Michael Tanzer is a portfolio manager at a hedge fund called Callaway Capital and author of a newsletter I read each week call Stuff to Read Over The Weekend (STROTW). Michael asked me if we could hop on a call and talk about COVID and I thought I might try just putting this out as a podcast as an experiment. I might do more of these with various people as I struggle to make sense of this crisis, partly to get my own mind off the concerns I have for myself and my family. Let me know what you think!
We cover a lot of my own current thinking about how insurance responds to this crisis and also models for economic and market disruption and how COVID-19 fits into all this. It’s an insurance-style crisis hitting the border economy?
Show notes at:
David Wright: 0:00
Okay, so I'm just gonna launch, and then we can just We can just chat, um, about this. That's all I'm thinking about doing. This is literally just come whatever conversation we would otherwise have, we'll just have it. You mean make sense? Okay, Good. Welcome to the not unreasonable podcast hosted by me, David Wright. This is a show of interviews with people who have something to teach us about managing our businesses and ourselves. There's a lot to learn out there, folks. So let's get to work. This show is brought to you by alway insurance, where we are building software and a I to improve education and access to health benefits. We're hiring. We're exploring all kinds of opportunities, and we're always looking for ideas. If you're interested in joining us or learning more, reach out to me anytime on LinkedIn or David at all way dot com. Welcome to a special edition may be the first of many of this sort for not unreasonable podcast. So my guest today is Michael Tanzer, portfolio manager Calloway Capital and author of a newsletter I read every week called S T r O T w. I don't think it's meant to actually spell something as an acronym. Does stuff to read over the weekend. This newsletter's pretty old school looks to me. Just been email You literally send to people with a B C C list. Is that right? That's right. Yeah. And they can They can sign up by e mailing you, and you want to give your email out?
Michael Tanzer: 1:10
Sure. It's an M I t at Callaway cap dot com.
David Wright: 1:14
Pretty cool. Um Okay, So, Michael, we've known each other a little while now, and you e mailed me to catch up about all things COVID-19. I think especially the way impacts the insurance industry. I thought it might be an excuse to experiment a little bit with my own personal educational journey here because there's something I'm thinking about a lot. I don't know how to think about it yet. I think the world is gonna change in some some ways. Some of them are really permanent. Some of them are not. I know. I want to figure out for my own personal and professional purposes where the puck is going so I can skate there. Um, but let's just have our conversation so hit me with a question,
Michael Tanzer: 1:48
Um, yeah, yeah, sure. So I guess, like, you know, in podcasting you're not really supposed to Ah, timestamp the interviews. No, we should Yeah. Different. Yeah. You know, I think that like, um
David Wright: 2:05
so Sunday morning, 11 a.m. March 22nd. There's a time stamp.
Michael Tanzer: 2:09
That's right. Um and I think, you know, one of my favorite books about the financial crisis is this book. Um, it's called Diary of a Very Bad Year. Okay. Ah. Put out by this, this Brooklyn based literary publisher. And they basically got some portfolio manager at a multi strategy hedge fund to do a series of interviews over the course of the financial crisis during the crisis during the crisis. Yeah, So it's interesting because the guys is obviously super smart. Um, but, you know, clearly gets a lot of things not exactly right. And something's wrong. And you get that palpable sense of uncertainty and feel better if someone who is obviously very key then, um um you know, maybe maybe we'll channel a little bit of that too. That
David Wright: 2:59
Yeah. Great. I'm gonna write that down. I hadn't heard of that book. That sounds awesome. That is exactly what I'm trying to do.
Michael Tanzer: 3:05
Yeah, um, so I guess, like, before you just, like, launch into hypotheses of magnitudes or whatever. You know, lines of insurance you think are particularly success susceptible to whatever is going to come. I mean, in general, do you have a model of, like cycles in the insurance industry that you kind of adhere to our implicitly, But you've personally
David Wright: 3:34
So I mean, I want unusual. I think, as usual, isn't in the sense that I don't see many of the people who say these kinds of things, But I believe in the old fashioned price signal. And so I think that the extent that prices go up, that is ah ah, indicator of surprise. And so you just come back to the insurance industry's of forecasting machine. And to the extent that that that the prices were going down, it means that people believe that that everything is good and when prices go up, they believe everything is bad. I'm kind of an efficient markets person. The sense that I think that those prices do incorporate all the knowledge of the future. So, you know, under that model, it's when you have an exogenous shock of some sort, something people didn't see coming from before And that causes a real problem. And I think that you know that record a podcast with a guy named Colin Gray? Uh, E not for how long ago. It was probably years ago.
