Blessed are the Economists, for They shall inherit (what is left of) the Earth…

It is a truth now universally acknowledged that an economist trying to understand a problem, must be in search of a model. Unfortunately, many of them no longer seem to work.

This is a point that Robert Skidelsky (a British economic historian, generally considered the definitive biographer of Keynes) makes in his recent, essentially polemical book “Money and Government: The Past and Future of Economics”.

It is almost an axiom that the upper policy levels of most governments are riddled with economists, as are central banks. They may not obviously be in charge, but they are very influential.

Unfortunately, as Skidelsky points out, many of them are captives of intellectual orthodoxies which, while no longer able to explain the world as it is, nevertheless permeate their thinking. The classic example is inflation. Above a certain level, inflation is considered (quite reasonably) a “very bad thing”- something to be managed and tamed- as the late Paul Volcker famously did in the early 1980s as Chairman of the Federal Reserve. Therefore, in the wake of the Great Financial Crisis (GFC), there was (and still is) great concern that the printing of money by central banks, their monetization of government debt (cf. Japan), and repetitive “quantitative easing” (done in one form or another by most major central banks) would cause a rapid and potentially uncontrollable rise in inflation. That has demonstrably not happened.

Similarly, NAIRU (the Non-Accelerating Inflation Rate of Unemployment) and the so-called Phillips Curve (plotting the relationship between inflation and unemployment) remain tenets of economic orthodoxy, even when, as in the US and the UK, levels of unemployment are at very low levels without visible signs of changes in levels or expectations of inflation.

Now we are not, of course, advocating that the involvement of economists in policy-setting and -management should be avoided (having a weak spot for the Bank of England’s Andy Haldane); but rather that, as in most areas of political economy, a diversity of views and rigorous empiricism should be encouraged. Repeatedly stating that something should work, when it manifestly does not, is both fatuous and harmful.

The problem is that, if the orthodox economists (and their educational approach) remains dominant, nothing changes; and hand-wringing or bluster are hardly effective in terms of economic management. Certainly, there remain “orthodoxies” that do hold true, such as the fact that high or arbitrary levels of tariffs are not only harmful in a macro sense, but also a hidden tax, with little, if any, offset in terms of domestic job creation. Nevertheless, change is sorely needed.

In reality (and hardly alone in this respect), many economists and the policy makers they advise are focused on yesterday’s “battles”; blithely ignoring or downplaying the issues that matter in the real world, such as how to identify why levels of productivity change; how to deal with a potential decline in the sustainable demand for labour; the impact of demographics on demand; or the changing landscapes of the financial industry.

At Awbury, we are strong believers in the potency of studying and trying to understand the world as it is and may become, not as we might wish it to be. Some models are always necessary; but becoming in thrall to any particular approach is something we aim to avoid. What always matters is exploring, testing and incrementally enhancing what demonstrably works!

The Awbury Team

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“People tend to overestimate what can be done in one year and to underestimate what can be done in five or ten years”

The above is a quotation (from 1965) by Joseph Licklider (usually referred to as “Lick”), an American psychologist and computer scientist, who was considered by most of his peers and famous successors, to be the visionary architect of much of what we now take for granted as part of modern technology and systems.

Skeptics should consider this (from 1960): “Computers are destined to become interactive intellectual amplifiers for everyone in the world, universally networked worldwide” from a paper entitle “Man-Computer Symbiosis”. Lick was not writing science-fiction (although to most of his then readers it much have seemed so), but deploying his intellect and knowledge to formulate a new concept, which to him must have been obvious. Bear in mind that the integrated circuit which still forms the core of almost all computers (except those of the nascent quantum design) was only invented in 1958 by Jack Kilby of Texas Instruments.

While the world’s population may now amount to 7.8BN people, and intellectual capacity is theoretically normally distributed across it, the impact of exceptional talent is non-proportional. The late Steve Jobs was notorious for applying this approach, making real Robert Taylor’s dictum (who ran the legendary Xerox PARC computer science laboratory): “Never hire “good” people, because ten good people together can’t do what a single great one can”. Taylor was quite ruthless: “…if you can get rid of people who are not so good, the spirit of the place is improved.”

In essence, Taylor was trying to create an environment in which closely connected and properly incentivized individuals, would co-operate in research that would literally change the world. Normal it was not; nor short-term.

To quote at some length another computer scientist (and Turing Award winner), Alan Kay: “Because of the normal distribution of talents and drive in the world, a depressingly large percentage of organizational processes have been designed to deal with people of moderate ability, motivation and trust… [A]dministrators seem to prefer to be completely in control of mediocre processes to being “out of control” with superproductive processes. They are trying to “avoid failure” rather than trying to “capture the heavens””. One can see this in the real world in the guise of the truism that no-one is fired for being as equally wrong as everyone else.

