speaker 4: loss from one event, in the last five years the
Speaker 4: average was sixteen. So the change is real, and the
Speaker 4: cost of insurance is real. But at the same time,
Speaker 4: you know, if you look across you know these markets,
Speaker 4: the costs are going up, but we also have house
Speaker 4: prices going up, we have inflation. So over the last
Speaker 4: ten years, you know, the national data actually only goes
Speaker 4: through twenty one, but the price increase has been a
Speaker 4: little bit higher than inflation, but not a lot higher
Speaker 4: than inflation. And I think this is partly what we're
Speaker 4: all dealing with, is we're coming to grips with a
Speaker 4: bunch of different forces coming and hitting homeowners in exactly
Speaker 4: the same time in the same way.
Speaker 3: Joe, did you know the most expensive hurricane of all
Speaker 3: time was nineteen thirty eight in New England. I can't
Speaker 3: remember if that's inflation adjusted or not. It must be, yeah,
Speaker 3: it must be, and I always that's a good fact
Speaker 3: for Yes, you're welcome. There's a really good book about
Speaker 3: it called Sudden Sea, The Great Hurricane of nineteen thirty eight.
Speaker 3: But okay, wait a second. So whenever we have these
Speaker 3: conversations about insurers, a lot of the numbers here kind
Speaker 3: of blow my mind, because, as Joe just mentioned, we
Speaker 3: talk about insurance premiums going up by sometimes insane amounts.
Speaker 3: I was reading a Bloomberg article that came out recently,
Speaker 3: and it was the owner of a business I think
Speaker 3: in Colorado who was paying forty thousand dollars and his
Speaker 3: insurance premium jumped to four hundred thousand dollars a year,
Speaker 3: and he thought it was a typo initially, and then
Speaker 3: I read analysis from people like the strategists over at
Speaker 3: credit sites, and they say that they think insurers maybe
Speaker 3: sixty percent behind in terms of pricing where they actually
Speaker 3: need to be. And then I look at the numbers
Speaker 3: behind the amount of capital that's actually flowing into the
Speaker 3: insurance industry, where you know, it's not just people paying premiums,
Speaker 3: it's also stock, it's also bonds that are being issued.
Speaker 3: These just seem like insane numbers don't seem to match
Speaker 3: up what is happening here.
Speaker 4: So two things. One is that always the question is
Speaker 4: how do we get this price right? And so a
Speaker 4: lot of times what people feel is I can't get insured,
Speaker 4: But what's actually going economically is I can't get insured.
Speaker 3: At that price right, the price you want right.
Speaker 4: The price that you want. I think there's also some
Speaker 4: dynamics where fire is scarier in a lot of ways
Speaker 4: compared to hurricane and wind. Partly this is a dynamic,
Speaker 4: which is the hurricane increase has been quite extreme but
Speaker 4: also relatively linear, right, so there are more storms, they
Speaker 4: tend to be a little bit more severe, but fire
Speaker 4: has been a little bit more of a tipping point.
Speaker 4: So if you were living in Colorado, you probably didn't
Speaker 4: think about fire risk as like a really important part
Speaker 4: of your home insurance until only last ten or fifteen years.
Speaker 4: So there is a more of a tipping point dynamic
Speaker 4: with fire as compared to hurricane where it's just culturally
Speaker 4: understood that if you live in Florida, you're going to
Speaker 4: deal with hurricanes. If you live in the Carolinas, you're
Speaker 4: going to deal with hurricanes.
Speaker 3: So, just on the pricing point, one thing I wonder
Speaker 3: about all the time is what do the pricing models
Speaker 3: actually look like? And again, that sixty percent estimate that
Speaker 3: I mentioned is based on the actuarial models of insurers,
Speaker 3: like this is what their model says they should be
Speaker 3: charging currently based on I assume forward projections of what
Speaker 3: the weather is going to be. But of course the
Speaker 3: question always is if you're having forward projections, if you're
Speaker 3: forecasting something, I mean insures our for profit enterprises, why
Speaker 3: not say that the risk of catastrophic events is much
Speaker 3: higher and therefore we need to charge this particular amount.
Speaker 3: You're trying to discern the future. It's not like anyone
Speaker 3: is going to be able to say, no, you're wrong.
Speaker 4: Well, first of all, a lot of the price comes
Speaker 4: from the reinsurers, and the reinsurance prices have been increasing,
Speaker 4: but it's been a roller coaster ride. So if you
Speaker 4: look at like a history of reinsurance prices since ninety four,
Speaker 4: so think about Hurricane Andrew as kind of you know,
Speaker 4: for those of us who are gen xers, like this
Speaker 4: is the time in which we started to really think
Speaker 4: about hurricane So you know, early teenage years for me,
Speaker 4: the price shot up post Andrew, then it came down steadily,
Speaker 4: shot up again in Katrina, came down steadily, and then
Speaker 4: in the last five years is shot up again. So
Speaker 4: even though the trend is up, it's very boom and
Speaker 4: bust in terms of reinsurance prices. And that also you
Speaker 4: see the same dynamic with home insurers. And this goes
Speaker 4: back to your earlier question about having an independent agent.
Speaker 4: So if you are an insurance carrier and you think
Speaker 4: you need to raise prices, but one percent of your
Speaker 4: clients are intermediated through an agent, if you're the first
Speaker 4: carrier to raise prices, all of your customers will move.
Speaker 3: Oh, there's a first mover.
Speaker 4: There's a first mover disadvantage. So everybody needs to reprice,
Speaker 4: but they're very afraid of repricing because of the insurance agents.
Speaker 4: And then the last thing, and this is what you
Speaker 4: see happening in the debate in California right now, is
Speaker 4: that in California, until very recently, it was literally not
Speaker 4: allowed to take into account future casts, and so there
Speaker 4: are a bunch of different things going on that make
Speaker 4: that repricing very messy.
Speaker 2: You said, there's not really so much a shortage of
Speaker 2: insurance so much as a shortage of insurance at the
Speaker 2: price that people think they should pay. But we do
Speaker 2: get these stories right of insurancing. We're just out of
Speaker 2: this market, right, And I think we've seen it a
Speaker 2: lot in California. I think Florida is.
Speaker 4: You've seen it in Florida as well.
Speaker 2: So what it goes into that decision where an insurers like,
Speaker 2: we just we're not in this market. Yeah, so because
Speaker 2: that is a real thing.
Speaker 4: Right absolutely, And that too is kind of the fractal
Speaker 4: geometry of the thing. Right. So, at the level of
Speaker 4: your house, you're saying, like, I think this price is crazy.
Speaker 4: I can't get anyone to ensure my house at a
Speaker 4: price that makes sense. And then at the level of
Speaker 4: the state, the insurers are going to the regulators and saying, well,
Speaker 4: if you don't let me raise my prices by x,
Speaker 4: I'm going to pull out entirely. And so what you
Speaker 4: see in these kind of big crackups with large insurers
Speaker 4: pulling out is usually a dialogue or you know, a
Speaker 4: disagreement about the regulatory framework and how quickly they can
Speaker 4: raise prices.
Speaker 3: Oh yeah, there's always a discussion about whether or not
Speaker 3: this is political posturing because they want the actual regulation
Speaker 3: to be changed. But what happens when an area this
Speaker 3: is an extreme statement, but if an area becomes unensurable,
Speaker 3: So if the bulk of insurers decide to move out
Speaker 3: of particular counties in California, things like that, what happens
Speaker 3: to home owners, business owners, car owners totally.
Speaker 4: So in both Florida and California, which are sort of
Speaker 4: the furthest along vanguard states for this kind of catastrophe risk,
Speaker 4: both of those states have public insurers of last resort
Speaker 4: and so they will give you insurance at a price
Speaker 4: that is underwritten by the state. Now, there's complicated rules
Speaker 4: about what the state has to charge, but those get
Speaker 4: very political. And in Florida, for example, this has followed
Speaker 4: a little bit of that same boom and bus cycle
Speaker 4: that we've seen with reinsurance rates. So currently citizens in
Speaker 4: Florida has about one point two million policies. This is
Speaker 4: the this is the state insurer, So the state sponsored
Speaker 4: insurer today has one point two million policies in Florida.
