FT : Catastrophe models are good for the insurance business

Catastrophe models are good for the insurance business
John Dizard analyses the art of pricing risk in the wake of Hurricane Harvey and Irma

Hurricanes Harvey and Irma are now being described as a moment of vindication for climate change models. Well, up to a point. While insurance people believe that climate change is a real phenomenon, and at least partly caused by human action, they do not use climate models as their principal method of pricing storm risk.

Rather, for the most widely insured and then re-insured “perils”, they use catastrophe models, which incorporate modest but steady increases in assumed losses due to climate change. Climate models do not generate results that can be used directly to price risks, because they have problems modelling extreme weather events and are too expensive to run on the required scales of time and space. The most commonly accepted climate models divide the world into cells that vary from about a kilometre to hundreds of kilometres. Such constructs are not currently able to model the observed number of hurricanes, nor their strength or where they make landfall.

Policies that cover windstorms are generally priced annually, while climate change happens over much longer time periods. Catastrophe models are mostly built on the observed weather record of recent decades. Those models also incorporate long-term climate trends, economic growth and coastal construction, windstorm hydrodynamics and the effects of storms’ passage over land. They have a spatial resolution of 10 meters to 10km, and model year-to-year loss probabilities, or even losses just after storms take place.

Catastrophe modellers are compulsively careful with their projections, and are careful to note ranges of error and uncertainty. However, there can be certainty that models are good for the insurance business.

As one Bermuda catastrophe reinsurance executive says, “Assume this is a $100bn loss year for the industry. The forward-looking industry models that take extreme events into account say that will occur every six years. The history of hurricanes for the past 100 years says this happens every 20 years. Since 1900 there have been only 33 hurricanes that have cost more than $10bn in damage.”

Other insurers might use different timescales or historical loss estimates. Perhaps the most challenging problem for insurers is to keep rates up during long periods of low storm or earthquake losses, despite competitive pressures, so as to have the company and industry resources to deal with the occasional mega-disaster.

In the 12 years since Hurricane Katrina, the industry has built substantial reserves and capital. According to a London reinsurer, “The consensus was that the industry was overcapitalised by $50bn-$60bn before Harvey’s landfall. If there really is an insured loss of $30bn for Harvey and $20bn-$25bn for Irma, and if we assume on top of that the insurance-linked securities business reloads [capital] with a few billion, that excess capital is gone.”

You could also consider those tens of billions as a safety margin. Robert Muir-Wood, the chief research officer of RMS, a prominent catastrophe-modelling consultancy, asserts that “before the models became available after Hurricane Andrew [1992], insurance companies would go bankrupt. Actually, insurers have more or less stopped going out of business after catastrophes.”

The increased reliance on commonly accepted catastrophe models made it possible to tap outside capital, including insurance-linked securities. You could call that a benefit of greater accuracy or the cause of chronic underpricing.

The cat models (not climate models, remember) can be useful just after a catastrophe to estimate ultimate losses before the next pricing season. That is how, for example, that the size of justifiable claims made on Harvey and Irma losses can be more accurately estimated before many reinsurance policies are renewed in January. Also, the US hurricane season is not over until October, so depleted reserves and capital can be drained by more storms, never mind earthquakes.

The pleasurable frisson of being a reinsurer comes from a season that is just loss-y enough to increase rates dramatically without the actual pain of your own company losing capital. Sort of like going to a theme park ride rather than a war.

At the moment the reinsurers believe they are close to getting that outcome. Many were at the annual “Rendezvous de Monte Carlo” insurance convention that took place in Monaco over the Hurricane Irma weekend. “On Friday,” one of them recounts, “we expected a $150bn event. By Wednesday it seemed more like $24bn.”

That would be a thrilling but not terrifying rollercoaster.

By the end of November the reinsurers should have an idea how much they can increase rates for next year. They are pencilling in increases of up to 30 per cent for reinsurance on Florida wind and storm surge policies, though not much, if any, rises for lines of business unaffected by the storms.

The surprise could come in the scale of auto insurance losses in Houston. As one underwriter points out, “Unlike Florida before Irma, nobody left Houston before Harvey. There could be auto insurance companies going out of business thanks to Harvey.”