Michael Tanzer: 4:21
I was gonna bring up his clock of fear, actually, So it was
David Wright: 4:25
interesting about that. And it will put a link up to that show and the clock that the so that he recognized patterns isn't seventies or sixties. Even I think he recognized patterns in the response crises. But his model for the the preconditions or conditions of a crisis is just that people are scared and and they get scared because they don't recognize the environment anymore. And once and the fear in his mind gets manifested and like people losing their jobs. And so until they were getting fired, nothing changes until people are feeling real personal pain. And I think this is something that is so interesting and different, and we're just gonna use kind of like a fairly dry academic terms of things like interesting when this is a truly I think, honestly terrifying we're in right now. I mean, my wife is pregnant, She's doing a couple months and, um, you know, it's in there layer of fear. So, like from a personal standpoint, it's really distressing. And I think that once that happens, you know, it's kind of like now you know you're gonna have something like something's gonna change now for the insurance industry. Generally, I think that I don't think there's gonna be much surprised. There's a potential surprise. There is. Um, Cem. Look, press came out this week on governments kind of mulling over the possibility of forcing business insurers to cover business business interruption claims. And that would be a classic example of a surprise, right? So where the rule of law breaks down and it does happen, right, So that Hurricane Katrina post Hurricane Katrina, Um, a lot of the I think governments, I forget, kind of the exact mechanism here, but they force him to cover flood claims. And so that was something is excluded in the policy and that, you know, that that I think is underrated and the degree to which she shakes the feeling of, like, understanding for like, the rule, I mean institutions of our economic society. Breakdown, like, literally like the law says this and its contracts say that and the original weight that aside and make you do something else. You know, that's what that's what really screws things up. And that's what really forces people Thio say. I don't understand here what's going on, and then they back off. Then the capacity pulls out of the marketplace to prices go crazy. You have new entrance. Come in because you know what they're kind of predicated on is the new entrant. You don't know anything more that people are leaving. But they do have, though is they don't have a legacy of business to protect. And so they can be really, really tough on bringing the terms and conditions up on the policies. And as a result, yeah, as long as rule holds against, there's an assumption, implicit assumption that whatever the original pain was, which is this called degradation of the rule of law or the understanding of the law that will that will restore itself. And then we'll have. We'll have this recovery, which is which is what happened to you, right? I mean, I think that whenever you've had some kind of breakdown and people's feeling of certainty of how the world works that does get restored. This kind of like a natural response from the economy, from the political institutions from society that just restores order. Like as an example, when prices for insurance go up, people use less of it. And when they use less of it, you know they want having higher deductibles and wind up self insuring more than wind up being more risk averse. So it takes a long time for that to kick in. Uh, you know another example from the polling Great interview where he said, You know, they're raising prices by 100% in 1981 1982 and the market to actually turn until 1984 1985. So you had you had years, years of extraordinary pain before people finally lightbulbs, switching their heads and like, Oh, we can't just keep doing this. And then people actually start pulling out. And so I think that you can be so it takes a lot longer than you think. Sometimes people to change their minds. We'll change their model for how it works and I feel like I have this conversation right now with my wife and my friends and people in my neighborhood here where, you know, do you really believe it? Like, do you really believe that you have to? You cannot. You kids can't play with each other. You can't go outside. You can't go to the grocery store. You have to watch you like you know, I I'm not sure it's totally sunk in for everybody. I think there is a minority. But like, you know, you see that Don't you watch CNN, But the kids they're partying out in, like the the the whatever that place ST something island in Georgia, you know, you know, until you see kind of behavior change like that. It's like an analog of the insurance industry. You know, I'm not sure you get riel like, really changes signals of, like, genuine, you know, genuine social change, like people are changing how they live and you know, metaphorically how they work in the insurance industry. Like the assumptions of the past are no longer valid. That's when you know you get something new you get, you know, and an opportunity for those removing in um, but you get a lot of pain for those who want who want to try and fix it in place or pull up.
Michael Tanzer: 8:54
So So you know, when you when you're thinking about the current environment and the people you speak to in the, you know, work environment, they're just industry context, generally much like, ah, lots of conversations I'm having with people that work at other investment funds. There's just pretty widespread recalibration of the possible. Yeah, you know, outcomes, right? Starting happen. Yeah. And so when you think about that piece, um, you know, it's interesting that you kind of dove directly into this notion of basically overriding contract love for the good of against social utility and how, that's kind of, you know, maybe, uh, I wouldn't call the Black Swan event, but maybe the effects of the Black Swan event. Yeah, um,
David Wright: 9:52
that would that would have obliterate the insurance industry. I mean, obliterated. The amount of leverage that exists in an insurer's balance sheet is inconceivable. It's it's It's like, you know, if you take click, you think like the average rate on a general liability policy, for when these restaurants or something, they're spending on what is a 50 100 bucks something like that, if that on their exposed for potentially a $1,000,000 or more than that, that you know that ratio is very large. And that's like, You know, I think like the insurers, they rate their capital one premium. And so you already sitting there looking at a few orders of magnitude, more exposure on their balance sheet. Then they even measure measure. Yeah, now they don't even count like there's no point. The numbers are too big. It's like trillions and trillions. So as soon as you like, flip the switch there and you think like, if whatever, like I don't know what's gonna be 70% of all restaurants, United States could go to business, you know, like it's gonna
Michael Tanzer: 10:37
be something incredible together. You're
David Wright: 10:38
incredible, right? Um, that that I mean, it's It's so it's so the insurance just it would wipe out every single insurance company, so it's almost like it's like they can't do it. They just can't do it. It's too big. It's too big, like U turns. Just be like here. Here's you know, you're gonna have to have a sophisticated lobbyist. You just like here. Here's a little post it note. Let me just write a few numbers down for you. Tell me how this is gonna work. Ain't gonna work. Yeah, it's just too big. So they were protected in the sense there about how bad it would be. Just too simple. Yeah,
Michael Tanzer: 11:09
Yeah. I wonder either When you talk about the when people are discussing the government responds right now from an economics perspective, Um, you talk about fiscal stimulus in terms of emailing or, you know, sending people checks in the mail or, you know, corporate. Mmm. You know, injections of cash like they're discussing with the airline industry. And I really wonder how it's going to work for the small business segment. You know, 80% of restaurants plus in the United States. Um, you know, you could you could use Thean Suren industry as a bailout mechanism. Theoretically, right, If you just need, I just feel like
David Wright: 11:55
you need too much money. You know, there's just like there's not that kind of money, like you can't replace the scale of already been talking about GDP right now, right? I think we're moving into the wealth conversation. So It's like stock of capitalists not flow. So the flows air fun, You know that if, you know, But I guess there was a g rating, but, um, but the stock now we're talking about, like, credits, credit risk. So now you're saying, like So what happens if you have a balance sheet of a bank exposed to somebody loans? I mean, in restaurants, you never were a favorite place to lend money for pranks. But e I think other interest, other other business, maybe. And so, you know, once you destroy that much capital, I just don't know that there really is a pot of money big enough to fill that. I don't know. I mean, you know, maybe you have a holiday on interest payments or something. And maybe that's something that, you know, preventing people from going to default, maybe as a way of doing that, hoping to rebound happens. But you know what? What do you think? I mean, that seems to me that there's a huge systemic risk possibility here of the loss of confidence. People can pay anything.