Speaker 4: That's about twenty five percent or more of the state.
Speaker 4: That's actually significantly up from five years ago, almost three
Speaker 4: x up, but it's down from when it's last peaked
Speaker 4: in twenty eleven. So there is this dynamic of waxing
Speaker 4: and waning. What we're seeing in California is just a
Speaker 4: straight upward tick. Now there it's only about three percent
Speaker 4: of the state, but in the counties that are worst off,
Speaker 4: it's about twenty percent.
Speaker 3: In Florida, didn't they start cracking down on the roof
Speaker 3: scandals as well? Wasn't that part of it where these
Speaker 3: roofing frauds were so prevalent that they were actually boosting
Speaker 3: premiums for everyone in the state.
Speaker 4: Yeah, that was a really significant issue. So this issue
Speaker 4: Tracy is called assignment of benefits. Where you could come
Speaker 4: as a roofer. You could come to Tracy's house post
Speaker 4: hurricane and say, hey, I'll take care of this, and
Speaker 4: then you assign your benefit to me, and now I'll
Speaker 4: go deal with the insurance company on your behalf. Now,
Speaker 4: the challenge of this is that there's a bunch of
Speaker 4: different things going on, but one of things had to
Speaker 4: do with what were the terms under which you could litigate,
Speaker 4: what were the terms under which the insurance company had
Speaker 4: to pay the lawyer's fees, and whether assignment of benefits
Speaker 4: was possible. And Florida has done a series of reforms
Speaker 4: to try and pull that in, you know, the other
Speaker 4: piece going back to the direct consumer element here, this
Speaker 4: is also a place where from where we sit, we
Speaker 4: do think there's a ton of opportunity for technology and
Speaker 4: for companies to do better because the reason why there
Speaker 4: was assignment of benefits is because homeowners were frustrated. And
Speaker 4: so like again, after a storm, every single policy holder
Speaker 4: gets a text message and within a couple of days
Speaker 4: we'll do aerial imagery and say, hey, look you might
Speaker 4: have had to evacuate, but here's an aerial image of
Speaker 4: your house. Would you like to start your claim. So
Speaker 4: there's a bunch of things that you can do to
Speaker 4: make the system better. But yeah, there was a pretty
Speaker 4: significant reform effort.
Speaker 2: And so what was the basics of the scam?
Speaker 4: Okay, so the basics of the scam are your house
Speaker 4: is damaged, I'm a roofer instead of you contracting with
Speaker 4: me and then you following up with the insurance company.
Speaker 4: You assign your benefits to me, I do the work.
Speaker 4: You know, maybe the price is the right price, maybe
Speaker 4: it's a much higher price, and then I, with your
Speaker 4: legal rights, sue the insurance company. And in that context, right,
Speaker 4: you've got big players on both sides. There was a
Speaker 4: litigation finance dynamic here. There were hedge funds getting into
Speaker 4: the market to finance lawyers because there were dynamics in
Speaker 4: the Florida market where if there was any settlement at all,
Speaker 4: the insurer had to pay the legal fees. Oh yeah,
Speaker 4: So there was a bunch of incentives built into the
Speaker 4: system that made it very advantageous to sue even if
Speaker 4: you weren't being you know, truthful about the amount of
Speaker 4: cost that it actually took to fix the house.
Speaker 3: My impression was also that in addition to all these
Speaker 3: legal peculiarities that you just described, it was just really common.
Speaker 3: Like you would get a knock on your door and
Speaker 3: it would your roof for going like, hey, do you
Speaker 3: want a new roof? No worries, I'll take care of
Speaker 3: it for you. All you have to do is sign
Speaker 3: away you know the right to file a claim and
Speaker 3: then suit your insurer.
Speaker 4: Yeah, and this goes back to this idea of are
Speaker 4: we using the best in modern technology or not?
Speaker 5: Right.
Speaker 4: If I have an aerial image of your house two
Speaker 4: weeks before the storm and two days after, my ability
Speaker 4: to know whether that's a roofing scam or a proper
Speaker 4: claim goes way way up. If you know, the last
Speaker 4: time I saw your house was an independent insurance agent
Speaker 4: coming to sell you the policy five years ago, it's
Speaker 4: a lot harder to defend against the exact same facts.
Speaker 4: And so there's a lot of room in the insurance
Speaker 4: market for things to get better, in addition to the
Speaker 4: fact that we've got to find ways to get the
Speaker 4: regulations right and ultimately model the climate correctly.
Speaker 2: So something I'm interested in is, you know, Florida in
Speaker 2: many parts of California, I mean actually the whole country,
Speaker 2: but there's two states that have just seen these incredible
Speaker 2: like real estate booms, and Florida's always in a real
Speaker 2: estate boom, but the incredible price, especially over the last
Speaker 2: five years in the post COVID environment. And so you're
Speaker 2: in a situation which maybe like so someone you know
Speaker 2: bought their house in nineteen ninety five, or I don't know,
Speaker 2: two hundred thousand dollars and now it's worth two million
Speaker 2: dollars or something like that. And so the homeowner is
Speaker 2: paying insurance on a two million dollar house even if
Speaker 2: that's right, if it's much bigger, Yeah, that's exactly right.
Speaker 4: And if you think about how much Florida home insurance
Speaker 4: has gone up, yeah, right, if you're a homeowner, what
Speaker 4: you feel is, oh my gosh, Florida home insurance over
Speaker 4: the last three years has gone up nine percent a year.
Speaker 4: But what you don't recognize because you're the homeowner is
Speaker 4: Tampa real estate has gone up ten percent a year.
Speaker 2: Just on this sort of similar point, particularly in the
Speaker 2: sort of inflation that we've seen. I mean, I imagine just
Speaker 2: the cost of repairs, even on a given structure, given
Speaker 2: we know labor shortages and cost shortages, et cetera. Just
Speaker 2: the actual process of putting a roof back on whatever
Speaker 2: must be much more expensive than it used to be.
Speaker 4: Yeah, that's right, and this is part of what disrupts
Speaker 4: the industry. But that should come out in the WAH. Right,
Speaker 4: we see that in the inflation data. We see the
Speaker 4: premiums going up about the same rate of inflation. In fact,
Speaker 4: Over the ten years from twenty eleven to twenty twenty one,
Speaker 4: Florida home insurance went up less than inflation. But since
Speaker 4: it's gone up a little bit faster.
Speaker 3: I realized we probably should have asked you this earlier.
Speaker 3: But what's the pitch to investors in insurance companies now,
Speaker 3: whether it's through buying equity or you know, buying something
Speaker 3: like a cap bond something like that. It used to
Speaker 3: be that you have these uncorrelated returns. Natural disasters don't
Speaker 3: really have anything to do with the market. But if
Speaker 3: natural disasters are happening on a more frequent basis, then
Speaker 3: it seems like some of that correlation argument sort of
Speaker 3: falls by the wayside.
Speaker 4: Yeah, I mean, there is a sense in which reinsurance
Speaker 4: costs are, like almost everything else we see, affected by
Speaker 4: interest rates because there is capital scarcity in the world
Speaker 4: when the risk free rate is five and a half percent.
Speaker 4: And also, the reinsurance markets happen on an annual basis,
Speaker 4: just like the home insurance markets happen on an annual basis,
Speaker 4: So there's a lot of friction and slow movingness that
Speaker 4: is built into the system. So the average home insurer
Speaker 4: in Florida will place their reinsurance, you know, somewhere between
Speaker 4: March and June. If you think about that from a
Speaker 4: capital allocation perspective, you're a reinsurer. You're making that decision. Okay,
Speaker 4: what are we going to bid on? What capacity do
Speaker 4: we want to give to this market. You're making that
Speaker 4: decision as a bureaucratic matter, not like naturally fluctuating with
Speaker 4: the prices. So you definitely have this idea that And
Speaker 4: by the way, what's on the reinsurance balance sheets?
