Irrational exuberance?


Being a pessimist by nature does not mean that thinking the ILS boom is overdone is irrational, does it?

Big news in the ILS sector as cat bond/ILS issuance in the second quarter of 2014 broke all records, according to the good people at Artemis.
I do not pretend to be an insurance expert, more of an interested observer, and can’t quite figure out if all the excitement over ILS is irrational exuberance, or if this is the latest and greatest example of creative disruption.
Because ILS has so many boosters, most people will know all the reasons why this is the best thing ever.
For the more skeptical (and I sometimes suffer from seeing all glasses as half empty), the Artemis story has one or two interesting points.
What was the previous highest second quarter for cat bonds? 2012? Wrong. 2007? Right. And what started to happen in 2007? The investing world as we knew it started to implode.
Does that mean this is an example of investors looking for a new bubble to pour money into? Not necessarily.
But it does seem to me that this boom is mostly driven by excess liquidity. When people who should know better start talking about how reinsurers need a strategy that is more asset-driven than underwriting driven, that is both a sign of a soft market and of risky approaches.
One veteran re/insurer who has seen several soft markets, noted that similar things happened in the 1970s and 1980s when all kinds of naïve capital entered the market and eventually got nailed.
Indy remembers a lot of talk about how investment earnings were more important than underwriting earnings as well. It is no accident that a lot of Bermuda captives then got turned completely upside down when they started underwriting for multiple insureds then as well.
There is a counter-argument to this, but whenever people start saying this time is different, and that pension funds are so huge they will barely notice a multi-billion dollar loss, it makes Indy nervous.
There’s no doubt that ILS is an extremely efficient way of raising capital and putting it to work. But old-fashioned sensible underwriting and expertise counts for a lot as well.
When Warren Buffett starts saying he doesn’t like the direction of a business, then people should take note. He’s right a lot more than he’s wrong.
Add that to cat bond pioneer Munich Re having to pull an issue because it can’t get the pricing it wants, and that’s a warning too. Maybe I will be proven wrong, and I kind of hope so, but the warning signs are growing that maybe this isn’t such a good thing.

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