Insurance is where the money is

Insurance

One basic weird thing about the financial industry is that it consists of a lot of big pots of money that you can buy for less money than is in the pot. Occasionally there are stories about how a pharmaceutical or tech company is trading for below the value of its cash and marketable securities, and how weird and shocking that is, but it is absolutely the norm in the banking and insurance industries. JPMorgan Chase & Co. has a stock-market valuation of about $342 billion, but it has something like $600 billion of cash and cash-like investments and another $675 billion of trading assets and investment securities. 1 American International Group has a stock-market valuation of about $37.6 billion, but it owns something like $240 billion of bonds. 2 If you could buy all the stock of JPMorgan or AIG, you’d immediately control a much larger pool of money than you spent for the stock.

This is not a magical free lunch or a scam; it is just another way of saying that the financial industry, compared to more normal industries, tends to operate with a lot of leverage. Banks have a lot of money, much of it invested in relatively liquid financial assets, but most of that money is borrowed (from depositors, etc.) and will eventually have to be paid back. Insurance companies have a lot of money, much of it invested in relatively liquid financial assets, but most of that money comes from insurance policyholders and will eventually have to be paid back. The banks and insurance companies are just holding all that money in trust for someone else. That’s what a financial institution is; it’s a business that holds money for other people.

But the “pots of money that you can buy for less money than is in the pot” framework can be useful. For instance, if you need $100 million for some project, but you only have $10 million, you can go to a bank and ask to borrow the rest, but they will ask you tedious questions like “what is this for” and “how do we know you will pay us back.” But if you go find an insurance company with $10 million of equity value and $90 million of “float” (money from insurance premiums that will eventually need to be paid out in claims) that owns $100 million of bonds, you can buy that company for $10 million, and now you’re in charge of a pot of $100 million. You control the company, you can make yourself the boss, you can sell the bonds for cash and invest the $100 million in your project. 3 If your project is good, then you will pay back the insurance company’s investment with interest, and the value of your equity investment in the insurer will grow. If your project is bad, then you won’t be able to pay back the insurance company, you’ll lose your $10 million equity investment, and policyholders’ money will also be at risk. If your project is “I will buy a $100 million yacht and sail far away,” then the policyholders will lose everything, and you will have gotten a $100 million yacht for $10 million.

This is mostly not a magical free lunch or a scam, but not for some deep structural reason or anything. It’s just that this is all pretty well-known stuff, so a big focus of banking and insurance regulation is making sure that the people who control banks and insurers don’t just loot them for their own personal projects. But, you know, sometimes!

Here is a Wall Street Journal story about Greg Lindberg, a Yale graduate who runs a group of businesses with the unfortunate name Eli Global, and who started buying insurance companies to fund his business:

Mr. Lindberg began scouring insurers for possible acquisitions in about 2012. What most seemed to attract him, former employees say, was the large cache of assets on insurers’ balance sheets.

Initially, he looked for small insurers that wouldn’t cost much, according to a deposition in later litigation over banking fees. His purchases eventually included a Louisiana insurer bought out of receivership and a struggling Dutch insurer acquired for €1.

Mr. Lindberg told regulators that investing in his own businesses was a safe strategy for the insurers because his company had achieved 35% annual investment returns. “Eli Global has a long history in establishing private placements and managing the risks successfully,” the company said in one presentation to regulators.

His first acquisition, in 2014, was a small Alabama burial-policy insurer, Southland National Insurance Corp. It had about $170 million of assets to cover future claims as policyholders died. Mr. Lindberg paid about $22 million for it.

And by now:

He bought nearly 100 companies around the globe, an estate in the Florida Keys, an Idaho lakeside retreat, a Gulfstream jet and the most expensive mansion ever sold in Raleigh, N.C. In September 2018 he added a 214-foot yacht with room for a dozen overnight guests. He also became the largest political donor in North Carolina and lavished money on other races around the country.

The cash came, at least in part, from huge sums Mr. Lindberg diverted from the group of life insurance firms he began assembling in 2014, a Wall Street Journal investigation found.

The Yale-educated executive lent at least $2 billion from those insurers to scores of entities he controlled, using much of it to expand his private holdings, according to interviews, regulatory filings and more than 4,500 internal documents from Mr. Lindberg’s companies reviewed by the Journal.

The sheer scale of Mr. Lindberg’s use of insurance assets to invest in his own businesses has little precedent in recent decades, industry experts say, and exposes hundreds of thousands of policyholders to an unusual and potentially risky strategy.

The story mentions a federal criminal investigation, and notes that Lindberg’s insurers have sometimes exceeded regulatory limits on related-party transactions, gotten approval to exceed those limits from state insurance commissioners whose election campaigns he supported, or used somewhat flimsy structuring to get around those rules. Lindberg’s spokesman says that he is cooperating with investigators and “aggressively working” to cut back on related-party transactions, and that the insurers are well-capitalized and, “to this point, there has never been a payment default” on the loans.

