Geoinvesting is a bunch of short-sellers who I grew to respect during the great era of picking off Chinese reverse merger scams. They got several right and the ones that they got wrong (notably on Zhongpin) they were I believe right on most of the analysis.
Yesterday they came out with a “hit-piece” on Seeking Alpha on Amtrust Financial Services (AFSI). This is a complicated, high growth, multi-jurisdictional insurance company. For most people a black box. For me it is home turf. Most my career I was a bank and insurance analyst (and the first 200 or so posts on this blog are about financial institutions). [Check my title here if you want career details…]
Amtrust is clearly a worthy candidate for examination by a short-seller. Several of the executives have colourful backgrounds and it is in a bunch of difficult, even problematic businesses. The first problem is identified by Geoinvesting. The second not so much.
One business that they are in – and one responsible for a large proportion of the growth – is California Workers Compensation, sometimes written (and any insurance junky will tell you this is problematic) through Managing General Agents.
Other businesses are also difficult, eg life settlements or buying of in-force life-insurance policies, in this case originally written by marginally problematic insurance companies.
They are also in the slimey business of offering warranty extensions on electronic goods sold through second tier retailers. [Anyone who buys the warranty extension is an idiot, and many of these are missold leaving all sorts of liabilities behind.]
But the real warts in this business (and there are many) are simply not identified by Geoinvesting – and instead they make howling error after howling error in their report.
Howler one: accusations of reinsurance accounting fraud by someone who does not understand what is meant by “ceded losses”
The allegation in the Geoinvesting report is that Amtrust has – and I quote:
From 2009 to 2012 we believe that AFSI has not disclosed a total of $276.9 million in losses ceded to Luxembourg subsidiaries.
What Geoinvesting mean by this is that they believe that Amtrust has simply failed to recognize in their consolidated P&L $276.9 million in losses.
This is a total misunderstanding of what is meant by “ceding losses”. To explain I need to explain reinsurance a little (though in this case with some help from the very well written Wikipedia article):
When an insurance policy is written the insurance company “writer” will recognize as an asset the premium received. They will also recognize a “loss reserve” an amount being the amount they will expect to pay out on the policy over time. Â
This “loss reserve” is not a loss. Its simply a reserve for future payments. Whether the policy makes a profit or loss will be determined as the decades roll on. [If it is a workers compensation policy for instance an insurer may be paying an injured worker’s medical bills thirty years hence…]Â
In a typical (and in this case proportional) reinsurance arrangement, a reinsurer takes a stated percentage share of each policy that an insurer produces “writes”. This means that the reinsurer will receive that stated percentage of the premiums and will pay the same percentage of claims. In an accounting sense this is called “ceding the loss” and “ceding the premium” to the reinsurer. The reinsurer also recognizes no loss in the P&L. The gain or loss of the policy is recognized over decades.Â
In addition, the reinsurer will allow a “ceding commission” to the insurer to cover the costs incurred by the insurer (marketing, underwriting, claims etc.).
Geoinvesting has simply added up the “losses ceded” to the (internal) reinsurers and wondered why the “losses” did not wind up in the P&L.
This is profoundly amateurish.
It must be galling for the management of Amtrust to be accused of reinsurance fraud by someone who does not appear to be able to comprehend the basic Wikipedia article on reinsurance.
Life settlements
Life settlements are a business with a reputation for scumminess. It is the business of buying life insurance policies for more than their surrender value but less than their face value.
There are legitimate reasons for life settlements. Insurance companies are parsimonious slime-balls on the surrender value of a life insurance policy. They consider surrender a significant source of profit.