Speaker 3: A bunch of bonds, right, those are making more money?
Speaker 4: No? But those no, because those bonds repriced down when
Speaker 4: rates go right. So, Tracy, to your point, your intuition
Speaker 4: exactly right. That you have both kind of climate shock
Speaker 4: over the last couple of years and you had a
Speaker 4: capital supply shock over the last couple of years as
Speaker 4: bonds repriced on insurance balance That's great.
Speaker 2: Talk to us more about that capital supply aspect. So, oh,
Speaker 2: so they take a hit on their balante because their
Speaker 2: bond portfolio is down. So does that mean just the
Speaker 2: sheer amount of dollars that they can then lend out?
Speaker 2: Talk to us about that. I guess, like supply chain
Speaker 2: of dollars and how it feeds down to the end homeowner.
Speaker 4: Yeah, so the supply chain of dollars is you know,
Speaker 4: like everything is kind of simple. Right, You've got large
Speaker 4: pools of capital looking for return. In reinsurance, those are
Speaker 4: an increasingly diverse mixed insurance link securities, cap bonds, captive reinsurers.
Speaker 4: You know, hedge funds can go into it directly, you can,
Speaker 4: you know, there's a bunch of different things you can do,
Speaker 4: but they all come back to this idea that I'm
Speaker 4: sitting on a pool of capital. I'm trying to figure
Speaker 4: out what's the best way to get returned for that capital.
Speaker 4: And that return is in a world of low interest rates, right,
Speaker 4: this climate risk is extremely attractive because it's uncorrelated and
Speaker 4: it provides a rate of return that is sort of
Speaker 4: set by the actuarial tables, not set by you know,
Speaker 4: global macro. In a world where rates go way up,
Speaker 4: now that implied hurdle rate, right, the actuarial return is
Speaker 4: going to be still the same. Right, It's basically set
Speaker 4: by what's the risk of a storm and what's the
Speaker 4: right way to price that. But then as the risk
Speaker 4: view rate goes way up, you know what else should
Speaker 4: I do with the dollars. Should I just buy treasury,
Speaker 4: should I buy corporates? Whatever it is that sort of
Speaker 4: gets a little bit more competitive. And then the last thing,
Speaker 4: of course, is that reinsurance markets do have this unfortunate
Speaker 4: boom bust dynamic.
Speaker 6: Right.
Speaker 4: So one of the great stories about you know, Berkshire
Speaker 4: Hathaway is that they wrote reinsurance after Hurricane Andrew. Right,
Speaker 4: so they took basically no losses in Hurricane Andrew. When
Speaker 4: they came into the market, there was very little reinsurance capacity,
Speaker 4: and so they wrote reinsurance into Florida in the wake
Speaker 4: of Hurricane Andrew. So these stories are relatively common, and
Speaker 4: you see this. Actually there was a sequence of three
Speaker 4: years where reinsurance got super expensive in Florida, and over
Speaker 4: the last year it's actually come down and flattened a
Speaker 4: little bit because make people make money. Oh, then the
Speaker 4: capital piles in.
Speaker 3: So you mentioned investments, So you have this pool of
Speaker 3: money and obviously you can invest it in different things,
Speaker 3: whether it's corporate debt or treasuries. You also mentioned technology
Speaker 3: earlier on what levers do insurers have to pull in
Speaker 3: a situation where risks are going up, expenses are going
Speaker 3: up in some areas of the country. They're still limited
Speaker 3: in terms of how much of a premium increase they
Speaker 3: can pass on. How do they go about reducing costs.
Speaker 4: So the first thing is insurance is all about getting
Speaker 4: the price right. And while it is hard to model,
Speaker 4: it's not impossible to model right. So, as you said earlier, right,
Speaker 4: we're all capitalists here, we can sort of figure out, Okay, well,
Speaker 4: next year, we think the chance of a hurricane is
Speaker 4: a little bit higher than it was ten years ago,
Speaker 4: so we can adjust the price for that. So the
Speaker 4: first thing is getting the price right, and we have
Speaker 4: seen a lot of innovation around just understanding that climate
Speaker 4: science and building that into the system. The second thing is.
Speaker 3: Wait, can can you expand on that a little bit more?
Speaker 3: Because as someone who spends a certain amount of time
Speaker 3: in New England nowadays, I feel like the weather forecast
Speaker 3: still leaves something to be desired.
Speaker 5: Yes, so the weather is hard to predict, but climate
Speaker 5: is the climate, you know, moves in ways that are
Speaker 5: you don't care whether the hurricane comes on Tuesday or Thursday.
Speaker 4: You care about what's the probability of a hurricane this year. Now,
Speaker 4: even within that right, we had hurricane in and then
Speaker 4: last year was a more mild here. So it's not
Speaker 4: that they're so good at predicting the where and the when,
Speaker 4: but we can see the trends, and so you start
Speaker 4: with that. The second thing you start with is just
Speaker 4: actually getting much more sophisticated about the interactions between the
Speaker 4: house and the weather. Right, so houses can be hardened,
Speaker 4: building codes, roofs. Think about California fire breaks, right like,
Speaker 4: do you have a bunch of shrubbery in your lawn
Speaker 4: or do you have a bunch of pebbles? Like these
Speaker 4: actually make a real difference to your risk of catastrophe,
Speaker 4: you know, And so at least at Kin, what we
Speaker 4: see is that it really matters which house on the
Speaker 4: block you underwrite, because some of the houses are just
Speaker 4: naturally harder, or they're shaped a little bit differently relative
Speaker 4: to where the water might come.
Speaker 3: I learned that word today, Joe hardened, like the idea
Speaker 3: of protecting houses in this way. And now I have
Speaker 3: this idea in my head of like these hard houses
Speaker 3: walking around going on, I'm so hard you can't get me.
Speaker 2: You reaised that, like, you know, sometimes when people are
Speaker 2: talking about health insurance, like oh, the health insurance should
Speaker 2: give you incentives like go to the gym or whatever.
Speaker 2: And my understanding is that that stuff doesn't really work
Speaker 2: that much. But I guess, like with technology in theory,
Speaker 2: are you able to say, like a homeowner comes to
Speaker 2: you and you say, okay, it'd be this price, but
Speaker 2: if you do X to your property, it could be
Speaker 2: this price.
Speaker 6: Yeah.
Speaker 4: So it's probably not quite that much of a negotiation, okay,
Speaker 4: but implicitly it is. Right, how old is your roof, Okay,
Speaker 4: what are your singles? Do you have tile or tar?
Speaker 4: And so these kinds of things are directly impacted in
Speaker 4: the price. And then sometimes I mean, we're not investors
Speaker 4: in any of these companies, but we have seen home
Speaker 4: insurers in California say like, literally, you come to us,
Speaker 4: we underwrite your house, and then we're gonna tell you
Speaker 4: what to do with your backyard. Oh and then some
Speaker 4: are trying to do this, some are trying.
Speaker 5: To do that.
Speaker 2: You mentioned fire, So as you said, like this sort
Speaker 2: of like hurricane risk over time has been sort of
Speaker 2: linearly going up, fire has been sort of less predictable.
Speaker 2: There have been a little bit more of a tipping
Speaker 2: point issue, I would call it. Does the industry feel
Speaker 2: like it has a good way of modeling fire at
Speaker 2: risk or at this point because it's sort of hitting
Speaker 2: this tipping point, do the insurers or the reinsurers like
Speaker 2: need a margin, a bigger margin of era, a bigger
Speaker 2: cushion due to the sort of the tipping point or
Speaker 2: the novelty of the risk.
