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Local & Global Economic Forecasts, Demise of Commissions, Taxi vs. Ride Sharing

Posted By Thom Young, February 14, 2017

Happy Ground Hog Day—Global and Local Forecasts

Since the fat, privileged rodent named Punxsutawney Phil apparently found the day too nice to run back into his burrow, this scientific process of long-term weather prediction has determined that winter will not soon be over and spring 2017 will not arrive earlier than normal. One wonders if good old Phil has some scientific equipment down in the ground that is giving him some confidence that the earth is in fact warming at an ever increasing pace. Hard to say, but it’s a safe bet he’s not watching Fox News!

Regardless of the bulletins from Gobblers Knob Pennsylvania, the real scientific reports clearly show that the past two years have been the warmest since we’ve been keeping records. Sceptics keep challenging the conclusions: the data is limited and inconclusive, the time frame of the measurements is limited, other variables are at play, etc., etc. Even considering these concerns, the information those of us in the risk management business have to analyze gives us a basis for concern. Regardless of statistical variances and the inconclusive outcome of an analysis, the probable outcome is significant enough to demand that we develop a plan to mitigate the risks.

Actuaries around the globe are already using predictive loss formulas for rate adjustments responding to the variables in losses predicted by models allowing for global warming. Reserves are being established to provide for severe weather losses. Reinsurance treaties are being negotiated for catastrophic losses using rate allowances for increased incidents of hurricanes, tidal surge, and changing weather patterns that produce more frequent and more severe weather systems. Loss ratios that are better than predicted continue to generate significant ROE for the insurers as a whole, which continues to keep the marketplace very competitive for most classes of business. In a strange way, even with the upward actuarial adjustments for increased loss, the expanding insurance marketplace is producing competitive benefits for consumers. I believe we will continue to see this market producing a positive outcome until a very severe catastrophic loss occurs.

Fairly accurate predictions about the performance of the insurance industry are not that difficult to make using the information we have from historical results and predictive modeling. The math is not that difficult and recorded variances can be explained. However, one uncertain variable needs to be identified and qualified in any discussion about economic performance, that being the economic performance of other industries and sectors. Globalized trade is as important to the economic returns in our industry as in any other.

Our world has become so interdependent on the delivery of goods and services that no economic unit can survive on its own. Reinsurance arrangements today transfer risk for losses all around the globe. For example, the Fort McMurray catastrophe had a global effect. Homeowners not only in Canada but also in cities on every continent are seeing a portion of their homeowners premium set aside to cover the insured losses in Fort McMurray and a little extra for the possibility of another Canadian community going up in flames. Likewise, when Australian brush fires destroy a community, the Santa Ana winds blow wildfires through the suburbs of Los Angeles, or even the French Riviera sees communities in flames, we all become part of the risk transference. Through the risk transference and sharing facilities of reinsurance, even a homeowner in Red Deer contributes premiums into the pool that funds the payment of those global claims.

I was recently at a seminar discussing the evolution of business models and how they are affected by disrupters. This term seems to be the new buzz word for those people and situations that force situations to change and adapt, often for better outcomes. Corporate emphasis has for a long time been focused on finding team players and implementing systems that support the status quo, but research seems to show that the evolution of successful strategies often comes from those who “think outside of the box” or “challenge the norms.” While many successful business people have long known this strategy to be productive, the concept is making the rounds as a new business model. Certainly, the discussion above regarding predictions of a continuing stable market for the insurance business is focused exclusively from the perspective of the “norms” challenging our business. Continuing and new situations such as the effects of climate change are being dealt with in the normal way. The best laid plans can always be disrupted by irrational and unexpected factors. Such disruption must be considered in light of the current economic and political events unfolding in our world today.

Outside of the capital in play in our business to meet the reserve requirements set out by the insurance regulators, this money isn’t always in play as cash waiting pay claims. Funds for all kinds of developments and investments are sourced from the funds managed by insurers until such times as they are needed to pay claims. These are managed in a balance of liquidity and security to generate much of the “investment income” that supplements the results of the underwriting profit or loss when determining income for our insurers. Disruption in our economy can have devastating effects on the insurance industry. As we saw most recently in 2008 and other times in recent history, the decline in the value of investments as a result of the failure of capital markets can very quickly see insurers trying to line up their business written with the capital values they are holding in reserves. This shedding of market share is the primary cause of a hard market. Hard markets and soft markets are never a good thing for our business. Every investment manager hopes for stable markets moving in predictable directions, either up or down.