Clearly, such statements are easy to label as “elitist” and disparaging. However, whether one looks at social structures, bureaucracies or commercial enterprises, most of the value is created or produced at the far right tail of the distribution. It is mathematically impossible for the majority to be above average, and this applies as much to (re)insurance as to anything else, as we have written about previously.

Circling back to the title quotation, creating sustainable value stems from a combination of vision, application and persistence. Its immediate impact may not be obvious, and often there are failures or necessary adjustments along the way. Nevertheless, the goal remains always in sight, and significant change is possible within the medium term.

At Awbury, whatever the circumstances, our aim is always to try to create demonstrable value over time for all our clients and partners by avoiding “normal” frameworks and standard approaches. Paradoxically, to us that just seems normal!

The Awbury Team

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Another Year, Another Decade…

The past decade has seen Awbury grow from what one might term a “glint in the eye” of its founders into an established specialized insurer, focused on helping its expanding client base find solution to their complex credit, economic and financial risks.

Building a business from scratch is both an exhilarating and humbling experience: exhilarating because one has to address multiple issues “in real time”; humbling because, no matter how experienced one is (and the Awbury team has a market memory covering more than four decades), there is still an unrelenting torrent of data and information to absorb as markets, economies and products change over time.

What then are some lessons learned that are worth distilling? Here are ten:

Firstly, to paraphrase von Moltke The Elder, “No business plan survives contact with the market”. In other words, no matter how well-researched, debated and thought through one’s initial business plan is, its execution will inevitably encounter circumstances that require adjustment. That being said, Awbury has never wavered from its stated purpose, nor been tempted to “pivot” into other product lines. Doing so would be a distraction and dilute our resources for no good reason. However, the ability to adapt remains critical

Secondly, size is not everything, Being the biggest is not a sensible goal for a business built upon the ability to create intellectual capital. Much better to pursue targeted, patient, careful growth

Thirdly, a consistent, definable and effective culture matters. This is much easier with a smaller team, in which everyone knows and interacts regularly with everyone else

Fourthly, the ability to identify replicable and scalable business products is important in terms of creating sustainable income streams

Fifthly, being unsentimental and intellectually ruthless are essential in selecting transactions with the best probability of both execution and a compelling risk/reward ratio

Sixthly, the perfect is the enemy of the good (to slightly adapt Voltaire). What matters is effective execution; not designing some aesthetically perfect artefact

Seventhly, relationships matter. Our business is based upon creating and maintaining long term relationships based upon trust, respect and mutual benefit. Win-Win is always the best outcome

Eighthly, ensuring the proper alignment of interests and incentives underpins effective risk management

Ninthly, selection of the right professional partners means that one can focus on the factors that create and sustain value and success

And finally, never believe your own propaganda! Self-confidence and intellectual humility are not incompatible.

Through the past decade we believe we have built a franchise which is structured to remain effective, relevant and valuable to our client base, as well as a source of high-quality premium flows to our partners who help provide our capacity.

We could not have done this without them; nor without our roster of trusted advisors. To all of them, and to our clients, we offer our gratitude.

We look forward to the new decade- both its challenges and its opportunities.

The Awbury Team

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13 Ways of Looking at (Re)Insurance…

The title is a tongue-in-cheek homage to Jane Smiley’s excellent book analyzing the origins, history, structure and impact of the novel, “Thirteen Ways of Looking at the Novel”- a literary form which is now so embedded in our culture that very few give much thought to anything other the content of the particular book they are reading.

In a similar way, the business of re(insurance), because it is simply “there” and generally works very well in meeting its primary goal of honouring valid claims, tends to be seen as rather mundane.

So, we thought we would enliven matters a little by using Smiley’s clock analogy (see p 179 of her book) to view (re)insurance through different lenses by employing some of her categories, and adding some of our own:

  • History: Insurance as a construct, even if it was not called that, has a history going back thousands of years, to the Babylonian era pre 2000BC; while the first recorded stand-alone insurance contract was written in Genoa in 1347
  • Tale: Think of the classic film noirDouble Indemnity”, based upon James Cain’s 1943 novel of the same name. It was all about the insurance
  • Joke/Humour: We’re not sure that (re)insurance has a humorous side. It is a very serious business. However… How many actuaries does it take to change a lightbulb? Well, how many did it take last year?
  • Gossip: In its original form, Lloyd’s Coffee House would have been rife with gossip. One might almost say that the London Market was founded upon it; but, of course, rapidly evolved to insist upon “utmost good faith” and ”my word is my bond”
  • Diary/Letter: The bane of any compliance department is the manuscripted policy, whose creator has failed to enter its full terms into the system
  • Confession: Do depositions count?
  • Travel: Just think of the opportunity to be an underwriter in Bermuda
  • Polemic: We all know that those 1/1 renewals can become a little fraught
  • Essay: For those studying for a degree in insurance and risk management, a form of mental cruelty, but “character-building”
  • Epic: Just think of Jarndyce vs. Jarndyce in Charles Dicken’s novel “Bleak House”. Someone should have bought a litigation cover
  • Dynamic: The industry  prospers on being able to respond to fresh challenges and adapting to provide new products and seek new forms of capital. Those systems which do not adapt, cease to have a purpose
  • Balanced: That Combined Ratio could go either side of 100%. Almost a random walk
  • Composition: The industry is going the way of so many others- scale versus specialization. The formerly great middle continues to be hollowed out.

We trust that our readers will forgive us for being a little “unserious”!

And may we take this opportunity to wish all our partners, advisers, and clients good fortune in 2020.

The Awbury Team

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The world is going backwards- discuss…

Recent reports that the Central Committee of the Chinese Communist Party has ordered the removal of all western-sourced computer hardware and software from government and public institutions by the end of 2022 (to be replaced by locally-sourced equivalents and potentially affecting up to 30 million pieces of hardware) not only is the latest evidence that the era of “globalization” is probably ending and a long-term trend of rising global trade reversing, but also of why economics really should still be called “political economy”: one cannot properly separate the components.

This act is a response to the uncertainties caused by the continuing US/PRC “trade war” (which may now have reached the “phoney war” stage) , but it raises questions in terms of its likely consequences. While the PRC may have capacity in terms of hardware (through, for example, Lenovo, which is said to derive a third of its sales in the US and only 20% from the PRC), it does not yet have equivalent capacity in high-quality operating software. Ironically, the PRC is already showing increasing interest in developing systems using so-called “open” software.

The key risk in all this lies in the fact that after decades of growth in cross-border trade, and thus in the scale and complexity of supply chains, any government needs to be able to understand and parse each link within such chains, otherwise it may find itself embarrassed by the imposition of “counter-measures” by those impacted by its own high-level policy decision. In the case of the PRC, while Huawei, for example, has seemingly weathered the sanctions placed or threatened upon it by the US better than many had expected (or hoped), it is unlikely that the PRC’s domestic manufacturers can yet replicate every aspect of the technology component list and be able to provide hardware and systems with equivalent functionality to existing ones. Of course, no-one should under-estimate the PRC government’s determination and ability to achieve its goals, but one may wonder whether the announced intention to replace western technology is symbolic for now.

Dealing with such actions, ambiguities and uncertainties is all part of the job description for any seasoned trade credit or political risk underwriter; but it does introduce a question about the need to adjust the weightings applied to the probability that a particular entity will act, or be forced to act, in a way that is not rationally in its economic interests. We are sure that those who write, say, Contract Frustration will be paying close attention.

It is also important to put such announced actions into the wider context, and examine their knock-on effects. It is one thing to wonder where the current weaknesses or vulnerabilities may be in a particular supply chain, but very much another to try to predict where the next “adverse” action will occur and its nature. The growth in international trade is a key reason why the PRC, for example, has been able to grow its economy at the rate at which it has for the past 40 years. Returning to autarky in no longer a viable option for any society which wishes to continue to prosper, particularly one that clearly wishes to become (the PRC) or remain (the US) the regional and global hegemon.

The spectre of the 1930s should give any rational government pause for thought because of the damage which supposedly “protective” actions wrought not only globally, but domestically.

At Awbury, as avid students of history, we try always to understand motivations and reasons for government-level actions, in order to minimize the risk of being “surprised” by how events may impact our business and portfolio; though, as we frequently state, dislocations bring opportunities as well as threats.

The Awbury Team

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Is the paradigm changing…?

In many, if not most areas of life and business (including (re)insurance) there are certain constructs or approaches that are considered axiomatic or fundamental. They can appear in many guises- the inevitability of business cycles, the superiority of democracy or capitalism, and the need to manage aggregates.

However, sometimes it pays to re-examine and re-assess what amounts to a paradigm, in case something has changed.

For example, those familiar with Marx and Das Kapital (published in 1867), will recognize the paradigm of the 3 factors of production- land, labour and capital, with much of the resulting argument being not about the components, but about their relative importance, and which one should or must dominate.

