Insurance has a steep learning curve – and understanding what a policy covers, believe it or not, is the bottom of the curve. Some say learning is more caught than taught; and, if that’s the case, I caught a lot more than I bargained for last week – and learned even more from research over the weekend.
Before I explain why you need to invest your sweet potatoes on the weather, you need to take a look at this picture of the the insurance industry. It’s the one I had in my head – although far more developed (understatement) – when I posted this link on the ALL Board in response to a comment from Slabbed’s friend cominglatersooner.
Now. about those sweet potatoes – or commodities as they’re known when they’re not groceries.
Federal regulators with the Commodity Futures Trading Commission are investigating whether large institutional funds and hedge funds are behind the sharply rising costs of oil, food and many other commodities in recent months. Investigators are concerned that futures contracts for oil and other commodities may have skewed the market and are behind the price increases.
The Commodity Futures Trading Commission recently held a hearing where testimony was heard from investment experts that indicate that the same forces that were behind the global financial crisis has moved into the commodity market and dumping huge funds into buying commodities that has resulted in the rising prices consumers are seeing at the gas pumps and in grocery stores.
At risk is more than what people pay at gas pumps. There are growing concerns that the commodities markets have been compromised and that if not checked, the result could undermine the national and world economies.
In a May 20, hearing in Congress, Michael Masters, a hedge fund portfolio manager, said the sheer number of investor dollars flowing into the commodities markets had skewed the relationship between oil supply and demand. In his testimony, Masters said that only $13 billion traded in commodities indexes in 2003, compared with $260 billion in March 2008.
Masters testimony is a warning to Congress that serious problems are developing in the futures market regarding the impact of hedge funds and institutional funds pouring money into the commodities market.
In other words, some folks are making a lot of money and driving up the cost of gas and groceries to the extent that a whole lot more folks are unable to afford the cost of gas to get to the grocery store and still have money to pay for groceries – and they’re making that money in the capital market by investing in related hedge funds including those where the risk involves the weather.
Now, who might be doing that and how?
…adverse weather creates adverse financial conditions, which can be managed by financial instruments or insurance policies built around the weather element to which the buyer is exposed. The outcome of purchasing the risk transfer instrument is to limit the adverse impact of weather on the buyer’s economics and to finance the consequences of adverse weather conditions when and if they take place. Insurers, banks, financial houses, specialist companies and exchanges make their business in assuming weather risks from those with natural exposures, often through brokers and other intermediaries.
You got it – the same folks bringing higher cost insurance to coastal areas because of the increased risk from the weather are among those betting on the weather and making money from the risk of the adverse weather conditions that make insurance cost more.
Talk about a perfect match. What industry is better positioned to make money predicting the weather than one that relies on weather modeling to predict its own exposure to risk?
Reportedly, investments in weather derivatives are increasing as other changes take place as well.
According to a survey jointly released in June 2006 by the Weather Risk Management Association (WRMA) and PricewaterhouseCoopers, the total weather derivatives market had grown more than ten-fold over where it stood two years before, to more than $45 billion notional in size.
Folks, that’s a lot of sweet potatoes – although it’s far more likely folks are betting on corn given the flooding in the mid-west. Nonetheless, it’sa sure bet the insurance industry is going to continue to bet on hedge funds, including those where they’re betting on the weather.
When I began putting all this together, my plan was to make a transition at this point noting that
Not all reinsurance is created equal…[and we now have ] custom hedges in a reinsurance wrapper –
and suggesting the real “hedge” is that reinsurance is now all “wrapper” and no “fund”.
All that was before I discovered folks had been performing some “unnatural acts” with the sweet potatoes we’ve given them over the past several years –
Currently, there is industry discussion concerning the pending convergence of capital markets and reinsurance; in reality, it is a “past tense” event – the convergence has, in fact, occurred and is beginning to radically transform the traditional global insurance carrier and broker distribution models. (emphasis added) –
Well, now do I see it – how about you? I suppose one could call NFIP “reinsurance” – assuming the wind blew the wrapper off some hedge fund.