Is this a complex system which I see before me…?

With apologies to Shakespeare, one could argue that systemic complexity and inter-connectedness remain as daggers pointed at the heart of the world’s economy. Or, to use another unpleasant analogy from epidemiology, there are still quite a few “super-spreaders” around (such as the largest international banks) able to “infect” the global financial system.

In a recent speech, Andrew Haldane (Chief Economist, The Bank of England) discussed how complexity theory could be used to try to understand the ways in which economic and financial systems interact and inform the design and application of tools to create effective policy and regulatory instruments.

A key point that Mr. Haldane made was that modern economic and financial systems are not, in fact, complex adaptive networks, but more akin to “systems of systems”. This sounds tautological, but what it really means is that both the economy and its financial architecture comprise a nested set of sub-systems, and that within each sub-system there lies its own complex web of interactions. Not only that, but such systems are regarded as “scale free”, being configured to appear as a hub-and-spoke network. This is important because something which affects the “hub”, the element that is widely connected, can create a so-called “systemic cascade”. One could certainly argue, that the demise of Lehman Brothers demonstrated that if the failure of a supposedly medium-sized financial entity could have such an effect, preventing the failure of, say, a CitiGroup was actually essential, because no-one could know the extent of its linkages to the financial system, only that they were extensive and dangerous if severed.

Of course, the debate over whether one can actually ever avoid “Too Big To Fail” continues to rage, with regulators pursuing various approaches intended both to reduce the risk of failure and also to minimize the impact should a failure occur. Paradoxically, however, being designated as a G-SIB or G-SII (Global Systemically Important Bank/Insurer) almost seems to be like a “scarlet letter”, because such a designation carries with it the assumption that failure is not an option because of the damage it could wreak. And yet, we then have the spectacle of the largest banks being required to create “living wills”- essentially a guide for a regulator to dismantle and “save” the essential components- and being threatened with unpleasant consequences if they are unable to comply.


So, in reality, attempts to curtail or corral complexity have simply engendered further complexity and uncertainty; because, while a better-capitalized and more rigorously monitored banking system ought to be less prone to failure and its destructive consequences, no-one really knows if that is true.


Interestingly, there is one part of the financial system that has generally proved robust in the face of wider systemic issues, namely the large, diversified P&C (re)insurers who are Awbury’s partners and provide its capacity. That is not fortuitous, but a deliberate  component of our robust business architecture.


– The Awbury Team


The Underwriting Turing Test…

We are sure that our readers will have come across the famous Turing Test, named after one of the acknowledged founders of computing as we now understand it, Alan Turing; who introduced it in a famous paper from 1950, “Computing Machinery and Intelligence”. In very broad terms, a non-human intelligence (or Artificial Intelligence- AI) would pass the test if it could fool a human interlocutor into believing it was, in fact, human; or, as Diderot stated some centuries earlier in his Pensées: “If they find a parrot who could answer to everything, I would claim it to be an intelligent being without hesitation”. If you could not see the parrot, and its answers came via some intervening medium, how could you be sure it was not human?

So, let us pose further questions: How do you know, in a world of financial models and the use of “big data”, that an underwriting decision was actually made by a human being? And, if it were not, would you, or should you, care?

Some may think we are being flippant, or facetious. We are not. Consider how much has changed since Turing’s paper was published; and how algorithms and self-learning machine intelligence are not fantasy, but fact.

So, another question: why would you even need a human underwriter? What advantage do they provide? We are being completely serious when we state that in at least some insurance products, there is no longer any obvious benefit in having a sentient being make the underwriting decision; and that the days of the human underwriter are numbered, if not already gone. We shall leave it to our readers to fill in the blanks on which lines of business we might be referring to!

Of course, we all like to think that, if not individually indispensable, we at least have a sustainable economic value in the (re)insurance market as a human agent, better able to carry out an underwriting role than an algorithm. But is that really so? Again, in an environment, such as NatCAT, where margins are being eroded; and human beings may be the most significant “cost element”, at what point does a model-driven, data intensive, underwriting process become the better alternative? Of course, at least for now, it is likely that a human being or two actually designed the model and arranged for the collection of the data; but is it really that difficult to imagine a scenario in which the entire process becomes self-governing, self-learning and “aware”?

We shall now attempt to calm those of our readers who are readying the Molotov Cocktails to burn down the data centres and incinerate the servers!

We are firmly of the opinion that it is naive and foolish to expect the world to continue as before, or to assume that underwriting any risk must by definition require a human agent. Massive datasets; patterns; and the law of large numbers mean that, in many cases, a human underwriter is no better, and may in fact be worse, than an AI. However, (sighs of relief all round…) we would argue that there are still lines of business, with our E-CAT range being one, in which a human intellect, with appropriate education, knowledge and experience, supported by appropriate models, remains essential to the proper identification, analysis, execution and management of risk.

So that’s all right then!