Speaker 4: So there's two issues that make this question a little
Speaker 4: bit hard to answer. Okay, The first is that California
Speaker 4: is historically underpriced, as we talked about earlier. So the
Speaker 4: average home insurance cost premium in California is only about
Speaker 4: thirty dollars more than the national average. So and again
Speaker 4: this is twenty twenty one data, so it's probably moved
Speaker 4: a bit, but that is kind of interesting. It demonstrates
Speaker 4: to Tracy's point earlier that California is more behind, whereas
Speaker 4: in Florida is more like twenty four hundred dollars. So
Speaker 4: the first thing is the gap between what California is
Speaker 4: charging and where insurers want to be is so vast
Speaker 4: that it's a little bit of a little bit harder thing.
Speaker 4: On top of that, I do think fire is harder
Speaker 4: to model. A lot of the work modeling it is
Speaker 4: around these topographical models, right, so where are you relative
Speaker 4: to the wind? Where are you relative to the hills?
Speaker 4: Where are you relative? And I think there's definitely a
Speaker 4: lot of work still to be done there, But right
Speaker 4: now it's a little bit hard to tell how much
Speaker 4: whether the margin really is on just getting the price
Speaker 4: right or the margin is on better modeling. But either way,
Speaker 4: you come back to Tracy's word of hardening the house.
Speaker 4: Hardening the house is going to make a big difference.
Speaker 3: Oh, I would have thought for California, maybe it's drought
Speaker 3: conditions or something like that, where I guess twenty twenty
Speaker 3: three was a historic drought in that state, and then
Speaker 3: flipping into twenty twenty four, I think we've seen a
Speaker 3: historic amount of rain. So maybe the hope was that
Speaker 3: fire premiums would start to come down. But I guess
Speaker 3: that's not the case. That's never the case. Price never
Speaker 3: it could be.
Speaker 4: I mean, we've seen this again in Florida. You see
Speaker 4: this like premiums went way up, right ten years ago
Speaker 4: or thirteen years ago, we hit a peak of people
Speaker 4: moving into the public option came down, come back up.
Speaker 4: I think with California it's a little too early to know.
Speaker 3: You mentioned people going into the public option. Do insurers
Speaker 3: in places like Florida see that public option as a
Speaker 3: competitor to their business?
Speaker 4: Yes, But most of the time the states set these
Speaker 4: up so that you have to prove that you couldn't
Speaker 4: get insurance, and that's obviously ends up being a price
Speaker 4: question as well. And so, for instance, I believe in Florida,
Speaker 4: the rule is if a Florida carrier is willing to
Speaker 4: quote you within twenty percent of the Citizens price, the
Speaker 4: public price, then you no longer become eligible. So that's
Speaker 4: how they manage it. So the states generally don't want
Speaker 4: to be in this business, and so they try to
Speaker 4: set up situations where Citizens is or the Fair Plan
Speaker 4: in California is an insurer last resort rather than a competitor, just.
Speaker 2: Out of curiosity from the perspective of like a startup
Speaker 2: tech forward insurer, how do people believe you that you'll
Speaker 2: pay out? I mean, you know, it's like companies have
Speaker 2: heard of All State or AIG or whatever. It's like, yeah,
Speaker 2: they probably have the money, and it's good. Kin comes
Speaker 2: along and I don't know what it is and maybe
Speaker 2: it looks like an app or something like that. Like,
Speaker 2: is there an FDIC equivalent of insurance where it's like, Okay,
Speaker 2: they have that FDIC stamp, so I feel comfortable that
Speaker 2: they'll like hold my money, Like, how do you How
Speaker 2: is that a step?
Speaker 4: Yeah, so there's not an FDIC, but it is. It
Speaker 4: is highly regulated, right, and it's it's a combination of
Speaker 4: insurance regulation and then rating agencies, and so there's insurance
Speaker 4: specific rating agencies, and so that's why if you actually
Speaker 4: pay attention to the insurance ads that you'll get, they'll say,
Speaker 4: you know, rated by am Best or rated by Demo Tech,
Speaker 4: which is the sort of predominant Florida specific rating agency.
Speaker 3: But going back to the first part of Joe's question,
Speaker 3: how do you convince customers that you're going to pay out?
Speaker 3: Because this seems to be the focus of nearly every
Speaker 3: insurance commercial in existence, and insurance is also still one
Speaker 3: of the industries where word of mouth actually matters. So
Speaker 3: people will say, I had a good experience with this
Speaker 3: insurer when I was filing my claim, you should go
Speaker 3: with it too. How do you go about having that
Speaker 3: discussion with people for an industry where the incentives are
Speaker 3: not necessarily aligned the insurer wants to make money, and
Speaker 3: the customer wants to get as much as they can
Speaker 3: out of putting their money into premiums.
Speaker 4: Yeah, so I think you hit the nail exactly on
Speaker 4: the head, which is the dynamic is actually less about
Speaker 4: the financial strength and more about the customer experience. And
Speaker 4: that's where you know, for us, we put a lot
Speaker 4: of effort into this idea of how do I give
Speaker 4: people the customer experience that when they come to us
Speaker 4: with a claim they actually feel satisfied. Now, naturally, customer
Speaker 4: satisfaction post claim always drops. That's just like a rule
Speaker 4: of life, but by how much? And so I talked
Speaker 4: about like this thing about people left their homes after
Speaker 4: Ian and we sent them text messages that said, here's
Speaker 4: an aerial image of your house. We're sorry to tell
Speaker 4: you that your roof is destroyed. Would you like to
Speaker 4: start your claim? Now, that's an incredibly positive experience for someone.
Speaker 4: Usually the other dynamic here is just you know, within Kin,
Speaker 4: we actually did it as a capital structure issue as well.
Speaker 4: So Kin uses what's called a reciprocal So the carrier
Speaker 4: itself is a nonprofit owned by the policyholders, and then
Speaker 4: the technology company is what's called an attorney in fact,
Speaker 4: so that technology company managing the pricing, the underwriting, the
Speaker 4: consumer response, but the carrier itself, the risk is all
Speaker 4: born as if it were a mutual. So we have
Speaker 4: done some interesting things and that's why people like mutuals
Speaker 4: in the insurance industry.
Speaker 3: And so the carrier pays a fee presumably to the
Speaker 3: technology company.
Speaker 2: Exactly as you mentioned, what was the peak year for
Speaker 2: citizens twenty eleven.
Speaker 4: Twenty eleven.
Speaker 2: So it sounds like, even though there's a ton of
Speaker 2: focus on what's going on in Florida right now, what's
Speaker 2: going on in California, et cetera, that it's not necessarily
Speaker 2: a death spiral dynamic. That we have these crazy moves,
Speaker 2: but it doesn't mean they happen in perpetuity and that
Speaker 2: the nature of the business is such that you could
Speaker 2: just have years where they thinks swing wildly.
Speaker 4: Yeah, that's right. I mean, unfortunately, insurance does have a
Speaker 4: little bit of this boom and bust dynamic. And that's why,
Speaker 4: you know, when we think about it, you know, when
Speaker 4: we're sitting in the boardroom, we're talking about strategy. From
Speaker 4: the perspective insurance, it's all about getting the price right.
Speaker 3: So you've been talking a lot about that boom bust cycle,
Speaker 3: and in some respects that makes a lot of sense
Speaker 3: because you're dealing with nature and extreme events within the
Speaker 3: weather or the climate, and so you could see how
Speaker 3: one year will be terrible and then the next year
Speaker 3: will be bad, and the insurance industry is kind of
Speaker 3: trying to catch up or react to those events all
Speaker 3: the time. But is there stuff that could be done
Speaker 3: to try to smooth that boom bust cycle.