Michael Tanzer: 12:56
I think that the, um that is not, I think, in the consensus view. Um, if you wanted maybe draw. Ah, in analogy to the financial crisis in terms of the, uh I guess you could call amount of psychological fear people factoring into their view of the world. I mean, if you go back, Thio Post lean in the immediate aftermath was the ah, the money market funds broke the book. There were daily rumors about, you know, if Bank of America was solvent. If working Stanley with solvent, like you're saying investment professionals were thinking about, you know, the viability of your career, Um, you didn't know if your prime broker would be ableto keep your financing lines in place or even have your, you know, cash in the right bank. I know I personally know investment professionals, that room moving bank deposits from Citigroup to Bank of America to get below the FBI, see deposit insurance limit. And there's not that kind of worried that the banks are going to be insulted. I would say firstly, because, you know, a number of things have kind of evolved in the credit markets, since some have been a function of natural market responses. Others have been responses to some of the regulations that were put in place after the financial crisis. Um, and then just in general, if you just look a TTE very simple leverage ratios. So, you know, assets toe to equity. The banks were just significantly less lever. Now, I don't think there's that systemic fear in the investment community today of, you know, the idea that Citigroup would be nationalized and you know, what are the implications of that or if they're not nationalized? Whether the implications of that I don't think that's in the in the, um in the overton window of, ah of stuff that people are talking about. But
David Wright: 15:18
what about insolvencies? That, like, for for for regular business is because I got I got I think that, right? I mean, one of those one of the one of the fax forecasts that the has really hit me over the head in the last 10 days is just how long this could last. So we have this social distancing Don't go out. Uh, you know, there's there's schools, are closed private schools, universities. So I mean, like, I mean, surely many of these institutions organizations have loans that they're just gonna not pay that right? I mean, I guess you have the hard assets are still there, but now we're talking about like a, you know, potentially a downward spiral. Right? Who's gonna buy that? You know, there's only so many distressed buyers. Well,
Michael Tanzer: 16:03
I think I mean, in general, the way I think about credit cycles is that this one, this one's very different. Um, most credit cycles are driven by an oversupply of capital over time, leaving to a mis allocation of resources. And then that mis allocation of resources ends with a supply shock, leaving Thio an increase in defaults. And, you know, basically, monetary tightening, um, still fed raises interest rates at the end of the cycle. Losses occur because theme mis allocation of resources don't earned their acquired rate of return based on the cost of capital are weighing an equity, etcetera, defaults take up, lots of things go bankrupt. And, you know, we kind of start and then fed drops interest rates except for except you. Um, so you know, the financial crisis. An example of that, right? So you just had interest rates very low for a very long time. There's large mis allocation of resources into housing, uh, into stuff that was put on banksbalance sheets. And then after that all unfolded, you had a monetary response to that crisis, right? There's a monetary response to a systemic banking crisis. And if you think about it, right, the only way this crisis could have happened given the feds need your responses to weaknesses in the system since is kind of the way it happened, which is this, you know, very black Swan esque exogenous demand shock. Yeah. So what we're dealing with now is kind of that I wouldn't say in Brooke first, but it's sort of like the economy is stopped. You're going to see, you know, a sharp contraction in GDP, and then the significant rise in unemployment and defaults. Um, but it seems, at least for the moment that, uh, the uncertainty is based on how long this is going to last. And, you know, the duration of the shut down the, you know, threat of double dips. And then this idea that there will be these kind of blow up, knock on effects. So, you know, to give an example. One thing people are talking about is that comparing this to the financial crisis in terms of these blow on knock on the vex that have never happened before. You know, in the mortgage backed security market, no one had ever modeled, you know, a countrywide hyper correlated, simultaneous decrease in housing prices. Ah, and the effects Thio all those mortgage backed securities and related products, right? The analogy here is the in the crude oil market. Um, systemic demand shocks have been of the magnitude of 3 to 5 million barrels. If you do some kind of back of the envelope math on contraction and miles driven, you know, you could have a contraction and demand of 3 to 4 times that. Three. That five million barrel. Yeah. And so either the way that plays out is that storage fills up after the curve is in contango. And then oil is just, you know, dumped on the market at a price contracts significantly And that, you know, every shale producer in the U. S. Goes bankrupt, And that has systemic kind of implications for the rest of, you know, high yield credit and high alum markets.
David Wright: 19:56
That feels pretty plausible to may. I don't know if you're richer kind of assessment. That story.
Michael Tanzer: 20:02
Yeah, I mean, So this is kind of something that seems plausible. And you could follow the storage Did, uh but, you know, maybe there four or five other things like that that we just We were in the release for May. It's just not on my radar. And I don't understand. The longer we stay in this kind of depressed state, the higher the chance that these things play out.