I don’t know! The point I want to make is that the good version of this is not that different from the bad version, and it’s not always easy to tell which is which. “Guy buys insurance company and invests its float in his other business ideas” can describe a scam, but it can also describe Warren Buffett. 4 There are important differences: Buffett doesn’t have any separate ownership interest in any of his businesses, and only makes money from those investments if his insurance conglomerate does; also, his insurance conglomerate does not lend him money to buy yachts or anything. But the basic idea of acquiring insurance companies because they are pots of cash that you can use to fund your investment ideas is an old and common and sometimes good one, and it’s almost the nature of the business.

Hunting

Traditionally, the way Swiss banking worked is that if you were a wealthy person in the U.S. or France or Russia or wherever, and you didn’t want to pay taxes on your wealth, you could put it in a Swiss bank account and the tax authorities in your country would never be able to find it. (This is changing.) This was a reasonably well-known thing in popular culture, and I assume it was even better-known among the financial advisers of rich people who didn’t want to pay taxes. So it’s reasonable to think that there was some inbound inquiry, a steady trickle of people flying into Zurich with suitcases full of cash and asking their cab drivers to take them to the nearest private bank.

But banking services are usually “sold, not bought,” as the saying goes, and that’s especially true of complex, structured, legally aggressive ones. Possibly stuffing your cash in a suitcase and flying it to Zurich is not actually the best way to evade taxes and open a Swiss bank account? This is the sort of thing that you’d want your Swiss banker to tell you before you show up on his doorstep. And so in practice there was also a steady trickle of Swiss bankers flying out of Zurich and hunting up clients in Dallas or Moscow or Paris.

There is a problem with this, though, which is that while for many years Switzerland more or less took the position that hiding money from foreign tax authorities was a natural right of every human being, the foreign tax authorities did not. Squirreling your money out of the U.S. or France or wherever to hide it in Switzerland and avoid taxation was illegal in those countries, and so the Swiss bankers who flew around the world to pitch it were, viewed in a certain light (that of the law), soliciting crimes. And so there was a lot of this:

According to the judgment, the Swiss bankers found business by travelling through France using encrypted hard-drive and business cards without a logo. They were also given a “security risk governance” manual that provided guidelines about how to limit the risk of discovery while they moved about.

The manual told employees not to keep clients’ names on them, to get rid of sensitive data if needed or when crossing the border, to use different hotels to other UBS employees, and to be unpredictable in their movements, including which taxis they took and restaurants they ate in.

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That’s from a Financial Times story about a 4.5 billion euro French court judgment against UBS Group AG for illegally soliciting French clients “at literal hunts in the French countryside, at top-end restaurants in central Paris, over games of golf, at the opera in Nantes and Lyon, rugby tournaments and in an €80,000 box overlooking the main court at Roland-Garros,” basically anywhere you might find wealth French people who dislike paying taxes and, perhaps, who enjoy play-acting at espionage?

(UBS is appealing, and strongly protestedthe judgment, arguing that its bankers’ activities in France were legitimate meetings with existing clients or “simple marketing events” with no intent to solicit tax evasion. We talked a while back about one UBS banker who testified that, sure, his bankers met with prospective clients on hunting outings, but these weren’t solicitations: “I have a hard time imagining signing a swaps contract between two rifle shots.”)

Let me ask you this question: Does this sound fun? How much money would you have to save in taxes to make it worthwhile for you to hang out with a UBS representative with a logo-less business card who communicates with you using dead drops, addresses you by a code name and is constantly changing taxis? One reasonable answer would be “quite a lot, because my time is valuable and this sounds like a lot of work, plus it makes me worry that I will end up in jail or getting my money stolen.” I once wrote, about similar methods that Credit Suisse AG used in dealing with U.S. tax-evasion clients, that my main takeaway was “just how tedious it would be to evade taxes” this way. But reading this story, I started to consider the opposite perspective. Surely some rich tax evaders are also bored. If you met a mysterious stranger at a hunting lodge, and he gave you his blank business card and told you to meet him in a cafe next week and make sure that you weren’t followed, wouldn’t you be tempted to see where it went? Maybe UBS wasn’t just selling tax evasion; it was also selling excitement.


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Anyway:

In order to keep track of the money raised by the bankers, prosecutors say a “double accounting system” — called “carnets du lait”, or milk tickets — was used. According to former employees, “the ‘carnets du lait’ were in the form of hand-written notes on a Clairefontaine type grid paper” which were eventually centralised in an excel file called the “vache”, or cow.