Speaker 4: So from the perspective of the actual insurance carriers that
Speaker 4: are dealing with homeowners, that's actually their core mission, right,
Speaker 4: is that there's gonna be a little bit of a
Speaker 4: boom and bust cycle when you think about what's capital
Speaker 4: market's appetite to buy climate risk. And similarly, there's gonna
Speaker 4: be bad years and good years when it comes to
Speaker 4: the question of what's the weather going to be like,
Speaker 4: what's the hurricane? And the whole point of insurance is
Speaker 4: to act as the buffer between those things. And so
Speaker 4: even though I talk about this boom and bicycle, that's
Speaker 4: really more about access to capital and pricing, and it
Speaker 4: is the role of both insurance regulators and insurance companies
Speaker 4: to keep that customer interface smooth. So that's why you
Speaker 4: see a lot of pressure on both sides. But it
Speaker 4: comes out in price, right, it comes out in how
Speaker 4: do we serve our customers and then increase the prices
Speaker 4: as necessary to make it actually really sound and that
Speaker 4: that's really the whole mission of insurance. But it puts
Speaker 4: a lot of pressure on both sides.
Speaker 2: Mayas Garrity, thank you so much for coming on od lots.
Speaker 2: That was fascinating, my pleasure.
Speaker 3: That was our conversation with Amayas Garrity, partner at QED Investors.
Speaker 3: And now we are on to our second guest. We're
Speaker 3: going to be speaking with r J. Lehman. He's the
Speaker 3: editor and chief for the International Center for Law and Economics. RJ,
Speaker 3: thank you so much for coming on ad lots.
Speaker 6: Thank you for having me.
Speaker 2: Uh, why don't you tell us a little bit? I
Speaker 2: guess why are we telling you? What is your background
Speaker 2: and sort of like your work and understanding the sort
Speaker 2: of regulatory environment for home insurance.
Speaker 6: Sure thing my background is I was journalists. I was
Speaker 6: business journalists. Like y'all, there's hope for us, there's hope.
Speaker 6: Insurance was my beat and I recommend it to anyone
Speaker 6: who is considering going into financial journalism, insurance is the
Speaker 6: best beat. It touches everything, and although there are parts
Speaker 6: of it that are dry, you have the greatest panoply
Speaker 6: of potential subjects to expound upon. So I was a journalist.
Speaker 6: I entered think tank lend back in twenty twelve. I
Speaker 6: co founded a group called the R. Street Institute with
Speaker 6: Eli Laher. Initially, Our Street was overwhelmingly insurance focused. It
Speaker 6: is diversified over the years. I led their insurance program
Speaker 6: as long as I was there, which was until late
Speaker 6: twenty twenty. Most notably, I produced for them an annual
Speaker 6: report card of the fifty states with respect to their
Speaker 6: insurance regulatory environments, ranking who was doing a good job,
Speaker 6: who was in need of improvement. California in particular, was
Speaker 6: always near the bottom because of the system in California
Speaker 6: Florida over the years had been by the time I
Speaker 6: left Our Street and stopped doing that report card, had
Speaker 6: been creeping up from the very bottom to towards the top.
Speaker 6: But they've certainly had some challenges in the past few years.
Speaker 3: So one thing I always wonder when we have these
Speaker 3: insurance discussions, I think there's a tendency to look at
Speaker 3: the current system and feel like it was inevitable. And
Speaker 3: this isn't just regarding insurance, but a lot of things
Speaker 3: in the financial system. But how is it that we
Speaker 3: ended up in a place where insurance premiums are regulated,
Speaker 3: especially in places like California and Florida, And we have
Speaker 3: this mix of private insurance companies but also again in
Speaker 3: places like Florida, a public backstop.
Speaker 6: So why are they regulated? Goes back to basically anti
Speaker 6: trust law. Just after World War Two, there was a
Speaker 6: famous Supreme Court case that determined that insurance was interstate commerce.
Speaker 6: The Congress responded by passing a law called the mccaren
Speaker 6: Ferguson Act that acknowledged that case and acknowledged that it
Speaker 6: was interstate commerce, but nonetheless left it to the states
Speaker 6: to handle regulation of the business of insurance. And insurers,
Speaker 6: particularly back then, used to file rates collectively. The reason
Speaker 6: this was an anti trust concern was because they used
Speaker 6: underwriting bureaus where they shared data because no one insurer
Speaker 6: was large enough to know what the correct rate should be,
Speaker 6: and that was collusion, and so the states initially just
Speaker 6: accepted or rejected rates from the industry as a whole
Speaker 6: and individual insurers only differed in how much they charged
Speaker 6: for market expenses and things like that for their agent force.
Speaker 6: That system kind of broke apart by the late seventies
Speaker 6: when insurers started, especially the larger ones in the personal lines,
Speaker 6: which is home in auto, basically started having enough data
Speaker 6: on their own to make credible actuarial projections without using
Speaker 6: a rating bureau. And that's when you started to have
Speaker 6: actually more complicated regulatory systems, because rather than just accept
Speaker 6: or reject a rate for the whole industry, you had
Speaker 6: to look at each individual company's filing. And so initially
Speaker 6: what most states did was leave it to the market
Speaker 6: in most cases to determine what the best rate would be.
Speaker 6: But some states in the eighties started having issues with
Speaker 6: rates climbing up. There was concern about especially in auto
Speaker 6: more than homeowners. There was concern about profiteering and gouging,
Speaker 6: and so some states responded by having a more intense
Speaker 6: what's called prior approval regulatory system. California did this ineteen
Speaker 6: eighty eight by a ballot initiative called Prop One O three.
Speaker 6: Florida does not have the same prior approval system as California,
Speaker 6: but what Florida was challenged with was after Hurricane Andrew,
Speaker 6: a number of companies simply had not been charging enough
Speaker 6: and were rendered and solvent, especially regional and domestic companies.
Speaker 6: Some of the larger companies want to get out of
Speaker 6: the state altogether. Florida responded by creating these entities what
Speaker 6: are called residual markets, insurers of last resort. Florida's kind
Speaker 6: of unique in two respects. One is, most states do
Speaker 6: have some kind of residual market for auto and for home,
Speaker 6: but it's usually like an assigned risk pool life. You
Speaker 6: can't get coverage, then you will be assigned to an insurer,
Speaker 6: and those assignments will be made based on insurers overall
Speaker 6: market share. In Florida, you have two entities, the Florida
Speaker 6: Citizens Property Insurance Corporation, which is a freestanding owners insurer
Speaker 6: capitalized by the state. Back by the state, it competes
Speaker 6: in the market, and the Florida Hurricane Catastrophe Funds, which
Speaker 6: is a state backed reinsurer. There's no other state that
Speaker 6: has anything quite like that, So the reinsurer. Every insurance
Speaker 6: company doing business in Florida has to buy their first
Speaker 6: layer of reinsurance from the state itself. And that was
Speaker 6: both because there was concern that reinsurers were taking excess
Speaker 6: profit but also because reinsurance rates can fluctuate wildly, and
Speaker 6: so the idea was to try to make it a
Speaker 6: little bit more stable.
Speaker 2: Two things. A. I like that you mentioned that everyone
Speaker 2: should cover insurance because I think Tracy and I have
Speaker 2: talked about there's like people forgot banks all the time,
Speaker 2: Wall Street banks, et cetera, and like, it is sort
Speaker 2: of remarkable generally how little coverage there is of insurers
Speaker 2: and what they're doing.
Speaker 3: It's also that essence of finance, right, like estimating and
Speaker 3: pricing risk.
Speaker 2: And then the other thing I think that's really important
Speaker 2: that you mentioned here is it's funny that like there's
Speaker 2: I don't know it's funny, but you know, a lot
Speaker 2: of the concern right now is about pricing too high
Speaker 2: and price gouging and promitteering. But pricing too low is
Speaker 2: also very, as you say, problematic, because you don't want
Speaker 2: someone an entity coming in and taking tons of market
Speaker 2: share and then not having the capacity to pay out
Speaker 2: when the hurricane hit. So you know, you mentioned that
Speaker 2: as part of your former job, you would create these
Speaker 2: rankings of each of the state's insurance. What goes into
Speaker 2: that ranking, What makes for a good or a bad
Speaker 2: in your view? And I think maybe you know, our
Speaker 2: Street is sort of a you know, free market bent organization.