Whatever the covered losses turn out to be, the world can expect significantly higher premiums, and more attention to catastrophe modelling, as well as climate change headlines.

>>> SoftBank plans to invest in Uber up to JPY 1tn for 20% stake - report (trans

SoftBank plans to invest in Uber up to JPY 1tn for 20% stake
SoftBank Group Corp [TYO:9984] is in a final-stage of talks to make an investment of several hundreds of billion JPY (several billion USD) in Uber Technologies, aiming to acquire about a 20% stake in the world's largest ride-sharing company, the Nihon Keizai Shimbun reported on 16 September.
The investment amount could reach JPY 1tn (USD 9bn), the Japanese newspaper report said, without citing sources.
Softbank is also considering an investment in Lyft Inc, a transportation network company, the newspaper report said, although the possible investment amount is not mentioned.

>>> US Close Dow +0.29% S&P +0.18% Nasdaq +0.30% Russell +0.47%

Closing Market Summary: S&P 500 Advances to New All-Time High; Hits 2,500

Equities ticked up on Friday, capping off this week's run to record highs on a positive note. The Dow (+0.3%) advanced to a new-all time high once again, as did the S&P 500 (+0.2%), which settled right at the round mark of 2,500. The Nasdaq (+0.3%) also finished modestly higher, but didn't gain enough to erase its Thursday decline, leaving the index about 12 points below its record-high close. For the week, the S&P 500 added 1.6%.

On one hand, Friday's uptick was surprising considering that it came on the heels of yet another North Korean missile launch, which crossed over the northern Japanese island of Hokkaido. However, on the other hand, the market's response was entirely consistent with the recent past as investors have generally taken Pyongyang's missile tests in stride.

Eight of the eleven sectors advanced on Friday, with the lightly-weighted telecom services group (+1.8%) leading the charge by a wide margin, securing its spot at the top of the week's leaderboard (+3.9%). The financials (+0.5%) and energy (+0.2%) sectors also outperformed on Friday, finishing the week on telecom's heels with weekly gains of 3.3% and 3.5%, respectively.

The top-weighted technology sector (+0.3%) broke its two-day losing streak, thanks in large part to chipmakers, which sent the PHLX Semiconductor Index (+1.7%) higher for the fifth day in a row. NVIDIA (NVDA 180.11 +10.71) led the semiconductor rally, climbing 6.3% to a new all-time high, after its target price was raised to $250 from $180 at Evercore ISI on Friday morning.

Apple (AAPL 159.88, +1.60) also played a major role in the tech sector's positive Friday performance, snapping out of its recent funk, which started immediately following the company's annual product event on Tuesday. The tech titan climbed 1.0% to settle with a weekly gain of 0.8%.

On the flip side, Oracle (ORCL 48.74, -4.05) dropped 7.7%, giving back all of its September gain, after issuing cautious guidance that overshadowed its better-than-expected earnings and revenues.

The health care (-0.3%) and consumer discretionary (-0.2%) spaces were the weakest sectors on Friday, trimming their weekly gains to 0.4% and 0.9%, respectively. Meanwhile, the rate-sensitive utilities group (+0.1%) eked out a narrow victory, but its Friday performance was far from enough to prevent a last place finish in the weekly sector standings (-0.4%).

In the bond market, U.S. Treasuries didn't do much to relieve the huge weekly losses they carried into Friday's session. The yield on the benchmark 10-yr Treasury note finished flat at 2.20%, locking in a 14 basis point gain for the week. Meanwhile, the 2-yr yield climbed two basis points to 1.38%, extending its weekly gain to 13 basis points.

Reviewing Friday's big batch of economic data, which included August Retail Sales, August Industrial Production & Capacity Utilization, the preliminary reading of the University of Michigan Consumer Sentiment Index for September, the September Empire State Manufacturing Index, and July Business Inventories:

  • August retail sales decreased 0.2%, missing the consensus estimate, which called for an increase of 0.1%. The prior month's reading was revised to +0.3% from +0.6%. Excluding autos, retail sales increased 0.2% while the consensus expected an increase of 0.5%. The prior month's reading was revised to +0.4% from +0.5%.
    • The key takeaway from the report is that it will temper forecasts for Q3 consumer spending as core retail sales, which exclude auto, gasoline station, building equipment and materials, and food services and drinking places sales, declined 0.2%.
  • Industrial Production decreased 0.9% in August (consensus +0.2%) while Capacity Utilization declined to 76.1% (consensus 76.8%) from a revised reading of 76.9% in July (from 76.7%).
    • The key takeaway from the report is that industrial production, excluding the hurricane impact, was still weak in August.
  • The preliminary reading of the University of Michigan Consumer Sentiment Index for September declined to 95.3 (consensus 95.5) from 96.8 in August.
    • The key takeaway from the report is that consumers' assessment of their financial situation is the best it has been in more than a decade.
  • The Empire Manufacturing Survey for September declined to 24.4 from the prior month's reading of 25.2. The consensus estimate was pegged at 20.0.
  • Business Inventories rose 0.2% in July, which is in line with the consensus. The prior month's reading was left unrevised at +0.5%.
    • The key takeaway from the report is that pricing power will still be hard to come by given the elevated inventory-to-sales ratio, which held steady at 1.38 (down from 1.40 a year ago).

On Monday, investors will receive just one notable piece of economic data--the NAHB Housing Market Index for September--which will cross the wires at 10:00 ET. 

  • Nasdaq Composite +19.8% YTD
  • Dow Jones Industrial Average +12.7% YTD
  • S&P 500 +11.7% YTD
  • Russell 2000 +5.5% YTD

WSJ : Japan’s SoftBank Wants Big Chunk of Uber, But at Steep Discount

Japan’s SoftBank Wants Big Chunk of Uber, But at Steep Discount
Japanese firm proposes investment that could total as much as $10 billion

SoftBank Group Corp. 9984 0.46% is nearing an ambitious deal to take a substantial stake in Uber Technologies Inc.—but only if the Japanese technology investor can persuade shareholders to sell enough stock at a steep discount.

After weeks of deliberation, Uber’s board in recent days has been hashing out its response to a potential investment led by SoftBank that could total as much as $10 billion, according to people familiar with the matter.

If successful, that would be among the largest-ever single investments in a private venture-backed startup.

It would also give SoftBank, whose Chief Executive Masayoshi Son has predicted that companies like Uber will transform the world, major stakes in nearly all the world’s top ride-hailing firms.

SoftBank and its $93 billion tech-focused Vision Fund are proposing to buy 17% to 22% of Uber through a combination of share purchases from the company and a tender offer extended to employees and investors, according to people familiar with the matter. But the tender offer would represent a discount of 30% or more from Uber’s last valuation of almost $70 billion, the people said.

Existing Uber shareholders have expressed concern that the process could devalue the company as it heads toward an initial public offering in as few as 18 months.

As part of the offer, SoftBank also is seeking two board seats, these people said, adding to Uber’s nine sitting directors. Negotiations could conclude as early as next week, according to one person familiar with the matter. Representatives for Uber and SoftBank declined to comment.

The possibility of yielding so much control to SoftBank—an aggressive investor that holds stakes in Uber’s biggest rivals in Asia—underscores the pressure faced by the San Francisco ride-hailing firm’s board to appease a restless group of shareholders who want to unload stock after a trying year of scandals. Some directors view the funding as crucial to ensuring SoftBank won’t weaken Uber by boosting competitors’ war chests. In recent weeks, SoftBank held informal talks with Uber-rival Lyft Inc. over a possible investment, but the discussions never advanced, according to people familiar with the matter.

Even though an Uber investment would mean SoftBank is plowing money into rival firms in many markets, that is ultimately good for SoftBank if its investments are in a thriving market where more customers turn to ride-hailing firms, said Rushabh Doshi, an analyst for market tracker Canalys in Singapore. “It is better for SoftBank if there’s healthy competition in the ride-hailing market,” he said.

But the offer faces hurdles. SoftBank’s hope of securing a sizable stake is dependent on investors agreeing to sell enough of their shares at a discount from Uber’s last valuation through an auction process open to most shareholders, people familiar with the talks said.

That would value Uber at around $50 billion, though the price could change based on how many shares investors indicate they are willing to sell, these people said.

