Self Perpetuating Pessimism – Just the Opposite in Insurance

Things have been bad.  The results have run against your strategy for some time now.  So you pull back.  Derisk.  Leave the game.

That may be the most prudent decision, or it may be simply self perpetuating pessimism.

Others may not share that pessimism.  Others may see opportunities in the chaos that has caused your losses.  Others are doubling down.

But how to know?  How to tell whether it makes more sense to move on or to stay in?

Sometimes, you cannot tell.  There is no indications whether the next day or the next year will be even worse than the last or whether it will be a big step on the road back to prosperity.  The most important element to determining that may not be something neutral in the environment.  It may be the mood of the people.

“The only thing to fear is fear itself”

The actions of the crowd to pull back all together cause or at least accentuate the very poor environment that the actions were meant to protect against.  It is a classical negative feedback look.  The poor results cause people to pull back that causes more poor results.

That is the way that an investment market works.  But an insurance market works just the opposite.  Optimism makes more people to rush into a market.  It causes the rates charged for a risk to go down because of competition.  It causes underwriting standards to deteriorate.  It encourages more and more of the underpriced misunderwritten business.  Pessimism causes insurers to withdraw from an insurance market.  Less competition allows rates to rise.  Pessimism makes insurers set the minimum rate at which they might write some insurance higher.

In insurance when the crowd deserts a market, the few who remain are suddenly able to raise rates to sustainable levels and beyond.

So why does it take so long for insurers to react to soft rates and leave markets?   They all know the game and all want to be the ones who are left when the rates get hard. So insurers are playing a few moves ahead.

For some reason, investors, who consider themselves to be much more sophisticated, only seem to be looking one step ahead.  Or at least the crowd does.  Maybe the real sophisticated investors ARE playing several steps ahead.  They will never let you know that.

Explore posts in the same categories: Complexity

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