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The Once and Future C&F
INTRODUCTION Cost of Goods Sold, Unknown
I nsurance is a tough business. One of the first things you learn when you start out is that insurance is different from other businesses in that you do not truly know the cost of goods sold when you are pricing your product. What they might not tell you (and “they” might not fully appreciate) is that you can have a whole career without knowing if you are a good underwriter or not. Actually, if you are a really bad underwriter, you probably know; it is those of us who see ourselves as good who will have to wait to find out. Don’t believe me? Let’s pick a date that will be relevant to our story: December 31, 1981. Back then, inflation was galloping and interest rates were skyrocketing. Insurance companies were competing on the basis of cash-flow underwriting, intentionally writing business at an underwriting loss with the idea that they would make up the difference in investment income. By today’s standard, the 1981 results looked ugly — even if management at the time felt they were doing just fine. I pick 1981 to illustrate the fine line between the knowable and unknowable aspects of the cost of goods sold. Assuming management teams were playing it straight, they knew the published underwriting results were not good.
Less knowable was that, by 1981, most of the business associated with latent asbestos and environmental pollution claims had already been written. The die had been cast. The insureds did what they did and the insurance companies wrote the policies — the damage had been done. But the plaintiffs and their lawyers had not yet organized, and the insurance industry had no idea of the magnitude of the problem. So insurance companies were still happily cutting each other’s throats to write long-tailed casualty business at a 115 combined ratio to enjoy the investment income on the float. Let’s look at some math. The industry statutory surplus at the end of 1981 was $75 billion. Technically, if we marked the bond portfolios to market (back then, bonds were held at amortized cost), most industry players would have needed to recapitalize. Then we throw in asbestos and environmental losses that are estimated at $200 billion and counting — and the insurance industry was triple bankrupt. That’s before we even factor in uncollectible reinsurance, product liability or the medical malpractice crisis. With that in mind, if we go back to the 1960s and 1970s — two decades for the entire commercial lines industry — the combined ratio for this period
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