Some investors privately say they don’t plan to sell any shares at the lower valuation, which could imperil the process. A few investors pointed to an August tweet from investor and venture-capital firm Benchmark, which also holds a board seat and a 13% stake valued at roughly $8.4 billion, as a reason to hold out for a higher valuation. Benchmark said Uber in two years “could comfortably be worth over” $100 billion. Benchmark’s partners met with Mr. Son in a meeting in July, but the two sides were unable to reach an agreement on Uber’s valuation, a person familiar with the matter said. Benchmark couldn’t be reached for comment

As part of the deal, Softbank is planning a direct investment in Uber of at least $1 billion, which would be priced to reflect Uber’s current valuation of about $68 billion, people familiar with the matter said. Such a move could placate existing investors concerned the auction process would devalue the company.

Other investors joining SoftBank include San Francisco investment firm Dragoneer Investment Group and New York private-equity firm General Atlantic, according to people familiar with the matter. Dragoneer and General Atlantic declined to comment. The exact terms of the investing coalition couldn’t be learned.

Uber’s board several weeks ago approved an exclusive negotiating period with SoftBank, granting the investor access to financial data about Uber, the people said. The potential investment has been a singular focus for Uber directors in recent days after successfully bringing in new Chief Executive Dara Khosrowshahi from Expedia Inc. last week, following the June ouster of Travis Kalanick.

The broad terms of the deal were reached prior to Mr. Khosrowshahi’s start. He has dealt before with SoftBank, which earlier this month led a $1 billion funding round for online retailer Fanatics Inc., where Mr. Khosrowshahi is a director.

Bringing in SoftBank as an investor would further muddy an already confusing mix of alliances and competitors in the global ride-hailing business.

SoftBank has sizable stakes in four global ride-hailing outfits: China’s Didi Chuxing Technology Co., India’s ANI Technologies Pvt.’s Ola, Singapore’s GrabTaxi Holdings Pte., and Brazil’s 99. It has directors on the boards of Ola and Grab, and made one of its top investment executives Grab’s president. Those two, along with Didi, are fierce competitors in their respective markets in India, Southeast Asia and China. Uber also holds a major stake in Didi.

Adding to the complexity is Saudi Arabia’s Public Investment Fund, a sovereign-wealth fund that is a big investor in both Uber—it infused $3.5 billion in the company last year—and SoftBank’s Vision Fund. The Saudi fund’s managing director Yasir Al Rumayyan is on the board of both Uber and SoftBank, and on the investment committee for the Vision Fund. It is not clear what role he has had in the talks between the two firms. Representatives of the Saudi fund couldn’t be reached for comment.

A big SoftBank stake wouldn’t automatically lead to a push for control by the Japanese firm. Mr. Son sits on the board of Chinese e-commerce giant Alibaba Group Holding Ltd. —in which SoftBank had a 30% stake as of March—yet the company has agreed to vote with Alibaba management on appointment of other directors.

SoftBank bought chip-designer ARM Holdings for $32 billion last year, promising to respect the U.K. company’s relationships with existing customers, some of whom are rivals to SoftBank’s mainstay telecom operations.

But Mr. Son has also taken a very hands-on approach to management of other acquisitions, such as U.S. mobile carrier Sprint Corp. , which he feels are struggling. Known to call branch managers the morning after daily sales figures dip, his leadership has prompted management overhauls and controversial strategy shifts at Sprint and Vodafone PLC’s Japanese unit.

FT : What is Mifid II and how will it affect EU’s financial industry?

What is Mifid II and how will it affect EU’s financial industry?

Far-reaching rules will have a big impact on everything from banks to brokers

The EU’s ambitious regulatory reforms, known as Mifid II, are poised to transform Europe’s financial industry. Here’s what you need to know.

What is Mifid II?

A revamped version of the Markets in Financial Instruments Directive, or Mifid II, is designed to offer greater protection for investors and inject more transparency into all asset classes: from equities to fixed income, exchange traded funds and foreign exchange.

The extensive piece of legislation, seven years in the making, already has more than 1.4m paragraphs of rules, which will grow as regulators complete the final standards in coming months.

When will it start?

From January 3, one of the EU’s most ambitious, yet controversial, packages of financial reforms will be rolled out.


Why is it being implemented?

The original Mifid was intended to be a cornerstone of EU efforts to create a single financial market for the bloc that could rival the depth and dynamism of the US capital markets.