David Wright: 20:26
Yeah, Yeah. And I think that the difference between kind of like my model, if I could be more than a little bit more succinct about it on insurance shocks is that they're primarily exogenous shocks. I think that and you're I think you're credit models in endogenous motor, right? So you have within the system, you're you're kind of playing and playing and playing. You start messing up more and more and more, and then eventually, you know your bad behavior catches up with you. Those insurance, I think that's a lot less common I think you need, and this is probably don't know. This is the majoritarian view insurance. I think people probably like the idea of of your model for insurance as well, although I just don't quite buy it. Um, I think that it's it's only because I've just seen so much of everybody else is an idiot kind of behavior. And I think that really plays into that bias of, you know, it's easy to blame the idiots. Um who Right who? Then you're causing the crisis for everybody else. And there is a certain kind of like everybody does have to move in the same direction in order for this, you know, weird, kind of like collusion to work. And you have you have forecasting based industries. Have somebody else's up the forecast, then then you know they can. They can put on a lot of business underpriced numbers. But when I look at history, no, I see. I see. Actually, the real bad ones happening when something crazy happens in a specious right or, you know, the the institution of strict liability, real enforcement of that in the seventies, Um, you know inflation as well. And then you have 9 11 You have a special kind of reboot around 2000 which is underappreciated, which happened around them to this big insurance hard market. And then, um and you have some kind of systemic your game playing happening there, too. But it wasn't anything. Anything like the asbestos crisis, which is so you think maybe this now, this is kind of insurance style recession. If you can call hard market a recession insurance business that happened in it everybody, because you have this kind of the media or hitting us from outer space. And now what happens if they're everywhere they read is just like, this is so different. This is a different. This is a different Mrs kind of breaking the model for for, ah, for an economic crisis. Yeah,
Michael Tanzer: 22:30
so, you know, maybe this is a point of differentiation. So, um, and correct me if I'm wrong. Um, so my understanding that a lot of like Thea life worrying did products over the last. You know, we've discussed this before, but, you know, in the late nineties, early, all these people were, ah, modeling mortality. That turned out to be, uh I guess, different. And, um ah, lot of ah, multi line life and health insurance companies were looking to divest their large books of the new the products and stuff like that. So that seems like, you know, and we're indigenously driven. Oh, that this sub product in the industry is it's just the returns based on the capitalization today are just unattractive. So either you have to you take a risk and recap the business or exit that business. And then there's stuff like asbestos where you know that there's a contagion effect. So they're just mass pain, and that causes a hard market across. And so these these pricing dynamics for policies there's a contagion or correlation. Um, so I think what happens
David Wright: 23:55
when you have kind of like this disagreement herd mentality problem? Yeah, you know what? When everybody heard sort of directing himself over the cliff, right, Is this kind of the problem is sort of a way of thinking about this, this phenomenon. I think that you
Michael Tanzer: 24:10
still have a bunch
David Wright: 24:11
people opting out and smart people saying, You know what? You're as idiots. I'm not gonna do this. I'm gonna get out of this business. I'm an exit, and a lot of organizations do that. The biggest ones pretends not because they sort of they're all indexes right. But I think there's enough smart money that sits on the sidelines waiting for things to change and to me that that's that's a really cushion, right? That's That's the net that's getting built underneath a trapeze artist. And But when you have an exogenous shock, you don't have that because nobody saw it coming. Maybe get the weirdos and crank shouldn't be like that. But they don't have any money. They don't have any influence right on there. And, you know, it's the stop clock, right? Right. Twice a day. I think that there is indistinguishable from that. You know, you're kind of perpetual. Bears are always gonna be there. Um, but the real the real shock, the one that maybe this is Amanda do to response definition problem here where it's like, I'm thinking hard market. I'm thinking one that's like, you know, for real, right? So what happened after? Even after Hurricane Katrina, which was pretty surprising, it didn't affect the best lines of business that were outside of the domain. That got shocked. So you have property, coastal property insurance, the bad, bad couple years for them people buying that insurance break up of yours, people writing it, But the other one's business, it didn't even notice it. Shrug it off, and I think that that to me, is a localized truck. And that's not something that's gonna that's worth, you know, putting in the model. I think that, you know, I think that you because the enough smart money will exit when they feel like things were doing stupid things so that the market's doing stupid things. They're just waiting to come back. Yeah, and that's I think that's more tomorrow, the pattern we've seen over the last 15 years in the insurance business where you have people kind of always coming in and out, always waiting for waiting for the next. No need for the next turn because, you know, there's a notice for the last few years many specialist specialty insurers who who are super smart, who are super conservative, who, you know, I don't know people making money here. And so they know they hired a division of like, you know, just build the base of Premium doesn't perform that well. That's okay. Big toe in the water. We're waiting for the waiting for the turn is what their what their strategy basically is and has been for a generation. And it didn't come and then and then eventually they just get get kind of bored and they just closed down for losing a little, bounce money for their size organization and just close down the whole divisions. We'll start up again in a heartbeat, right? Because because they have this kind of the marketplace is just generate this diversity of opinion. This is a no no, no, but it's like I know that the price. We don't know what the price is, but I know that that's a problem that I'm trying to solve. Like, how do you rate the price and what are the If I look back cast over history and I have this for a bunch of examples, nothing like that happens. I'm ready for it, but it's like a meteor from outer space. Thing is the one that nobody's really ready for, and you can't There's no way there's no way to do it. There's just no way to do it. Waited because at that point it's like it's very easy to just sort of it would be terrified of everything and the yeah, and then and you will do nothing. And that's just, you know you have to you have to participate in the marketplace. You have to choose somewhere to be. No. Once you get to know the real fantastical kind of, you know, stuff like this, Like, you know, if you had we talked about this six months ago, nobody. You maybe have people in an insurance company that would have talked about this problem. Um, but nobody would have said, Oh, wow. You know, that's something we should really be worried about. Um, maybe, maybe even. Maybe even they were wrong. Anyway, maybe insurers don't have to be worried about which I think is probably the case. Like, I think that we're talking about something like a, um you know, a big event. Cancellation insurance. Ah, you know, massive, massive problem there. But that's that. That market place is tiny, you know? Yeah, It's like a sub $10 billion event for the insurance industry, which is, you know, it's no big deal at all. That's nothing.
