My Ego is Smaller than Yours…

Allowing for some semantic debate about exactly what one’s “ego” might be (usually, “a person’s sense of self-esteem or self-importance) and avoiding the existential question as to whether an insurance underwriter or risk manager can even have a soul, it is generally considered bad form to profess to possess one.

Frankly, this is nonsense, as the persistent carnage caused throughout history, both literally and metaphorically, by those who were not “egotistically-challenged” attests.  The idea that those CEOs who engage in creating and building business empires did so for altruistic purposes and “without ego” is laughable.  After all, it is now generally considered demonstrable that the prevalence of psychopathic tendencies among business leaders is somewhat higher than in the general population; and titles such as the “Genghis Khan Guide to Business” (sic) are taken seriously (having more resonance than “Who’s Moved my Cheese?”).

At Awbury, we try to curb our psychopathic tendencies; and you, Dear Reader, will have to wait rather a long time for the publication of our distillation of wisdom, to be entitled “The Awbury Way: How to avoid CATastrophe”.  However, none of us is naïve and foolish enough to believe that we do not possess individual egos, or that they do not matter or have NO value.  IN FACT, recognizing and allowing for a healthy balance between an individual’s ego and the team’s dynamics is essential for highly functional teams to achieve their best, particularly in creative and high-value-generating environments, such as new product creation and the building of innovative business models.

Scientific studies tend to demonstrate that most of us have an over-developed sense of our own importance- in the jargon, there is an “egocentric bias in responsibility allocation”; or, in plain English, each of believes that we have contributed more than we possibly could have to a given outcome (except, of course, when something goes wrong!)  The key point is to recognize this; manage it in terms of group dynamics; and avoid it becoming a distraction, as well as destructive.

Somewhat disturbingly, another study indicates that everyone enjoys talking about themselves. One would have to say that this seems rather intuitive (dead-pan expressions all round), but in a business environment, it is a distraction.  There is a reason why Awbury’s “Insights” are anonymous!

Nevertheless, egos do matter: The more senior and successful people become, the larger their egos tend to be, whether visible or not.  Any catalogue of successful business leaders would support that hypothesis, and its capacity for the destruction, as well as the creation of value.  We are deliberately not mentioning names to avoid accusations of bias – but you know who you (and they) are, and it is a long list.

In our view, a carefully-managed ego is actually essential for any normal human being.  After all, we each have an individual identity; and suppressing it too much is actually harmful.  Yet, we have to be mindful that the team is far more powerful than any one of us; and that starting to believe in “one’s own propaganda” is evidence of a slide towards delusional and probably harmful behaviour.  Not a good thing.

So, please be assured, that the Awbury team acknowledges, and channels its inner ego.  Now, as for the Id…

It’s not all R&R (Rum & Recreation)…

While much of the world has been transfixed by events in Greece and China (what happened to the Ukraine?), the US has its very own potential fiscal train wreck gathering speed in the form of the Commonwealth of Puerto Rico, whose Government has finally stated publicly that the island’s public debt burden of some USD 72BN (some 100% of GBP as of end 2014) is unsustainable and needs to be restructured. The Commonwealth’s economy has been contracting for at least a decade; while the government has run persistent budgetary deficits; and, in the absence of significant and radical structural reforms, the ratio of debt to GBP will continue to rise inexorably. Something has to give!

Because of Puerto Rico’s unusual triple-exemption for investors in terms of US taxation, its debt has long been popular with individual and institutional investors; but it has also, more recently, become “prey” for a number of distressed debt and hedge funds, who hope to influence and profit from what will probably be a complex and protracted restructuring. In addition, a number of so-called monolines, in particular MBIA and Assured Guaranty, have provided guarantees of principal and interest (i.e. “wraps”) on significant amounts of debt- a level of exposure that actually led them recently to provide funding to the Island’s power utility, PREPA, to enable it to avoid a payment default, which might potentially have led to a cascade of further defaults. Of course, as usual, the rating agencies were lagging indicators, holding off downgrading the Commonwealth’s obligations below investment grade for far longer than was warranted by reality; and yet, on July 15^th, one of its government-linked financing vehicles, the PRPFC, failed to provide funds to make an annual debt service payment of USD 94MM, so default looms.

Being a Commonwealth, not a municipality, means that the Government cannot currently seek to restructure under Chapter 9 of the US Federal Bankruptcy Code (as used by, inter alios, the city of Detroit). It has made several attempts to have legislation passed that would simplify its ability to restructure its own debts and  that of entities such as PREPA; but without success, so far. In addition, the Commonwealth’s constitution requires that any General Obligation debts be serviced before any other obligations; which, naturally, has created spread differentials between the various types of public sector obligations and the scope for arbitrage.

Given the complexity of the Commonwealth’s obligations; the diversity of those investing and speculating in them; and the absence of any clear mechanism for restructuring, it seems likely that only the lawyers are certain to get rich from the forthcoming legal battles. The Commonwealth’s government desperately needs to be given the tools and flexibility to negotiate with its creditors in a judicial rather than political process (even though, of course, political and policy decisions will be an essential component of any successful resolution.) Regrettably, there is no real sign of a dysfunctional and partisan US Congress taking steps to facilitate any of this, so one must expect crisis and confrontation à la Grecque before any eventual resolution.

At Awbury, we have no exposure, direct or indirect to the Commonwealth; but, as always, we pay close attention to events that can have consequences beyond the immediate and obvious. One can always learn from how decisions are made (or not); and how problems that may seem initially insoluble are eventually addressed. We simply hope that there will now be a concerted effort to deal with reality.

