On the Return of Cash-Flow Underwriting

Cash Flow Underwriting: dealing rooms eclipsed the underwriting floor

Cash Flow Underwriting: the action was in the dealing rooms not on the underwriting floor in the 80s and 90s

A distant memory now but when interest rates were measured in double-digits and equity prices only roared upwards, plenty of insurers threw away their rating manual to grab business at any price just to pile the money into high yielding bonds and on to the stock market. Needless to say under the weight of huge underwriting losses, those that aggressively followed this strategy eventually perished.  Since then the industry has concentrated instead on making a profit from underwriting, although not always succeeding, and investing conservatively to preserve capital rather than maximise returns.

For Berkshire Hathaway the “collect now, pay later” nature of the insurance business has generated a $73 billion “float” (claims and premium reserves) which is, according to Warren Buffet, the engine that propels his group’s broader expansion into Corporate America. Yet, in recording underwriting profits for ten consecutive years, totalling over $18 billion, Berkshire can hardly be accused of compromising underwriting standards in their pursuit of this enormous cash mountain. Known for deploying big capacity inventively, at speed and at times and in situations where there are few alternatives, Ajit Jain’s highly succesful reinsurance group has delivered much of Berkshire’s profit and cash over the past decade. However, with fewer capital dislocations occurring, most of their opportunistic plays reported lately have been on the fringes of the global marketplace and may be relatively short-lived. Turning now to broking giants Marsh and Aon to deliver premium volume through straight quota shares of business they place is therefore perhaps not such a surprise.

The attraction for Berkshire of accessing highly diversified portfolios whilst having no responsibility at all for their production or servicing appears obvious although profit streams that will probably track rather than beat the market average is not what they typically shoot for. Aligning with intermediaries whose duty is to serve clients, not deliver an underwriting return to suppliers, is also a departure from their earlier deals with insurers who are contractually bound to serve the reinsurer’s interest. Although the high quality of management involved on both sides should ensure that these arrangements do not end in tears, their effect on the wider market could be another story.

If buying into blocks of business becomes the norm and not so adept carriers sacrifice risk selection and rating discipline in the effort, the industry could sink into a pricing trough. For the time being low interest rates should be enough to discourage old school cash-flow underwriters but as Warren Buffet said himself in his recent shareholder letter: “there are a lot of ways to lose money in insurance, and the industry never ceases searching for new ones”. Ironically his company may have just planted a fresh signpost to the cliff that others less competent could at some point choose to dive off.

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2 Responses to On the Return of Cash-Flow Underwriting

  1. Peter Hughes says:

    Excellent article Roger. To what extent do you think that this is a play that demonstrates, and relies on, the quality of the Lloyd’s franchise board? I think I’m right in saying that it’s the business placed in Lloyd’s that’s involved, so thus shows great confidence in the quality of underwriting in the Lloyd’s market?

  2. rogerbickm says:

    Thanks Peter. As Tom Bolt reportedly said at the time the Aon deal is indeed flattering because a Lloyd’s lead is required on business ceded to Berkshire yet it is less clear whether the society, franchise, capital providers and/or market consitiuents will realise any benefit or potentially be harmed by the quota share.

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