I continue to be befuddled by the apparently common habit of using agricultural euphemisms to refer to illicit financial transactions. “Don’t call bribes chickens,” I suggested a while ago, after U.S. prosecutors charged someone with doing that. If your business has nothing to do with chickens, then when prosecutors see winking references to chickens in your email, they are going to know that you mean bribes, and a jury is going to agree. Much better to say “success fees,” so you have some argument that you were doing somehow legitimate transactions.

Similarly here, surely the way to refer to this money would be, like, “client deposits for totally legitimate purposes,” or “client deposits received due to inbound inquiry without soliciting at all,” or “deposits from existing clients whom we did not pitch on this business trip,” or whatever, except that I am joking about the overelaborate defensive descriptions and the actual right way to refer to this money would be “client deposits.” Just act natural! No one believes that the money is for milk, come on.

Indexes


Doesn’t it feel like indexing should be more passive? Like here is a story about how “index provider MSCI Inc. said it would more than quadruple the contribution of mainland Chinese shares to an influential global benchmark, a move that will make shares in Shanghai and Shenzhen much more important to global investors,” and you can read analyses about what this says about the development and integration of the Chinese stock market, and it is all overlaid with fundamental analyses of whether index funds will be buying the shares at too high a valuation and what it will mean for the performance of the index. It feels very decision-y. The index, here, does not feel like an objective and scientific effort to describe a thing—“the market”—that exists in the real world; it feels like a set of human decisions designed to shape and change the market.

Which it is, of course, fine. When we talked last month about MSCI’s original decision to add mainland Chinese stocks to its emerging-market index, I wrote:

A stock market index is mostly a summary of a set of social facts; the “emerging market index” is a list of the sorts of stocks that funds that call themselves “emerging markets funds” want to invest in. If every “emerging markets fund” invests in Chinese stocks, then the index should have some Chinese stocks; if none do, then it shouldn’t.

But the way in which the summary is constructed is subjective and human-driven. Oversimplifying, MSCI has customers (fund companies that pay for its indexes and benchmark to or track them), and it has other stakeholders (countries, companies, stock exchanges, securities regulators), and it goes around and talks to people and decides what makes the most sense and what will make its customers the happiest.



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But could you take the human element—the talking and deciding—out of the process? Could you make this more mechanical? Could you get a list of every mutual fund with “emerging market” in its title, weight them by size, and see what countries they invest in? If X percent of emerging-market fund assets are in Country Y, then shouldn’t Country Y’s weighting in the emerging-market index be X? If X is high then that probably means that the country is important to the world economy, and also that its markets are relatively fair and liquid; you can avoid most of the substantive subjective decisions by just letting the market decide. This is not perfect, of course; it just pushes back the decision-making by one level (someone has to construct the list of funds, etc.), and you might have to exclude index funds from your count in order not to make it too self-referential. But it might be a little more in keeping with the spirit of indexing.

Tesla did a thing

Why do you think that Tesla Inc. stopped taking orders for cars on its website for a few hours yesterday, leading up to its big announcement that it will start offering a Model 3 for $35,000 (and that it will cut the prices of its other more expensive models)? I don’t know the answer. Maybe Tesla’s web designers needed some time to revamp the website for the new offerings. Maybe—probably—Tesla just loves creating hype, and shutting down the website for a while was a good way to get people talking about it.

But another possibility is just that, if you put in an order for a Tesla Model 3 Mid Range for $42,900 yesterday afternoon, and then at 2 p.m. Tesla announced that (1) that car would now cost $40,000 and (2) a new, cheaper Tesla was available for $35,000, you might be annoyed. You wouldn’t have a fraud claim or anything; Tesla didn’t trick you into paying $42,900 when you could have saved $7,900 by waiting an hour. But it might leave a bad taste in your mouth. You might think, boy, if Tesla knew this was coming, it would have been nice if they’d told me. You might think, if I am going to spend my hard-earned money with this company, the least they could do would be to keep me informed; not whipsaw me with ever-changing information; communicate openly, clearly and transparently. Shutting down orders for a few hours might have been a nice gesture to Tesla’s customers, a way to make sure that they didn’t make any important financial decisions without being fully and fairly informed. This is just some idle speculation on my part. I don’t know what made me think of it.



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Anyway “Tesla shares jumped as much as 1.6 percent” on the news that there would be news, and then “ fell as much as 4.1 percent to $306.80 in late trading” after the actual announcement, which included the new pricing scheme, a move to exclusively online sales, and the news that, contrary to Elon Musk’s previous predictions, “Tesla probably won’t post a profit in the first quarter.” Also Musk is now predicting that Tesla will make as many as 600,000 cars in 2019. He is in trouble with the Securities and Exchange Commission for tweeting recently that Tesla will make 500,000 cars this year, and it would be funny if Tesla was speeding up production and cutting prices just to make his tweet come true.

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