Speaker 2: But from your view or when you were creating these rankings,
Speaker 2: what constitutes a good or a bad insurance regime.
Speaker 6: So my perspective was that there were certain tests that
Speaker 6: it was important for a department to perform. It wasn't
Speaker 6: seeking no regulation the most The two most important were solvency,
Speaker 6: doing solvency review and the other's consumer protection. I mean,
Speaker 6: it is certainly true that in the marketplace some consumers
Speaker 6: are abused, some insurers might give you the run arounds
Speaker 6: and not pay claims timely and appropriately, and there's a
Speaker 6: role for a regulator to examine those cases. So we
Speaker 6: try to emphasize in our rankings those states that we
Speaker 6: thought were doing those two tasks in particular very well.
Speaker 6: And we would gain states for mostly price regulation, because
Speaker 6: soligncy regulation is kind of separate regime. Then price regulation.
Speaker 6: If there is a competitive market, then I do think
Speaker 6: the market is the best price regulator and insurance historically,
Speaker 6: In fact, there has long been greater problems of companies
Speaker 6: seeking market share and so underpricing their product. It's a
Speaker 6: gain market share maybe to sell you other products, you know,
Speaker 6: maybe you sell auto and then you also tie in
Speaker 6: homeowners and life and possibly some banking services, and that
Speaker 6: in the long run, you may not be pricing appropriately
Speaker 6: or you may not be taking reserves appropriately to maintain solvency.
Speaker 3: First of all, what information are they working from when
Speaker 3: it comes to figuring out what's a reasonable or acceptable
Speaker 3: price for insurers to actually charge? And then secondly, like
Speaker 3: how do they come to that judgment? Like where does
Speaker 3: the information come from? And then what strikes them as
Speaker 3: a reasonable premium increase?
Speaker 6: It is overwhelmingly past loss data in all states. That's true.
Speaker 6: The states do differ in what factors they will allow
Speaker 6: a com need to consider and in the mix of
Speaker 6: factors how much weight you can place on any single one.
Speaker 6: I mean to give you an example. Race is not
Speaker 6: permitted to be used anywhere. That wasn't always true. There
Speaker 6: was a time when it was an actual factor that
Speaker 6: insurance companies in various kinds of insurance used. You cannot
Speaker 6: use race anywhere. It doesn't matter if it's actually credible
Speaker 6: or not. Certainly, loss costs. Things like the rising costs
Speaker 6: of both labor and replacement parts for auto or materials
Speaker 6: for homes are things that you can reflect in your
Speaker 6: rates and in homeowners in particular. Over the last twenty
Speaker 6: five years or so, many companies have started using off
Speaker 6: the shelf catastrophe models. So a catastrophe model takes information
Speaker 6: about climate and residential patterns and projects forward what the
Speaker 6: maximum probable loss might be. That's different than a pure
Speaker 6: loss cost approach, where you just look at what you
Speaker 6: paid in the past. So in California that's particularly relevant
Speaker 6: because prop One OZH three does not allow you to
Speaker 6: project forward. You can only use what is your average
Speaker 6: that you've paid out over the past twenty years in
Speaker 6: determining what your rates should be. Well, in twenty seventeen
Speaker 6: and twenty eighteen, California had these massive wildfires. So the
Speaker 6: industry from nineteen ninety one to twenty sixteen in the
Speaker 6: state of California had made ten billion dollars total in
Speaker 6: underrating profits over that twenty five year period. In twenty
Speaker 6: seventeen and twenty eighteen, they lost twenty billion dollars, so
Speaker 6: they more than doubled all the money they had made
Speaker 6: in the prior twenty five years. So if the future
Speaker 6: doesn't look like the past, and you know, climate change
Speaker 6: and residential patterns are both reasons that the future might
Speaker 6: not look like the past, not being able to project
Speaker 6: forward is a real problem.
Speaker 2: Is California the ow only state that doesn't allow for
Speaker 2: these sort of more forward looking projections of how damages
Speaker 2: might change.
Speaker 6: California is the only state that bars the use of
Speaker 6: catastrophe models altogether. Other states do have controls on how
Speaker 6: much weight you can place on cat models and crafting
Speaker 6: your underwriting and rate setting. Florida is kind of unique
Speaker 6: in that it actually the state created its own cat model.
Speaker 6: So not only does it have state backed homeowners insure
Speaker 6: and the state back reinsure, it also has a state
Speaker 6: back cat model, and it uses its cat model to
Speaker 6: judge the results of private cat models.
Speaker 2: So did you say that California is the fiftieth or
Speaker 2: was the worst?
Speaker 6: It not always depended on the year, but it was
Speaker 6: sometimes the world.
Speaker 2: So what else? So we have seen these stories over
Speaker 2: the last couple of years about various name brand insurance
Speaker 2: companies saying we're leaving the state. So what is it?
Speaker 2: I mean, is it just talk to us generally, Is
Speaker 2: it just about their inability to sort of use these
Speaker 2: cat models? Like, what is the environment or the situation
Speaker 2: that caused I guess your rankings were legit. If they
Speaker 2: like now they're running out of it, sure, I guess
Speaker 2: you're vindicated. Well overall, what is the situation that caused
Speaker 2: them to be ranked so low in your models or
Speaker 2: in your ranking and that now we see insureds playing
Speaker 2: the stame.
Speaker 6: The reason California is different it does have a prior
Speaker 6: approval system. It's not the only state that has that.
Speaker 6: It doesn't allow catastrophe models to be used. It doesn't
Speaker 6: allow anything to be used that was not specifically enumerated
Speaker 6: in this ballot initiative Prop one ZHO three that was
Speaker 6: past nineteen eighty eight. They're basically were no catastrophe models
Speaker 6: in nineteen eighty eight. They were in their infancy in
Speaker 6: auto people weren't really using credit yet, which is now
Speaker 6: a common thing to use in auto insurance, and so
Speaker 6: you can't use it in California. Also, Prop one oh
Speaker 6: three created this system called the Intervener system, where private
Speaker 6: parties consumer advocates every time an insurer files a rate,
Speaker 6: whether it's an increase or not is actually only somewhat relevant.
Speaker 6: But anytime and ensure files a rate files a form,
Speaker 6: these private parties get to object and you have to
Speaker 6: go through a hearing process to get that rate, which
Speaker 6: even if it's ultimately approved, that can take up to
Speaker 6: two years. So it is very inflexible system, and insurers
Speaker 6: have may do with it because California is one fifth
Speaker 6: of the country, and so you don't want to exit
Speaker 6: the California market unless you know the circumstances are really bad.
Speaker 6: But it is terribly brittle. You cannot change these rules
Speaker 6: without either a new proposition to be passed by the voters,
Speaker 6: and the voters are not going to pass something that
Speaker 6: raises their insurance rates, or the legislature by super majorities
Speaker 6: in both chambers can make adjustments to Prop One O three,
Speaker 6: but only if they, in the view of the Court,
Speaker 6: forward the purpose of Prop One O three. So you
Speaker 6: can't undo anything that's in the statute, but you can
Speaker 6: make tweaks. So there's been some effort in California over
Speaker 6: the last year. The Insurance Commissioner, recognizing that there's a problem,
Speaker 6: a serious problem of not having insurance available, has taken
Speaker 6: some emergency regulatory actions that would permit, in some limited circumstances,
Speaker 6: things like being able to use cat models, being able
Speaker 6: to reflect the cost of reinsurance, which is another thing
Speaker 6: that prop One Zho three doesn't specifically allow. But it's
Speaker 6: going to take the legislature taking action for any of
Speaker 6: those things to be permanent.