However, as Louis-Vincent Gave (of Gavekal Research) recently posited (in an excellent note entitled The Knowledge Revolution and its Consequences), a fourth factor must now be added- knowledge. One could argue that knowledge has always been important, even if not specifically delineated as a factor. However, as Gave emphasizes, real power now belongs to those who can best organize knowledge: the accumulation of capital thus being a derivative. “Knowledge is Power” (attributed both to Sir Francis Bacon and to Imam Ali) encapsulates the point.

Historically, the possession of knowledge was tightly and deliberately controlled- confined to those (almost invariably males) who were literate and had received a formal education- a prior form of extreme inequality. Power depended upon controlling the levers of taxation and coercion through violence or the threat of it.

Now, of course, mass education and the fruits of information technology have expanded access to knowledge to levels where the paradigm has seemingly shifted to a model based on essentially universal access in most of the world.

Yet, diffusion of knowledge is not the same as diffusion of the understanding of it; nor of how and by whom it should and can best be used. “Should” may be contentious, but (as Alexander Pope said) “a little learning is a dangerous thing”.

What if, as a result, the diffusion of knowledge has caused the economic paradigm to shift, but the political superstructures have yet adapted? Possession of or access to knowledge changes the expectations of those who were hitherto less able to make comparisons or exert influence; and one only has to look around the world to see the increasing tensions between citizens and governments.

For a risk manager, all this begs the question of whether it remains reasonable to assume the medium- to long-term continuation of the nation state in something resembling its current form as the basic unit of government, ruled in a hierarchical manner (whether autocratically or democratically). Given the increasing fiscal and budgetary strains that result from demographics, longevity and at least a perception of an increase in inequality even in the face of the above-mentioned rise in expectations, it is a question worth considering.

Logically, something has to give. Will it be the economic or the political side of the equation, or both? Smoothly and predictably, or violently? Just because relative peace has been maintained, in most developed countries at least, since the end of World War II, that does not mean it is rational to project such an underlying premise far into the future.

Of course, it is easy to dismiss such thinking as absurd. Yet, no economic or political system is immutable; and we are really only starting to grapple with the consequences of the diffusion of and access to knowledge.

At Awbury, this is just one factor in the scenarios that we ponder when trying to understand the macro and idiosyncratic risks posed by any of the large, complex transactions on which our franchise is built. We believe in taking the long view!

The Awbury Team

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Oily tails…

Like forecasting the timing of recessions, it is a truism that predicting the price of oil over anything beyond the short term is usually delusional, because of all the economic and geopolitical factors which have an impact.

How far will US tight oil production surge? Will OPEC decide to curb production with a view to maintaining prices at levels that support members’ already strained budgets? What will be the outcome of the US/PRC “trade war”? How accurate are forecasts of the demand side of the equation?

Amongst all this, there is that perennial favourite, Middle Eastern geopolitics. Venezuela’s production travails are seemingly yesterday’s news!

It can make one’s head spin to try to assess the various scenarios for mayhem that could unfold- especially in a “post-Abqaiq” world in which a few missiles and drones can take out more than 5% of global supply in an instant. In that case, while there was a temporary movement up in price, there was no sustained uptick, which perhaps begs the question of how bad things would have to be before there was a material sustained change in expectations and so prices.

While the world remains beset by far too many bilateral tensions (India/Pakistan being a good example of nuclear war as a tail risk), it is the Middle East which is the source of most state and state-supported conflicts; many of which, because of their seemingly interminable and intractable nature, lead to a jaded and potentially dangerous “so what?” response. What is interesting is that actions which would once have been considered a casus belli are now seemingly regarded as “background noise”. Israel attacks Iranian positions in Syria; or Turkey invades northern Syria, while Saudi Arabia is “certain” that Iran was behind the attack on its Abqaiq facility.

So one has to wonder what it would take for a real “shooting war” to break out that would actually get the oil market’s attention. After all, the conflict in Yemen seems only to elicit ennui.

Iran and Iraq are both much less stable than they may appear (which is saying something!) The governing elites in each, if they felt sufficiently threatened, could easily decide that a “patriotic” war (ruinous as it might be) was “necessary” to maintain power and disguise that increasing fragility. After all, there is a precedent from the war of 1980-88. Of course, this is just one scenario. Israel or Iran could each be seen by the other to have “gone too far” with a particular action, with either side goaded into a war of choice, simply because a failure to respond could be seen as an existential weakness.

These are the topics which “think tanks” and “pundits” enjoy speculating about- but without “skin in the game” it is mere idle chatter.

At Awbury, such things matter. The price of oil has both a macro and an idiosyncratic impact on portfolio risks, so, while we would not claim that we somehow have a special “edge” in forecasting, we most certainly do avoid “wishful thinking” and constantly update our knowledge and understanding of the key factors which do or could have an impact on the supply and price of oil. Regarding it as “background noise” would be foolish.

The Awbury Team

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