Bad Bookies

I was listening to the Michael Lewis podcast, “Against the Rules.” The season involved what I consider to be the highly unethical methods designed to attract people bad at evaluating odds to gamble on sports and then gamble more. I highly recommend the podcast and his books.

Hearing the old-fashioned bookies was one of the best parts of the podcast. One of them used terms identical to insurance terms. If you have a good underwriting model for judging risk and odds, you want to attract as much money as possible (Progressive is an excellent example of this). If you have a bad underwriting model for judging and pricing odds, you shouldn’t want any bets (premiums) because you’ll lose!

The key difference here is that an individual might know something the bookie does not know, which a smart bookie appreciates because it helps them move the line. However, a not-so-smart bookie won’t appreciate the information. That bookie will be adversely selected against. We use the same terms in insurance underwriting.

Perhaps insurance companies writing in certain states and lines are bad bookies? Maybe the public (rather than the individual) knows something the insurance companies don’t know and cannot process intelligently? How else can the horrible profitability of homeowners' insurance be explained?

Someone, i.e., the carriers, has not assessed risk correctly. Whether they failed because they failed to assess the weather risk in Minnesota, the regulatory risk in California, or the litigation risk in Florida, or whatever else, they failed to assess risk accurately.

I believe the best way to analyze any problem is to break down the situation to its simplest element and build back. The simplest element is a failure to assess risk correctly, so that it can be priced correctly.

The carriers, some of whom are horrible bookies, as a whole, simply failed to assess risk for ten consecutive years, which is the number one job of an insurance company. We can get lost in the details of how one carrier never assesses risk correctly and still makes a lot of money–they might have a gargantuan investment portfolio combined with an interesting tax strategy. But they could make even more money if they assessed risk correctly.

We can get lost in the details of carriers starting off with excessive surplus, wasting it by poor assessment of risk, and how it seems to take forever for them to correct course. We can get into all kinds of details, but the fundamental job of insurance companies is to take a lot of bets, knowing they will lose many of them. Still, overall, the carriers will make 5%-10%.

There is nothing different than running a gambling book.

No excuses should be made. Either the executives, over a five-year time frame, assess and price risk correctly or new executives should replace them. Obviously, this is easier said than done, but seeing executives that never make money should also be an easy decision for the board of directors.

It should also make for an easy decision for strategic thinking distributors to assess their risk of doing business with carriers that obviously are incompetent at assessing risk. It’s not going to work out without a miracle happening. Miracles are long shots, and smart gamblers will advise that methodical, well-researched, disciplined bets are the way to win.

Fundamentally, this industry has never deviated from the need to assess and price risk correctly. When we forget this, we lose, though a few individuals might get rich from people who are bad at assessing odds.

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