It mainly sought to end the monopoly of stock exchanges and drive down overall trading costs for investors, and, in its small way, contribute to economic growth.

Its arrival in November 2007 coincided with the onset of the financial crisis and the subsequent years exposed Mifid’s shortcomings in focusing on equities.

The review has more ambitious and structural aims: not only will it update existing rules to keep up with technological developments but will tackle what global policymakers saw as “under-regulated and opaque aspects of the financial system”. That included the vast off-exchange markets, such as derivatives and bonds.

How far-reaching are the new rules?

The new rules cover virtually all aspects of trading within the EU. They reach across the financial services industry, from banks to institutional investors, exchanges, brokers, hedge funds and high-frequency traders.

If a fund manager wants to buy anything that has an underlying product listed in the EU — such as an HSBC option in Hong Kong — it falls into Mifid’s scope, no matter where the asset manager is based. Another instance would involve an EU-based investor purchasing shares in Apple as the US group has a secondary listing in Germany.

But it goes much further. Buried within Mifid is a regulatory desire to push more trading away from the phone and on to electronic venues, which come with better audit and surveillance trails.

That will mean a wave of data, likely to be measured in petabytes. Institutions will have to report more information about most trades immediately, including price and volume.

Trades will be timestamped, to 100 microseconds for some, while information in documents for transaction reporting will stretch to more than 65 fields. It must be stored for a minimum of five years for example, while banks and brokers will be forced to show customers that they were offered the best available price for their trades.


How will Mifid II affect investment decisions?

One of the most high-profile aspects of the legislation involves how asset managers pay for the research they use to make investment decisions. It is a bullet to what regulators saw as a conflict of interest at the heart of trading that hurts fund managers’ clients: pension funds, ordinary savers and retail investors.

Until now, asset managers received research, including written reports and phone calls with analysts, for free, although the cost of this service was built into trading fees, which are usually paid by fund managers’ clients.

For the first time, fund managers will have to budget separately for research and trading costs, a move known as unbundling.

Longer-term, institutional investors will have more evidence to grill their brokers that they are doing their best. That may encourage fund managers to seek alternative ways in the market to execute their trades, much as they turned to equity dark pools after the original Mifid.

Will the regulation have an impact beyond Europe?

Yes. EU demands’ for the personal details of traders is already rubbing up against privacy rules in other parts of the world, such as Asia.

The new regime on research payments poses a significant challenge for US brokers. Under local rules they cannot receive direct payments for research unless they are formally registered as investment advisers. This means, in theory, that they will not be able to provide research to European clients — who will be obliged to make direct payments for this service — from 2018.

The Securities and Exchange Commission, the US regulator, has the power to waive the rules and allow brokers to receive direct payments for research from investors who are subject to Mifid. It is expected to make a decision by October. But once a precedent has been set, US brokers may come under pressure to follow European standards.

What can we expect on the first day?

Nobody really knows because many parts of Mifid II go further than any other piece of markets legislation. But it is unlikely to be a Big Bang as some institutions are woefully underprepared.

And there is one final sting in the tail. Mifid II comes into effect not on the first trading day of the new year but the second. The entire industry faces the prospect of switching their systems overnight in midweek, so business may be muted. A new, but uncertain, world awaits.

>>> US Gapping down

Gapping down
In reaction to disappointing earnings/guidance:
  • ORCL -4%
Other news:
  • TTOO -32.1% (commences common stock offering)
  • SAVE -1.8% (reported August Traffic (revenue passenger miles) +20.6% y/y on a capacity (available seat miles) increase of 21.9%; expect Irma impact to be significant )
  • MTW -1.7% (plans to undertake reverse stock split of Manitowoc's common stock at a ratio of 1-for-4), .
Analyst comments:
  • CCL -2.5% (downgraded to Neutral from Outperform at Credit Suisse),
  • AAL -2.2% (downgraded to Neutral from Overweight at JP Morgan),
  • UAL -2.2% (downgraded to Neutral from Overweight at JP Morgan),
  • SAVE -1.8% (downgraded to Neutral from Overweight at JP Morgan),
  • AYI -1.3% (downgraded to Market Perform from Outperform at Wells Fargo),
  • ALNY -0.6% (initiated with a Reduce at Instinet)