Michael Tanzer: 27:54
And so are most business interruption. Insurance policy is written with, you know, basically exemptions for pandemic exclusion. Yeah, well, they're designed.
David Wright: 28:06
They're designed to be property covers. You know, it's like if you're building burns down is like the canonical, orginal example then we're gonna pay for, you know, pay for your inventory and pay for your lost revenue for a period of time. Or if you get hit by a hurricane with great that kind of thing. You know, if your employees all get sick or if the government tells you to shut down, that's just it's not contemplated. It's not even like a Maybe it's something in the insurance, kind of like like vocabulary, that kind of thing. I guess it's not property. It's not liability. You're right. It's not like some somebody for harmed you. Some part of tort system, right, the mechanism for pain here. And so there's no there's no like it was a category of scut coverage. There's no sir insurance industry that's designed to do this like it falls into the catastrophe Rome. Because you have this kind of contagion effects, right in the conventional sense, the work or the you know one cause hits many different coverages, but no no catastrophe policy is gonna ever include pandemic because they just they don't have any way of modeling it. That's partly a hunch, partly based on some press I've read, partly based on some conversations in the industry. Um, you know, I haven't Don't throw kind of review of any of this, but, you know, the absence of conversation about it within the insurance world is pretty indicative. You know, if this wasn't anywhere in any bridge, this interruption is a policy insurance industry will be wiped out, and they're not.
Michael Tanzer: 29:29
So So where does the Yes and where is that? You say there's a situation or a scenario that you alluded to earlier Where your contract laws broken based on government intervention, what policies would be trigger? That I guess by that
David Wright: 29:50
it would probably be the general liability or pocket package policy for for a small business. Um, anything it's business interruption is that is that, you know, is the coverage that it would hit. And so that, like I said, tend to be in a property policy or a blended policy. You know, there's through some, like liability based business refugees like contingent business interruption. That's pretty rare and put back on pretty hard by a lot of insurance. Some some industries will have it. In a typical case, there is, like an oil refinery or something, right? So you know, if for whatever reason, you're finally blows up, then the gas distributors or whatever it's gonna be, you know, they have a big problem. Um, this corner little not not systemically important part of the business.
Michael Tanzer: 30:37
So what you're saying, basically, is that, you know, if the industry will take material losses, it would just be in this way. That would be, you know, kind of unprecedented. Ah, versus other there these specific pockets of the industry, which would be, I guess, analogous to the, you know, Katrina example with Coastal flood.
David Wright: 31:01
Yeah, it would be the one, like one part of it. You know, the one place that is a little bit of a wild card is the health insurance business, which, um, which has business. Simon. Now, and you know, the health insurance industry is kind of weird because it's not really insurance. A lot of it any kind of major medical policies. It's much of a prepaid medical plan. Um, and it's not like it presents a you know, like for the magnitude of fear. It's not like it's a really expensive like you go in the hospital for a couple of weeks and then you'll you kind of recover or not right, And that's only two weeks in hospital, right? The really expensive medical A medical insurance claims are like hemophiliacs ready. They survive for a long time with recording humongous amounts of expensive care. And so, you know, here you don't necessarily. It's very expensive course to go get admitted to the hospital whether you know it or not. I mean, insurance companies paying piles of money for that. Um, but, you know, to me, it's, you know, I haven't really considered the calculations on it, but it's gonna be a bad year for those organizations, I think. But I haven't seen a lot of evidence of it being like a calamitous year for them. Ah, and in any case, I think that there's, you know, there's a weird interaction with the government here where I don't know what they're gonna wind up. The government's going up paying for, um ah, you know, especially since I mean, I'm still pretty really. I think to figure out if you have, like, if you're going to quarantine, you know, who kind of pays for that, right? If you were, if you are sort of government imposed quarantine, you know, It seems to me that I think there's, you know, I don't know enough about it yet. I doesn't. Doesn't seem to me like it's gonna be a massive, um, problem for in the under the uninsured, right? Yeah, that's gonna be picked up by the hospital systems and the government, because they you know, they can't They can't know Insurance companies pay for that. So, um, it's hard to see the mechanism for, you know, big changes to the health insurance industry here.
Michael Tanzer: 33:08
And, you know, if you're, uh if your business just, you know either a large corporation or a small business and your policy is coming up for renewal, You know, at the end of March 2020 it has, you know, are you good? Has the pricing inflected already or it's like, You know what? You d'oh haven't
David Wright: 33:28
seen it. Um, haven't seen it. You know, I that you know, let's say like, I haven't been really keeping up daily. So this is writing a menace, you know, as we all know, this is ah, every day is different kind of thing. So business just doesn't move that fast right now. There's a lot of I think I think a lot of companies are just trying to delay, uh, delay stuff. So, yeah, let's just wait and learn more about what's going on. Um, gathering some information. There's no precedent for it. Um, so I don't know that, you know, a lot of the insurance industry itself is gonna be in trouble from the revenue side. Right? So if you have the huge economic collapse, Yeah, that is still the drivers for all the insurance premium calculations are revenues employees in place, right for workers come for miles driven, or most of the vehicles people's enforced. But miles driven is kind of implicit one there. So I think you're going to sing. You're gigantic reduction in revenue for the insurance industry, but a commensurate reduction and exposure. And there's gonna be some gonna messiness in that relationship between exposure and the rating braces for the insurance policies. Um, that you know that he is going to stop
Michael Tanzer: 34:41
and potentially an offset for the you know, if miles driven is down substantially, your policies enforce the loss. Ratios are likely to be much lower. Well,
David Wright: 34:51
yeah. So I've seen it go both ways. I've seen I've seen like you as you have This measurement is proxy for exposure, right? So, for, like, miles driven, let's say or it's gonna be revenues for a small business or whatever it is. And I think that that tense get caliber didn't work fairly well within kind of the known history, right? It's not a true measure of exposure because you have all these other exogenous effects, right? So, like, you know, you're miles driven, right? And if you were, if you were like a truck driver right now driving thousands and thousands and thousands of miles, you probably okay, It was the only one, Whatever it is, right. And so, you know, whenever you kind of hit it into the tail of the distribution here of the rating basis, you just don't know what you're going to see and, you know, financial crisis presented, uh, another example of this where I've seen it. I've seen companies be surprised how low the loss ratios. I've seen company Be surprised how high it waas and the same with this. You know, it's only because it's just hard to predict. I don't know whether it's just, you know, the error is symmetric or not? I'm not sure, but it's it's hard to tell.