Turning to the 800 pound orange gorilla in the room for a moment, the calamity that may come about by the disruption of international trade agreements and the removal of regulatory oversight of the finance business is what’s keeping the financial managers that I know up at night. The threat of 20% or 30% tariffs imposed on trade networks that have evolved to remain competitive in the new global supply chains and markets should concern everyone. This kind of disruption will not be good for anyone, particularly the USA, and failure of the American economy would be devastating to all of us. At the same time, the exit of Great Britain from the European market without bilateral adjustments with the whole of the EU will no doubt tip international trade on its side as well. The times are changing and my fingers are crossed that the reality of fair balanced cooperation for the good of us all will eventually be the reality we get in the end. So far the consequences of irrational disruption seem lost upon the man who thinks he’s running things down south. The wakeup call will no doubt be loud and confusing when it comes.

The Demise of Commissions?

Want to work as a true broker? No set commissions? Our associates in the life insurance business are facing a new challenge in regards to the way in which we are remunerated. A number of people hold the belief that agents should be allowed to charge a fee for service for their work with no set compensation percentage on the value of the amounts the client invests (see “The Higher-Cost, Higher-Service Future of Investing Advice"). The threat to ban commissions is real. On January 10th, 2017, the Canadian Securities Administrators (CSA) published CSA Consultation Paper 81-408 – Consultation on the Option of Discontinuing Embedded Commissions (Consultation Paper) suggesting the need to transition to a direct pay arrangement, where the investor directly pays the dealer’s compensation. Such an arrangement certainly would resolve the disclosure issues that always seem to arise, but would it make any difference in the long run? How would this work in the General insurance industry? This discussion has come up many times over the years about the insurers quoting their product on a net basis and leaving the broker to add commission to the bill. General insurers often start talking about this when a hardening market puts price pressure on holding market share. The thought is that, if the insurers have to forego revenue to remain competitive, the broker should too. I’ve never really seen the sense in that argument, but then I’m a broker at heart!

The life insurance agent’s main lobbying association Advocis isn’t taking this proposal sitting down. Advocis has launched a digital campaign targeted at both financial advisers and their clients. Financial Advice for All is a micro-site that outlines the issue of banning commissions and how it will affect Canadians. I wonder how General insurance brokers and agents would feel about the challenge of this kind of regulation affecting their business.

Thinking of Buying a Taxi?

Following along with the topic of business disruption and the effect on norms, the taxi business certainly seems in dire need of adaptation to the competitive pressure coming from Uber. Recently in Las Vegas, I learned that many taxi drivers are participating in the Uber model along with their regular taxi business. Either the meters in the taxi or the Uber app is collecting the money. Vegas Taxi drivers are notorious for scenic routes and special shortcuts to pad their fares. Uber seems to be keeping everyone honest. Those less technically proficient in the use of apps on their phones are stuck with the taxi meter. Those with the Uber app are getting directly where they’re going at a fair price with the tip included.

I don’t think that buying a taxi business would be a bright idea these days. I’ve written many times about the livery business and the manner in which it has evolved. The advent of Uber and Lyft has reduced the taxi business to something more like a bus service for moving large groups of people from specific locations or sectors to other sectors. The individual looking for a lift home or to a function from home is not looking for a cab service anymore. Uber is cheaper, more reliable, and more pleasant to use than any taxi ever.

I was introduced to Uber in Ottawa when we were bouncing around the capitol lobbying on behalf our industry. I had ridden to town in a cab from the airport. The cab was filthy, the driver was indifferent, and between texting while driving and using his hands-free function to have a loud discussion with an equally loud associate, he left me very unhappy with the transportation experience. At one point I wished to ask him a question about the route he was taking and ended up trying to yell over the discourse going on in the front. When he did give me his attention, he had no idea what I was asking him anyway.

The normal fare for a shuttle from my Phoenix house to the airport is $70 plus tip. Taxis are reluctant to come as far out as the urban setting where I live but will take me from the airport to my house for around $100 plus tip. Uber recently picked me up in a very nice, clean, four-door car and delivered me to the airport for $37.85, tip included. Hard to see the shuttles and the taxis staying afloat for long with that kind of price competition.

A survey by Angus Reid shows the consensus is that the Uber guys should be subject to the same rules and regulations as the rest of the livery business. Properly qualified drivers and equipment are expected by the consumer. Uber says this isn’t a problem.

In Closing

This is the second edition of Young’s Stuff for 2017. I hope you’re finding it enjoyable and thought provoking. Share your thoughts and open dialogue with all who are receiving it. Feel free to post in the blog link on the IBAA website or on LinkedIn, Facebook, or Twitter. I’m always looking for feedback and ideas. The direct email link below comes only to me..

 


The opinions expressed in this blog are not necessarily those of IBAA.
Comment on this post below or email Thom Young privately. Thom also encourages suggestions for topics.

 

Tags:  business disruptors  capital reserves  catastrophic loss  commissions  global economy  global warming  life insurance  orange gorilla  reinsurance rates  ride sharing  transfer of risk 

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