Can we assume that insurance companies will be able to do what they claim they will do under the ideology of fiat? If it seems not, what can be done to improve the situation? This essay aims to investigate the general situation of the insurance industry, likely problems that might evolve and potential remedies.
How does a general (non-life) insurance company operate? Say our company, InsureCo., provides automobile and housing insurance. InsureCo. takes in premium from their clients and pays out when required. The sum of premium earned but not required for pay outs comprises what is known as InsureCo.’s ‘float’ (or reserves.) The judicious investment of the float would give the management extra leeway in pricing v. peers. Without the imposition of fiat ideology, the float would most likely be invested in (gold coin) bills of exchange – a good that can be exchanged at ease for gold coin if required for pay-outs in order to compensate the insured for losses incurred at any moment and ahead of the bill’s maturity. If InsureCo.’s float became much larger than any pay- out that could be required, longer maturity assets such as (gold coin denominated) equity or property might be considered.
Under the imposition of fiat ideology, premium is taken in fiat and the float invested – on the whole – in government securities. InsureCo. is regulated and must keep a strict percentage of their total assets in ‘riskless’ government bonds. InsureCo. subscribes to government bonds at issue, holding to maturity earning fiat income in the interim and reinvesting the proceeds in the next issue. In a falling rate environment, each successive purchase of government bonds generates successively less income. InsureCo.’s are open – meaning the fiat ‘value’ of goods insured isn’t capped.
At some point, as fiat ideology precipitates market closures (beginning with the most marketable good; gold) InsureCo. will not be able to pay-out on claims for lack of ability; the fiat government bonds or fiat deposits on InsureCo.’s ‘asset’ ledger cannot be exchanged for the [combination of marketable] goods required for the pay- out. This is not likely to be because the fiat ‘price’ of the goods required is too high but because they’re unavailable for fiat at all.
Disappearing markets will cause much bigger problems for InsureCo. than for the general public. InsureCo. only pays out when an obligation to pay (i.e. insured accident) occurs – InsureCo cannot hoard goods that might be required to effectually pay out on obligations before any incidents have occurred because they are forced by regulations to invest their float primarily in government bonds! The general public are not as hindered; they are able to hoard goods before markets have closed (v. fiat.) The general public are likely to know what they require well before InsureCo does.
InsureCo.’s liabilities are based on marketable goods and not the fiat against which these goods are currently quoted and in which InsureCo. takes premium. Furthermore, the regulatory regime under which InsureCo. operates is likely to not allow physical gold to be held. Claims to gold are heavily penalised from a risk perspective.
InsureCo. must move to a jurisdiction which allows them to offer the premium for fiat – as usual – or gold coin. The premium purchaser has a choice of paying in fiat – as usual – or gold coin. A gold coin payment is much more likely to occur if a discount is offered for payment in gold coin v. the regular fiat quote. InsureCo. would have a stream of gold coins as income ready to pay out for goods that might not be available for fiat. The gold coins comprising part of the float could be hoarded or invested in (gold coin) bills of exchange as this develops from other initiatives to earn a gold income.
How could gold coins generate income for their holders? For this to occur, people need to be encouraged to have two quotes on their invoices: one in fiat terms – as usual – and one in gold terms. Everybody has a need to send invoices – even if it’s overtly hidden by automatic payment (e.g. with salaries.) Invoices that have regular fiat quotes as well as a gold coin quotes will be the basis for gold coin bills of exchange. What will determine whether the invoice will get settled in fiat or gold coin? The incentive given to the invoice payer; say an invoice is for $1,000 or 3⁄4 oz. gold ($918 equivalent); the invoice payer is likely to try to source the gold coins to take advantage of the discount.
The development of gold coin cum fiat bills of exchange (‘hybrid bills of exchange’) must be supported and left unhindered in a friendly jurisdiction. It would be beneficial for the jurisdiction if they offered the ability for gold to be coined into a standard unit coin. The ‘hybrid bills of exchange’ could be bid for, if offered, with InsureCo.’s gold coins in the float. The discount that the bills clear at would be the income on the gold coins.
A jurisdiction that would allow InsureCo.to hold actual gold – which is against regulations in most countries – as well as the ability for InsureCo. to reliably receive gold coin payment will ensure the survival of underwriting ability. Without this ability, the entire insurance industry is doomed.
Sandeep Jaitly, Fekete Research, 27th October 2014.
♦♦♦♦♦♦♦ Insurance underwriting in a falling interest rate environment ♦♦♦♦♦♦♦
The following questions were recently asked to a senior insurance underwriter:
Would you say that the falling interest rate environment over the past 5 years has been a surprise to the insurance industry?
I do not know whether or not the falling interest rates have been a surprise to everybody in the insurance industry. I believe that some have and some haven’t been surprised whilst most are probably wondering why that the recovery of the industry is taking so long despite of the low interest rates. Insurance people like to think in cycles and believe that a decline in the rate of interest is an aid to industry recovery. An interesting question would be what people expect for the future. Opinions may vary; however, generally speaking I believe that people expect that eventually the economy will recover. Therefore, they are probably expecting that interest rates will go up again at some stage.
How has premium pricing action changed over the past 5 years?
Insurance and reinsurance prices have been under a lot of pressure during the last five years. You would think that the lower interest rates have to be compensated by higher risk prices. However, the contrary is occurring when insurers are clearly experiencing a deterioration of prices for risk. The reason for this I believe that a huge amount of risk capital is available in the insurance industry looking for some return in a world with extremely low interest rates. Generally speaking, I believe that people accept risk that they would not accept in a healthier economic environment.
Has the industry been looking at longer maturity investments to compensate for a lack of yield?
Insurers need to have a maturity mix in their portfolio because they need to manage the interest rate related risk and because they normally hold their bonds until they expire. However, as from a historical viewpoint interests are low and since people expect they must go up at some stage (I am repeating myself), I believe that insurance companies have lowered the average duration of the bonds that they are holding slightly.
Does the industry foresee a problem with government bonds forming the vast majority of their asset base? If not, why not?
The insurance industry sees a problem with the low interests rather than with the fact that they are holding allegedly safe government bonds. The low interest rates are probably also the reason why insurance companies have an increasing interest in private equities.
Generally, are gold and silver considered suitable assets to hold?
Generally speaking, insurers are being punished – particularly under solvency ii – for holding gold when the underlying capital requirements are much higher than for government bonds. Further, gold doesn’t pay any interest which I believe is the killing argument for the insurance industry against holding gold and silver anyway.