Michael Tanzer: 35:51
And what about, um how does the brokerage industry respond? You know, the doctor said to only question
David Wright: 36:03
didn't like the brokers alone.
Michael Tanzer: 36:06
But But, you know, I've been so turn goes up because unfortunately, your yeah, some of your customers air. Are you filing for insolvency? Yeah, but how does the mechanism work? In terms of, you know, the prices inflect did do their do their profit margins go up because of the price volatility or because prices are rising. Like, how does that?
David Wright: 36:30
Um, well, if they so that you know, there's two. There's two kind of important, um ah. Measures here for the business that a broker you have deal. Count your deal size, right? I mean, if you're if you deal, count goes down. That's just that's bad, because now you're overstaffed. Um, if your deal size goes down, that's bad, too. Um, but it kind of a little of a different kind of bad. The way that they're margins expand is they do the same work to get more money, and that usually happens when you have a price inflection in the marketplace and then just like that, Just same guys, Same workhouse. And now the press of all gone 15% Boom. Yeah, you're just just gonna raise and, um, as a kind of an almost inflationary sort of thing and, you know, here gonna see a deflationary shock Where you'll, you know, you were reduced in size and deal account, so their margins we're gonna have a beer, they're gonna collapse. And the problem with the deflationary price sense. So if their client count doesn't go down, um, that means that they can't reduce staff. And so there, you know, the margins gonna collapse all the more because you still if you know, same work less money, um, and
Michael Tanzer: 37:36
savior if your deal count and your deal size go down but the pricing goes up, the pricing access an offset to the former choose to the former do work against you because you have negative operating leverage, like you're saying, you know? So, yeah, you just have staff and costs. Uh, but the question is like whether that price inflection offsets the before.
David Wright: 37:59
Yeah, well, I mean, I think a price in the price in the deal size is being basically Yeah, did a nickel, right? So that, like, the price goes up that caused the deal size t go up. Because the brokerage do you know the mediation there is, like your brokerage percentage and that, Yeah, that's not gonna change. Yeah, so yes. So prices fly up, and then they're good day, but
Michael Tanzer: 38:20
yes, it's a net net on those, too. You think the net result is is is negative.
David Wright: 38:26
Down, down, down their own Both, I think deal size goes down, somebody go bankrupt, and I think sort of deal. Count goes down, it's gonna go bankrupt. And deal size goes down just because you just have less economic activity. Uh, COC layoffs and then but the same time you'll see it will be suspect. Um uh, you know, more, more. You know, the margins will the, you know, the kind of the margins after the fact her still gonna be worse.
Michael Tanzer: 38:53
So one thing I've observed in the brokerage industry is, um, the success over the last 20 years by, uh, someone like brown and Brown, um, you know, has been noticed and, ah, replicated with lots of balance sheet leverage by Yeah, I think six or seven different private equity funds. Um, and, uh, you know, Oh, the result of that has been more competition for deals to roll these guys up. Um, probably more competition on on pricing. Um, do you think this catalog is is, uh, reversal of all that? If you no wonder or one or two of these guys go bankrupt, we
David Wright: 39:42
leverage leverage, intrusive fragility. I mean, I think that, um I think it's important to say to that this is all really contingent on, you know, come with the full year GDP level Looks like because if you have the sharp drop, any of the sharp increase at the end of the recovery, that happens pretty quick, which is I mean first. I can tell pretty possible, because once people just start going back to work, I mean, I'm not sure what looks like exactly you. Tyler Cowen talks about the destruction of intangible capital, and so to me that the ah, what that really means is that's just like the quality of the businesses that come up in queue for less than the quality that you know, the professor on food won't be as good. Um, you know, there's gonna be other kind of a little bit less trivial consequences in that. But I'm still not sure anything that kind of reduces, let's say consumer surplus or something. Right? But I don't think that necessarily reduces a lot of economic activity. So I think that a V shaped recovery is feels pretty possible. If that happens, then you know you can have this dipping up again and then, you know, feels to me like it, probably by not matter too much, which is Maybe that's what the credit markets are pricing in right now. Right there. Just thinking they're saying, Well, with the strong the recovery, then there is no credit, you know, credit crisis and probably okay. Or I might break it up. Okay.
Michael Tanzer: 40:58
No, you said okay. I mean, well, you know, I'll tell you from from my vantage point, um, the ah ah. Typically, in those private equity structures for the large brokerage roll ups, they were financed like a lot of private equity bios with, like, a first line. Secondly, structure and the first lane, you say creates the company for 5 to 6 times even a second. Lien creates it for 9 to 10 times even tow with the implication of the equity check valuing the total business. You know, save 12 to 14 right? And so it's very difficult to, um, under a normal distribution of contraction and economic activities to see that first lane bond being impaired, whether we're alone. But today, those those are trading at, you know? Yeah, let's say in the eighties, um, so you know, whether that's because of just wholesale credit liquidation, which, um, yeah, it hasn't been as bad as the A crisis at all, and, you know, and respect. But, ah, you know, there is some uncertainty being priced in.
