I just came across this really interesting article in Bloomberg Businessweek (h/t Planet Money).
Apropos of a year of natural disasters that is starting to make me think really hard about where I would feel comfortable living in the coming decades, it’s about the business of reinsurance, i.e. the insurers who insure the insurers. This very off-the-radar business is made up of just a relative handful of firms (compared with companies which insure the public). These firms write large scale agreements (known as treaties in the biz) with other insurers that kick in when things go seriously wrong. Major hurricanes, earthquakes, floods and (formerly) large scale acts of terrorism are the types of events which affect hundreds of insurance companies at once, threatening the liquidity, if not the very survival of said companies. When such things happen is when reinsurers get a call.
The most interesting thing to me about the article though, is that these companies are fairly unique in that they make a living by pricing unusual risk, namely VERY hard to predict and massively disruptive events. To do this, they must dispense with much of the shenanigans and posturing that characterize much of the corporate world and simply use the best available information, thought through as well as possible, to come up with a view of the world that gets it as right as they can manage. Perhaps aided by the iconoclastic nature of their business (there aren’t a lot of politicians scoring points by going on about those “fat cat reinsurers” or whatever the case may be), these firms end up being much closer to microeconomic ideals regarding price discovery, incentivization and other principles which are, today, often pretty hard to find. I don’t come across anything from reinsurers complaining about the “regulatory uncertainty” coming out of Washington or the “unfriendly” business environment, etc. etc.
Consequently, problems such as climate change are not in dispute in any way at all (business boosting politicians take note), but simply a known unknown among many unknown unknowns which these companies go to great effort to price correctly. What is the likelihood of the Greenland Ice Sheet sliding off into the North Atlantic during the term of this treaty and how much insured real estate will be affected in “X” region? How will a 30-year drought affect the likelihood of wildfires destroying thousands of homes and businesses in central Texas? These are the questions that reinsurers must attempt to put a model together for.
The article details the more recent attempts to take into account factors relating to cultures and their risk aversions (of the lack thereof) and how such things can affect the type of preparations embodied in building and behavior in different parts of the world. These things are not as easily modeled in terms of straight seismology, meteorology and straight insurance underwriting. Post-Katrina, several reinsurers began working more closely with social scientists and economists to try and put some figures to harder to connect dots before and after disasters accountable to human behavior, both rational and irrational.
Anyway, a fascinating read and seemingly a really good industry to watch for real, unvarnished assessments of the large scale dangers of the future.