As students of risk and history, we cannot let the centenary of the formal start of the Great War (“the War to End all Wars”) pass without comment.
Many articles have been written and debates held recently in recognition of this anniversary; and the epithet, attributed to Mark Twain, that “History doesn’t repeat itself, but it does rhyme” had been frequently quoted.
As Christopher Clark’s brilliant book “The Sleepwalkers” makes clear, none of those who “caused” the war, actually intended the outcome, yet by their collective actions and decisions, they were responsible for what occurred. So, it is worth asking, at a time when markets have generally ignored the several geopolitical fault-lines on the Eastern Marches of Europe and along the Chinese littoral, why that might be- and why we at Awbury might think it important to raise the question.
In our view, there is a tendency in the markets to price perceived risks on a continuum (e.g. the “credit curve” and “expected losses”), as if the distributions are normal and always easily predictable. Often they are; and we would not disagree with that view in general.
However, we are in the business of providing Economic Catastrophe Insurance (E-Cat), protecting our clients against risks that are low probability but high severity, or franchise-threatening; so we have to try to understand, price and protect against risks which are, almost by definition, “in the tail” and where there are often few observations that are truly analogous to the risk being analyzed and assessed. Therefore, we are somewhat obsessive about researching not just the “simple economic” variables, but also how to design and structure our policies of protection in ways that align the interests of all the parties involved so that the actions (or inactions) and decisions of one party do not have an adverse impact on all the others. Naturally, this involves much debate and scenario analysis by the team, as well as discussions with and inputs from our partners; and we are paranoid about falling victim to “groupthink”. To use the diplomatic code, this involves “full and frank discussions”; and, to complete the circle back to start of World War I, it is arguable that, if the chancelleries and ministries involved had been better equipped for internal debate and less constrained by their own processes, the outcome might have been different.
Of course, the fact that, in the Northern Hemisphere, August tends to be a time when decision-makers try to take time away (and thus can be harder to reach, delaying the process of managing crises that arise) simply compounds the risk of an unforeseen or unexpected outcome.
Enjoy your August!
-The Awbury Team