David Wright: 42:12
Yeah, that's means an interesting indicator. Um, in it may be, you know, the kind of whatever their credits. I mean, I'm not sure what the right comparative indicator is between the credit market and the equity market, but to me, like that might be an interesting proxy for how long the market thinks this crisis is gonna last. Because if the crisis is short, you could still see equity returns be bad, but bond returns to be okay, right? But the crisis is long, and I think the second shooter drop is the, you know, the credit just freaks out.
Michael Tanzer: 42:50
Yeah. I mean, ah, you look at this chart of, ah, between us, you and emerging markets sovereigns. What you see is this this, you know, kind of court related lines going over time. And ah ah, you know, this is measure than yield spread to Treasuries. So at the peak of the crisis, in a way that in US high yield, there was, like, 2000 basis points of yield spread on us high yield into they were at 800. So, yeah, that's that's far from a perfect and all encompassing indication. But it shows you at least where we are today.
David Wright: 43:38
Mmm. And so interpret that bit more for me. So that spread dropped. Um, what does it mean?
Michael Tanzer: 43:48
Um, yes, let's say, uh, in the quote unquote normal environment, high yield trades it like Ah, yeah, for the 500 basis points above Treasuries. Um, in the last few years, the spreads have been very, very tight. Ewing Thio, Let's say yeah, 200 basis points about Treasuries. Um, if we're if we're looking at the Treasury's is basically like, let's have it the 10 years, you know, 1 to 4% over this over the last 10 15 years. Um, that's if they yield tow worst at the high end of 24% higher. Ours on investing in our little credit at the height of the crisis at Thea the F, the tights say, like, you know, midway through last year, you're getting paid, like, four or 5% year to take that risk. And today, we're kind of, you know, 9 to 10% here
David Wright: 44:52
I may be missing is to the point there I thought you were talking about the difference between international spreads and the domestic spreads. Um,
Michael Tanzer: 45:00
I I only meant to say that, you know, they're vastly Oh, correlated.
David Wright: 45:04
Yeah. Okay. And that hasn't changed.
Michael Tanzer: 45:07
Not really. Um I mean, you see little quirky stuff going on. For example, e m sovereign credit is kind of the same yield spread where it was in 2008 today on. And you know, there are lots of different hypotheses and why, that is, in terms of the increase in, you know, uh, market capitalization and you know, various fund flow. Thank things, but by and large, you know, they're they're very quickly. How about
David Wright: 45:37
term spreads like how about like you put forecasts for the few? One of things I'm just fascinated by here is like what the future looks like And any kind of like any market prices that can predict the future for us here. Like, you know, the 5 10 year, 30 year, that kind of thing.
Michael Tanzer: 45:53
I didn't know. I mean, I tried to personally take it the other way. I look at, um when there's stuff in the market that doesn't make a lot of sense. Mm. I look at that as kind of like, Okay, you know, we've reached the real point. Those either fear driven or, you know, mechanistic lee driven liquidation. I mean, 11 reason why I'm, you know, kind of interested in what's going on in insurance. Is that for example, you could look today, You know, arch capital preferreds are treating of it meaningful discount from par. And you know, that tells me that there's market signal pricing that tells you that they're is a reasonable chance that there could be very deep distress in the industry. Yeah, well,
David Wright: 46:49
what's funny about that company in particular is the mortgage but portfolio that they have and so wonder there's a housing market kind of disturbance there potentially.
Michael Tanzer: 47:00
I mean, in general, it seems I'm I guess I'm more optimistic on the asset side of the balance sheet for the families, with some exceptions, Yeah, Um, I guess, you know, ah, a lot of them had kind of negative experiences during the financial crisis and having not necessarily permanent impairment of capital. But more just, you know, I thought, you know, we could get our money out of this thing when you know times were rough. And now you're telling me I can't Yeah, yeah,
David Wright: 47:32
yeah, yeah. I think that 11 part of the insurance industry that I think that will not change here is I think that kind of how you know, how the insurance companies will will ah, respond, which is to say they're excluded. And I think that, you know, the classic classic pattern of behavior is way won't we won't touch this or maybe any future pandemics for a period of time. And I think you're gonna want it would probably some kind of government issued, you know, like tria this to Terrorism Risk Insurance Act. 1000 won and I think that pandemics just gonna be a hands off for for insurance companies for a while. Um, you know, this looks to me like a once in 100 year kind of event, right? This sort of thing, Um, maybe society itself. Correct.
Michael Tanzer: 48:24
But if I'm if I'm a either a small business or a corporation with very direct exposure to the contraction that comic activity. So restaurants, look, you know, airlines? Um, yeah, casino, etcetera. Do I at the encouragement of my lawyers just file a claim is basically a call option that this
David Wright: 48:48
probably probably. And then the insurers will just kind of aza. That's kind of a matter of course. Just deny, you know, I think there's gonna be a little bit of legal theater that goes on with that, Which doesn't It wouldn't surprise me in the slightest. Yeah, you know, there's gonna be lawsuits that will hit, you know, the court system. But to me, it's all pretty, like, pretty straight up and down stuff. Unless the government puts some legislation through that that close everything up. But, you know, he's
Michael Tanzer: 49:16
So if you're a balance sheet provider, do you provisioned for losses at this point. You know, if the claims come in or is it just kind of?
David Wright: 49:24
No way. I don't think you do. I don't think you can. I think that even you know this this funny kind of like dance that happens on the claim side where they don't often want to, cause then that's like a pre admission of, you know, if they say well, you know, you put the reserves up, that means makes you must think this claim is valid. Really? No different apartment and like now, this work. So I think that they know they gotta hold the line on that because now that dam breaks, it's just over for everybody.