Speaker 3: So one of the things I always think about when
Speaker 3: we talk about insurance premiums going up and the regulatory
Speaker 3: regime that sort of limits them in places like California,
Speaker 3: or limits those increases. So the idea of having expensive
Speaker 3: insurance is partly it's supposed to deter you from doing
Speaker 3: stupid things, right, It's supposed to shape your behavior to
Speaker 3: some extent. So when it comes to things like climate change,
Speaker 3: you're disincentivized from building a house in a place that's
Speaker 3: prone to floods or in a place that is now
Speaker 3: prone to wildfires. How do regulators balance that aspect of
Speaker 3: this entire question?
Speaker 6: Awkwardly is the short answer. Regulators are chosen in different
Speaker 6: ways in different states. So as you might imagine, ones
Speaker 6: that are directly elected, and there's about eleven of those,
Speaker 6: are probably most attuned to public sentiments as opposed to
Speaker 6: the nuts and bolts of stay solvency, and so those
Speaker 6: who are appointed will vary. Some are appointed in kind
Speaker 6: of unusual ways. In the state of Florida, we have
Speaker 6: this weird system called the cabinet where the four directly
Speaker 6: elected executive officers have to vote together on who to
Speaker 6: appoint and also who to remove. So the Florida Insurance
Speaker 6: Commissioners actually unusually insulated if he has the vote of
Speaker 6: either the CFO or the governor, basically cannot be removed.
Speaker 6: Flood which isn't actually underwritten very much by private parties,
Speaker 6: it's mostly underwritten by the federal government. There is a
Speaker 6: direct relationship between where and how you build and the
Speaker 6: flood risks that are being generated. Wildfire is a little
Speaker 6: bit stranger because there are various tipping points, like if
Speaker 6: I build more densely in a floodplain, I'm going to
Speaker 6: have more flood risk because there's more people there, there's
Speaker 6: more structures there, You're covering the ground. If you build
Speaker 6: more densely in an area of wildfire, initially you may
Speaker 6: be having more properties exposed to the risk, but after
Speaker 6: a certain point you actually are reducing the risk because
Speaker 6: wildfire is generated in less dense. In essence, it sounds silly,
Speaker 6: but you can choose to get rid of the trees.
Speaker 3: Yeah, if we pave over all of California.
Speaker 2: If everyone moves to a wildfire risky area, then the
Speaker 2: wildfire risky.
Speaker 6: Base it disappears. Yeah, so it's not correlated linearly in
Speaker 6: the same way with that risk as it is with
Speaker 6: flood But obviously there are things that you can do
Speaker 6: in terms of creating defensible space around a property, making
Speaker 6: sure that you don't have wood decks and wood roofs,
Speaker 6: and you know, fire retarded materials, sprinklers, etc. These can
Speaker 6: all contribute, but it's not as simple as saying, you know,
Speaker 6: charging more yields the more environmentally responsible solution. Not necessarily.
Speaker 6: It depends on the particulars.
Speaker 2: That's extremely interesting. So Florida you mentioned that it had
Speaker 2: over the years climbed up the rankings. That being said,
Speaker 2: you know, we've all seen these headlines over the last
Speaker 2: couple of years just about these like eye popping insurance
Speaker 2: premium increases four homeowners in the state of Florida, and
Speaker 2: increased dependence on citizens the public option backstop. Why do
Speaker 2: you explain that? So, what did Florida do to prove
Speaker 2: its rankings, and yet you know, still it feels like
Speaker 2: just intuitively and maybe the market justifies it, but it
Speaker 2: feels like there's a problem still.
Speaker 6: Take you back to two thousand and six. Florida had
Speaker 6: just had in two thousand and four four major hurricanes,
Speaker 6: two category threes, two category fours make landfall in one year.
Speaker 6: In two thousand and five, they had Hurricane Wilma. That
Speaker 6: was also the year of Hurricane Katrina, which did massive
Speaker 6: damage and kind of took the reinsurance markets for loop.
Speaker 6: Florida was a basket case back then, and essentially any
Speaker 6: remaining major national homeowners insurers that we're doing business in
Speaker 6: Florida left. Citizens became the largest, not only the largest
Speaker 6: insurer in Florida, but one of the top ten in
Speaker 6: the country. So Charlie crist was elected in two thousand
Speaker 6: and six than a Republican on an insurance reform platform.
Speaker 6: The state legislature in early two thousand and seven passed
Speaker 6: this platform, which included rolling back rates, making it much
Speaker 6: easier to join Citizens, doubling the size of the hurricane
Speaker 6: catastrophe fund. And this was basically a bet that in Florida,
Speaker 6: no realistic assessment of what Florida did in two thousand
Speaker 6: and seven would say that the state, if it got
Speaker 6: a major hurricane, could finance those costs because it put
Speaker 6: enormous costs on potential costs on the state. But Charlie
Speaker 6: Christ and he said this in congressional testimony, made the
Speaker 6: bet that the federal government would pass a national Catastrophe
Speaker 6: fund that would bail out Florida if need be. So
Speaker 6: what Florida did in the intervening years and why they
Speaker 6: were improving, was they did allow rates to rise, They
Speaker 6: shrank the size of citizens significantly. The cat fund was
Speaker 6: put on better financial footing. But what allowed this to
Speaker 6: happen was a very lucky streak, which is that between
Speaker 6: Wilma in two thousand and five and Hurricane Irma in
Speaker 6: twenty seventeen, Florida had no major hurricanes and the historic
Speaker 6: record doesn't show that ever happening before. So the markets
Speaker 6: got much more solid just based on good luck. More
Speaker 6: or less, there were still problems, notably, the litigation environment
Speaker 6: in Florida deteriorated significantly. It was a very attractive place
Speaker 6: for the trial bar as you can see if you
Speaker 6: drive our hideways and see many billboards advertising the services
Speaker 6: of our local trial attorneys, and I have no objection
Speaker 6: to them. But in the last decade and half, nine
Speaker 6: percent of all homeowners insurance claims originated in the state
Speaker 6: of Florida. But eighty percent of all homeowners insurance lawsuits.
Speaker 3: Oh that's funny in Florida. You know what I quoted
Speaker 3: that exact statistic, Oh, yesterday after we recorded our conversation.
Speaker 3: But yeah, that is a stunning statistic.
Speaker 6: It is. It is so we weren't quite as healthy
Speaker 6: as probably we should have been, given our good luck,
Speaker 6: But that lucky streak did allow capital to accumulate and
Speaker 6: for a more robust market to evolve. That market still
Speaker 6: always had problems because it was reliant heavily on companies
Speaker 6: that only do business in Florida and only wrote homeowners,
Speaker 6: so not diversified at all, and they are relatively small,
Speaker 6: relatively thinly capitalized. Then Irma came in twenty seventeen, We
Speaker 6: had Michael in twenty eighteen, we had Ian in twenty
Speaker 6: twenty two, we had a Dalia last year, and those
Speaker 6: were just the knockout blow for like what was for
Speaker 6: these thinly We've had a dozen that have gone insolvent
Speaker 6: in the last couple of years. There are many more
Speaker 6: that are teetering. There needed to be a significant adjustment,
Speaker 6: and that's what you've seen is rates have risen significantly. Now.
Speaker 6: The the average homeowners rate in Florida's asked me to
Speaker 6: be about six thousand dollars a year, which is probably
Speaker 6: double the next state. And I'm not even certain what
Speaker 6: that next date would be. It's been wrenching. I do
Speaker 6: think we're to a better place, at least in terms
Speaker 6: of availability that right now. Ensure looking at the Florida
Speaker 6: market would say those rates are attractive, and if I
Speaker 6: have a clean balance sheet, maybe I'll start writing business there,
Speaker 6: even if I haven't in many years. But it's going
Speaker 6: to be a painful adjustment for sure.