– The Awbury Team


What’s the Greek for a Hail Mary Pass?

There are portents of the end of days so far as the ability of the Greek government to remain solvent, avoid default on its external obligations, and remain a functioning member of the Eurozone and the ECB’s Eurosystem.

Anecdotally, those who can are shifting their Euros out of the Greek banking system, and minimizing cash transfers into the Greek economy. As we have written before, while the Greek economy is still almost a rounding error in terms of the European construct, and the system is supposedly better prepared this time around, both practically and psychologically for a “Grexit”, we think that both the markets and the “political classes” are being rather too relaxed about what would more than likely be a disorderly default, as well as potentially a serious shock to Greek social cohesion.

For example, if the Greek government runs out of Euros available to pay its domestic obligations (let alone its external ones), what would happen next? How would the ECB cope with an insolvent Greek banking system? How would Greek society deal with a situation in which there was a collapse in services? Are contingency plans already in place to print a New Greek Drachma to enable at least some semblance of a domestic economy to function?

Unfortunately, the left-wing Syriza government has demonstrated its inexperience and lack of institutional knowledge in how it has tried to negotiate desperately needed “bail-out” funds potentially available to it under the existing support arrangements; managing to “mention the War” and thus make it harder for the German government to be seen to be making concessions and provide negotiators from the dreaded Troika (ECB, IMF and European Commission) with flexibility in addressing pressing issues.

Frankly, while the potential consequences of a “Grexit” are disturbing enough, we think the larger issue is its impact on the credibility of the Euro as a currency and the cohesion of the Eurozone as a currency union, rather than a currency board. Willem Buiter, CitiGroup’s highly-respected Chief Economist, has already pointed out that the ECB’s acceptance of only partial loss-sharing by the Eurosystem member central banks- forced on it by the Bundesbank as a quid pro quo for accepting quantitative easing- arguably turns supposed monetary union into a “glorified currency board”. A “Grexit” would tend to reinforce the concern that the Euro’s position a functioning reserve and international trade currency is vulnerable to both politics and macroeconomics, and its existence reversible. This may be seen as something of a tail risk, but it is not one that should be ignored, because currency boards work until they don’t!

At Awbury, we try to take the long view; and also recognize that the real world is full of “fat tails”, rather than stylized, Gaussian distributions- so we are paying close attention to events in the EU, bearing in mind that in a number of key areas the EU has to act unanimously in order to take action.

Of course, we also believe that in times of fear, risk-avoidance and disruption those who are rational and robustly-resourced are in a good position to seize opportunities and lock-in excellent risk-adjusted returns for themselves and their partners.

-The Awbury Team


The Full Montaigne…

We have written before about the decision-making process, because we consider it to be fundamental to the successful management of any business, especially one in which judging and pricing large and complex risks are critical.

In his Essays, Montaigne wrote the following: “We take other men’s knowledge and opinions upon trust; which is an idle and superficial learning. We must make them our own.”

Most people would take this as a statement of the obvious. Yet, think about it: to what extent do you rely upon others, in effect, to form and govern your own opinions? Of course, neither society nor business could function without trust; and few of us are true polymaths, who are expert in a broad range of disciplines, but it is easy to slip into the habit of relying uncritically upon others to do one’s thinking-something which is anathema to us at Awbury.

So, we underwrite thoroughly every transaction that we do. This means that we need to be sure that not only are we asking the right questions and identifying the key issues and risks; but also that we are not asking the ones that are irrelevant or otiose, even if having a bit more information may seem comforting. Quality, not quantity!

How then do we process what can range from seemingly straightforward datasets to the inordinately large and sometimes imprecise? We work as a team and allocate tasks according to expertise and experience (as we said, we are not polymaths!), without indulging in debates about who “should” do something.

Next, we bring to bear the fact that each member of our team has a different range of experiences and education; and will look at a particular issue or problem in a slightly different way, without any concern about that way being the “best” or the “only” way to do so, using a range of mental models. The outcome is a form of what is called Consilience Thinking, as defined by the Cambridge philosopher, Whewell, in the 1840s: “The Consilience of Inductions takes place when an Induction, obtained from one class of facts, coincides with an Induction obtained from another different class. Thus Consilience is a test of the truth of the Theory in which it occurs”. While the facts may the same, they are examined by disparate intellects; such that, if the conclusion reached is essentially the same, it is reasonable to think that the judgement and resulting decision are appropriate.

Note: this is not in any way the same as that bane of organizations and committees: “groupthink”. Each member of the team is entirely free, and encouraged, to challenge the “received wisdom”. We trust each other, but we form our own opinions. Similarly, our partners trust us, but we also expect and encourage them to form their own opinions; and welcome their input.

Of course, we have no illusions about being infallible- we are human, after all!- but we believe that our approach to underwriting and decision-making should continue to protect us (and thus our partners) from egregious mistakes and manifest error.

– The Awbury Team