Michael Tanzer: 49:52
Yeah, so I guess, like, you know, what you're saying is basically, ah, Net net. You know, you're saying you small stuff like event interruption insurance and that you know, we shouldn't And then the general just economic effects of lots of your customers are basically going bankrupt. That, like, that's the real problem. I guess not that there should be these blooming liability, except in this, you know, uh, tail kind of event. Where ah, the government steps in.
David Wright: 50:25
Yeah, this is a This is not an insurance crisis. This is like an incredible real shock to the economy that that will have implications for insurance like it does for many other businesses. But but not anything beyond you beyond that. And I think the credit markets are the ones that that to me, Is that the thing that could really make this thing a whole another level, if you know.
Michael Tanzer: 50:49
So asset side impairment this?
David Wright: 50:51
Yeah, I think that Yeah, that's right. Up the ass inside impairment for for the insurers. And then also the kind of the consequences for yeah, for the real economy. And I think that, you know, it's like employees of the insurers. Hey, you hear all kinds of stories where people, you know, like friends or friends who own businesses. And I don't know what they're gonna do, right? I mean, I think that a lot of people are gonna have a real problem on their hands No longer that lasts. Um, you know, it's a compound, you know, it's gonna be a compound in effect.
Michael Tanzer: 51:21
And, you know, if you were starting a insurance business, say where is there something you know there's clearly going to be a dislocation in this market for the next three or four years and, like, I could earn excess returns. Is there? Is there something kind of maybe obvious? We're not so obvious. I
David Wright: 51:40
don't see it yet. I don't see it yet. It's one of the things that I'm gonna studying pretty carefully right now myself over the next. Hopefully a couple of weeks, maybe longer. Um, that folks can subscribe to the show and follow him along with me if they like. Um, but that is what that is. The main thing I'm trying to figure out,
Michael Tanzer: 51:58
and that would be in your what you're watching. Aside from you know, people just literally getting fired and losing their jobs is the price signal that you know,
David Wright: 52:09
their price signal, which is availability capacity. So it's gonna be,
Michael Tanzer: 52:13
David Wright: 52:13
know, what I want to be doing for the next little while? I was talking to people in the business and on the front lines of a lot of these different lines of insurance business and seeing whether they're sensing any kind of abuse, unusual distress, and I don't have I don't have a way of predicting that anticipation that I don't see it myself. Like just reasoning through it. Um, yeah. Doesn't seem like it's gonna show up, but I feel like, um, I'm pretty humble about what I think I know about that right now.
Michael Tanzer: 52:42
Yeah, And you know, it's interesting, because I don't know, a financial market day it is is, um, is available to all or oh, qualified. Ah, by being able to afford the Bloomberg or something, right. Um, it's just like you know where you choose to put your attention, I suppose. Uh, but, you know, with this it's a little both of the pricing and these kind of call them informal pricing signals. Uh, David was a lot less transparent.
David Wright: 53:19
Yes, this it is not very good and takes a little while for it to emerge. I think that, um, yeah, I think that's why I gotta talk to people, right, because because that that and you'll see, you'll see there's enough earnings releases and stuff that that cos if they're pulling out of something. So you know, if the if the insurance company votes what's wallet and says we're pulling out of this business, or that they were gonna issue a winning issue, kind of earnings releases, you know, kind of like, you know, we're gonna reduce our forecast for premium written. That kind of thing is, will hit the financial Marcus Illes big insurers, you know, they're probably traded, and so they make decisions about it. They'll know, to me, it's like the more interesting question is, what about the world will be different. And I think that, you know, there's a few things that I feel pretty confident in. I think there's gonna be more remote work. I think there's gonna be Ah, LA and a lot of insurance is done face to face, which is interesting and maybe change the kind of company to be successful in the future. Um, and I think that you're going to see ah, different kind of, I think, different behavior. I think that this will I think this is could scar this generation a little bit. And, um, I mean, our generation, Michael, I think that, you know, we might make different decisions about how we live our lives in the future, depending on how long this lasts, how bad this is gonna get because we're still the beginning, right? I mean, if you know, if, like 1% 2% of the population dies as a result of this, like, man, that's that's, like people. Yeah, right. And that. You know, I think that you'll definitely the politics will change. I think that, you know, I think that, um there's a lot of stuff that could that could be different about the world in 2021 and ah, I don't know them yet. Um, trying to figure him out, and you know that they will have an impact that we will not will not expect On all businesses are the including insurance. Yeah, Stay tuned.
Michael Tanzer: 55:13
Yeah, I think that. Is that a good? Is that a good point to wrap up?
David Wright: 55:17
I think maybe it is, but it's dark right now. I mean, I think that you know what? We would be positive. Little bit positive. I think that ultimately, you know, I am personally trying to remain positive about it. And I've no personal situation is difficult like it is for many people. Um, but I think that there, you know, I believe in I believe in our ability to figure something out. Um, you know, deeply. But you're just gonna see what that's gonna be.
Michael Tanzer: 55:43
Well, you know that chart that I that I alluded to before with the high yield credit spreads. So if you look at, there's no time in history that, uh, if you start at a level of over 800 basis points on a forward to your looking basis, you've ever lost money,
David Wright: 56:03
Michael Tanzer: 56:04
So, you know, we're getting there
David Wright: 56:07
to buy long term credit about. Yeah, that's you go. There's a money making, uh, suggestion.
Michael Tanzer: 56:13
I mean, you don't hold me that
David Wright: 56:15
way. We'll look up to a church. Okay. Thanks a lot, Michael. Appreciate you get together with you on this, and we'll put a link up to this that you can share. Maybe. Or, you know, we'll talk to later.
Michael Tanzer: 56:28
Thanks so much.