Speaker 3: Recent steps in Florida aside, and I realize I'm talking
Speaker 3: very generally about insurance in the US, and it varies
Speaker 3: state to state, as you point it out. But if
Speaker 3: we have a situation where insurers are pulling out of
Speaker 3: markets because they say they can't raise premiums because of
Speaker 3: these regulatory limits, and meanwhile the risk of catastrophic events
Speaker 3: is increasing, and then what ends up happening is people
Speaker 3: lean on either you know, state or federal insurance, whatever
Speaker 3: backstop might be in place there. Why not cut out
Speaker 3: the middleman and just have a public insurance entity.
Speaker 6: Well, as we were sort of alluding to earlier, if
Speaker 6: you underprice the risk, and that that would be the
Speaker 6: assumption here, right, is that the reason that private companies
Speaker 6: would not write this business but the government entity would
Speaker 6: is because they are underpricing the risk. Then that is
Speaker 6: just shifting the problem to the taxpayer. And you can
Speaker 6: make that decision, sure, I mean, that's a policy decision
Speaker 6: that has been made in many contexts. It's certainly the
Speaker 6: way the crop insurance program works is that it's a subsidy.
Speaker 6: It's an explicit subsidy for our farmers. Whether this should
Speaker 6: be something subsidized, whether building beach homes is something that
Speaker 6: we want as a matter of public policy to subsidize,
Speaker 6: I don't, but you know someone can make that case.
Speaker 6: It's a democracy. There's someone believes that, and so you
Speaker 6: know that that's where we are.
Speaker 2: Is the Florida's stayed back reinsure? Is that re reinsured
Speaker 2: at all?
Speaker 3: It's all the way down.
Speaker 2: Reinsurance does exist, right, yes.
Speaker 6: And a bit is the answer there's largely through catastrophe
Speaker 6: bonds that the CAT funds issued, and those are a
Speaker 6: form of reinsurance. There isn't much facultative or treaty, and
Speaker 6: I'm not aware of any currently with the farther CAT Fund,
Speaker 6: but I will admit that I haven't looked at their
Speaker 6: balance sheet in a couple of years.
Speaker 2: What is your prescription for both states? It would be
Speaker 2: it sounds like California has to do much more, but
Speaker 2: it does seem like Florida has issues with the fact
Speaker 2: that it has to be a solely you know, these
Speaker 2: sort of undiversified companies. Definitely seems like an issue like
Speaker 2: what would be the ideal reforms we're looking at.
Speaker 6: In both cases. I think the ideal reform is to
Speaker 6: bring down the level of risk, which means shifting investment
Speaker 6: to the front end to mitigation, and both states do
Speaker 6: that to some extent. Florida could do much more in
Speaker 6: helping to raise properties and places where they're at risk
Speaker 6: of flood, ensure that the building codes are appropriately measured
Speaker 6: to the size of the risk. California's regulatory environment ultimately
Speaker 6: will have to be a thing that the people of
Speaker 6: California are leveled with about what is realistic and possible
Speaker 6: over the long term. And that's a democracy challenge because
Speaker 6: no one wants to pay more to be fair. In California,
Speaker 6: they do actually pay less, although they in Hawaii are
Speaker 6: the most expensive states, certainly for the cost of housing,
Speaker 6: they pay less than one would predict. And that is
Speaker 6: a function of the regulatory environment. In Florida, that's not true.
Speaker 6: In fact, if anything, it may be current rates there
Speaker 6: were probably peeking out at a level that will naturally
Speaker 6: come down with more compat but we'll have to wait
Speaker 6: and see on that.
Speaker 5: R J.
Speaker 2: Lehman, thank you so much for coming on odd Laws.
Speaker 2: That was great and clarified a bunch of things for us.
Speaker 2: So really appreciate you taking the time. Absolutely, thank you, Tracy.
Speaker 2: Those conversations cleared up a lot of things for me.
Speaker 2: Let's just start there.
Speaker 3: Yes, I have been wanting to dig a little bit
Speaker 3: more into the Florida fraudulent roof replacement schemes for a while.
Speaker 3: That was really fun.
Speaker 2: That was really fun. There were so many interesting things.
Speaker 2: First of all, like I think one thing that helps
Speaker 2: crystallize for me, the huge surgeon insurance premiums is a
Speaker 2: not only the increase in climate risk, but be just
Speaker 2: the surge in home values themselves, because it doesn't matter,
Speaker 2: as we talked about, like you might have bought your
Speaker 2: home in the nineteen eighties, but to replace it, you
Speaker 2: have to replace it at twenty twenty four dollars. And
Speaker 2: so if you are in a boom state, which many
Speaker 2: people have been, whether particularly if you've been in Florida
Speaker 2: or California over the last several years, or home prices
Speaker 2: have gone nuts, it just makes sense, just sort of
Speaker 2: mathematically right there, that your premiums are going to go up.
Speaker 3: Absolutely. I also thought the differentiation in the way some
Speaker 3: of these disasters happen is also interesting. So the idea
Speaker 3: that forest fires are maybe a little bit different in
Speaker 3: nature to something like a hurricane. They wipe out a
Speaker 3: lot more, they can occur sort of unexpectedly. I mean,
Speaker 3: obviously you can determine how dry the weather is, what
Speaker 3: the fire risk conditions are at any one time, but
Speaker 3: you don't necessarily have a good handle on whether a
Speaker 3: single power line is going to come down or whether
Speaker 3: I don't know, a crazy person starts a fire on
Speaker 3: purpose or a camper starts accidentally burning brush that I.
Speaker 2: Guess factoid about like fire risk, where it's like, if
Speaker 2: you build in an area in which there's fire risk, like, okay,
Speaker 2: maybe your insurance premiums go up. But if everyone builds
Speaker 2: in an area where there's fire risk and you just
Speaker 2: clear cut all of the trees, then the risk goes down,
Speaker 2: which is sort of I guess it's funny in some way,
Speaker 2: not necessarily funny, haha, but funny perverse. I think also,
Speaker 2: just in you know, talking with RJ, the sort of
Speaker 2: the diversity of state models and so the fact that
Speaker 2: we really do have, you know, every state has an
Speaker 2: insurance commissioner and every state has its own rules about
Speaker 2: how pricing works, I think contributes to the difficulty understanding
Speaker 2: this market absolutely.
Speaker 3: And also just the cyclical nature, the sort of boom
Speaker 3: bust cycle of insurance it feels like, and the degree
Speaker 3: to which some of the capital behind the insurers, so
Speaker 3: the reinsures is kind of cyclical. There's so many moving
Speaker 3: parts here.
Speaker 2: I'm really glad that you brought up the reinsurer's part
Speaker 2: because you know, one of the things and we talked
Speaker 2: about it a little bit on our recent inflation episode
Speaker 2: with Omayor and Skanda, is these sort of back door
Speaker 2: ways in which higher FED rates can contribute to higher inflation,
Speaker 2: and so hear this sort of amyas as he explained it,
Speaker 2: it's like the FED hikes rates, the reinsureds take losses
Speaker 2: on their bond portfolio. The reinsurer then has less money,
Speaker 2: less capacity to back home insurance, and so then they
Speaker 2: hike up their rates, and the home insurers hike up
Speaker 2: their rates, and so this sort of very backdoor way
Speaker 2: in which higher rates almost linearly flow through right to
Speaker 2: higher consumer prices.
Speaker 3: Yeah, and no one ever really talks about it except
Speaker 3: up all right, and the INSURAN and the and the
Speaker 3: reinsurance dedicated.
Speaker 2: Insurance reporters of Priye talked about this, but don't get
Speaker 2: enough attention.
Speaker 3: Yes, that is very good point. All right, shall we
Speaker 3: leave it there.
Speaker 2: Let's leave it there.
Speaker 3: This has been another episode of the All Thoughts podcast.
Speaker 3: I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 2: And I'm Joe Wisenthal. You can follow me at the Stalwart.
Speaker 2: Follow our guests Amias Garrity He's at Amias MG and RJ.
Speaker 2: Leman He's at Ray Leman. Follow our producers Kerman Rodriguez
Speaker 2: at Kerman Armann dash O Bennett at Dashbot and Kilbrooks
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