Psychologists have proven that in a negotiation it is always a good tactic to anchor your opponent's expectations with your first bid.
In experiments one group of people was told a bottle of wine was worth $20 and another that it was worth $10, then asked what they would be willing to pay for it.
As you would expect, the $20 group offered significantly more than the $10 group for the same bottle.
Their expectations had been anchored by the higher opening valuation, so they were happy to pay more.
The same things happen in asset bubbles. Long periods of irrational pricing anchor expectations so high that relative pricing weakness can seem like a good-value buying opportunity, when in fact it is just another way of buying at many multiples of what a fair price should be.
An overpriced asset is still overpriced, even if it is 20 percent cheaper than last week.
In our Floridian Irma version of this experiment we kept a running commentary of what we thought the bottle of wine was worth. It kept changing.
Today we are the $10 group whereas last week, and even on Sunday, we were firmly in the $20 and over camp.
This should have an effect on how our customers view our product and its value.
We should all be relieved that our rare and expensive 1-in-100 vintage did not get uncorked this time, but the reminder of the relative ease with which the state of Florida can produce $100bn+ events should have the effect of anchoring our expectations.
If last week I had told you that you were going to get a $20bn loss today and it ended up coming in at $50bn, you would be angry and upset.
But now I'm telling you that the $100bn loss I foresaw last week is only worth $20bn-$30bn, you are practically jumping for joy.
This should make you value your insurance, reinsurance and retro a little more highly. There will certainly be plenty of primary players that wished they had bought more protection and others that belatedly realised they had been staring at oblivion last week.
Now that oblivion has been avoided, there will be a relief rally in stock markets as the heavy discount applied to insurance equity of the last few weeks quickly unwinds. Yet the industry may also be in the worst of all worlds - a position where it takes significant losses but is subsequently unable to raise pricing, rather merely stem its declines.
The consequence will be another lost year for returns, but the stemming of rate falls might postpone important tasks for tomorrow that should have been done today.
However, the great positive is that Irma has so far been an object lesson in just how much volatility the reinsurance world removes from its clients. Volatility has been anchored extremely high.
The weather people gave us shock upon shock, hour after hour. Irma was heading this way and that and weakened and strengthened with a flightiness that defied prediction.
Now it's over to the modellers and our expectations have been anchored high again. We are now expecting to be surprised, not to have our theories validated.
This can only be good for the reinsurance world, for as expectation of the unexpected rises, so will the ultimate value of our volatility-removing product.
To read the third of our daily issues from Monte Carlo this year, please, click here.
Mark Geoghegan,
Managing Editor,
Insider Publishing