 

– The Awbury Team

Debt and Hypocrisy

As the Greek Tragedy continues to unfold, whether to catharsis or catastrophe, it is worth bearing in mind that what is being faced is ultimately a question of state, not private solvency (leaving aside the specific problems of the Greek banking system). Not only is the Greek economy largely uncompetitive in terms of tradable goods and services, but it has been subjected to externally imposed constraints that have reduced GDP by at least 25% (i.e., by levels associated with the Great Depression); and thus the ability of that economy to generate revenues (taxes) to support both domestic services and the servicing of debt denominated in a currency over which the supposedly sovereign government has no control.

There is no doubt that the Syriza government has done a masterful job of alienating practically ever external decision-maker; while, remarkably, persuading a majority of its citizens to support an approach to dealing with its future that may “not necessarily turn out to its advantage”, because no-one trusts its intentions and commitments.

That said, while we at Awbury strongly believe that obligations incurred should be honoured when due, we do wonder at both the effectiveness and the hypocrisy of an approach, largely dictated by the German Federal Government, which runs the risk of subjecting an already distressed polity to being forced to burden future generations with servicing debts at a level that may well condemn them to diminished opportunities for decades to come. The “No” vote in the recent referendum is, therefore, not a surprise in emotional terms, even if it may have negative economic consequences.

What we find distasteful is the rather sanctimonious preaching about “morality” by a government that has previously blatantly manipulated the EU’s rules in its favour when it needed to, because it could (in effect, acting as a bully); and represents a state that has, historically, been a beneficiary of forbearance when it comes to servicing its own debts in full.

As famed French economist, Thomas Piketty, recently pointed out in an interview with German publication Die Zeit, after both the First and the Second World Wars, the German state did not service fully its obligations. In the former case, they were effectively restructured and then repudiated (accepting that exacting reparations is usually a rather bad idea); while in the latter case, the London Debt Agreement on 1953 cancelled over 50% of German foreign debt and restructured internal debts, thereby essentially freeing West Germany’s economy to enjoy the Wirtschaftswunder of the 1950s and 1960s. To be fair, that was in the context of West Germany assuming all the prior external debts and obligations of the predecessor Third Reich, so there was clearly a need to restructure. Of course, Professor Piketty also pointed out that the nascent German Empire made a point of enforcing fully French reparations in the 1870s after the end of Franco-Prussian War. Nevertheless, the current German government might also care to consider the direct economic costs to it from a disorderly default and “Grexit” by Greece, given its exposure through the ESM and EFSF mechanisms set up to deal with the aftermath of the Great Recession. As an aside, Greece was a party to the London Agreement; and was able to be generous to West Germany because it was itself being supported by the US through the anti-communist Truman Doctrine. History is, as always, replete with ironies!

We are not suggesting that the Greek state (which essentially forged its own books for years prior to being found out in 2009, and was abetted by interested parties in doing so) simply be allowed and enabled to repudiate its obligations, or to indulge in the brinkmanship and ad hominem attacks that have characterized its behaviour since the election of the Syriza government in the hope of avoiding the consequences of its own actions. However, we do believe that certain governments and supranational entities should equally refrain from moralizing; and from treating a sovereign state as a test for the effectiveness of policies which have created at best (and being charitable) little benefit.

As we wrote in a previous post: It is not a game.

 

– The Awbury team

Beyond the Edge of Tomorrow…

Sounds like a Hollywood sequel, does it not? Actually, we are alluding to a recently published PwC report, entitled “Insurance 2020 and beyond: Necessity is the mother of reinvention”, part of a series of scenario analyses (dating from 2010) of what the (re)insurance industry might look like by 2020 and beyond.

Regular readers of our “Insights” will know that we pay particular attention to trends in the threats, risks and opportunities facing the (re)insurance industry, so it always interesting to read the views of others. It was instructive to note PwC’s comment that the industry’s CEO’s currently have a greater perception of disruption than those in any other commercial sector. While we would not rank order such perceptions, we would certainly agree that any CEO who is complacent (if there are any left!), is unlikely to stay in his/her role for much longer: Witness the two major transactions announced within the past week – Willis/Towers Watson and Ace/Chubb.

We have also written of the increasing importance of being able to analyze and understand seemingly endless torrents of data, so it was pleasing to see emphasis on the “game changer” in analytics, moving from descriptive and diagnostic to predictive and even prescriptive (i.e., determining and ensuring the right outcome); and this was a key them of the report. However, what the commentary did not emphasize was being able to find the appropriate analytical capacity (whether human or AI) to do so;  and then attract and retain it within the industry – something which we expect is challenging in a world obsessing about the next technological “unicorn”.

One statistic that struck us was that, at 2.7% of emerging markets GDP, insurance penetration is barely 1/3 of that in so-called advanced economies at 8.3%. It seems inevitable to us that, over time, the levels will converge as long as insurers can adapt and develop appropriate products. However, while the opportunity to build new markets is clearly significant, so are the risks (as the report points out), because of the concentrations that arise from rapid urbanization and inter-dependency. Therefore, at Awbury, we remain of the opinion that the potential for creating new products (such as our E-CAT suite), which would re-allocate current spending on insurance in advanced economies, is at least as significant. (Re)insurers are also going to have to be very comfortable that their data and models (many of which will be new) are sufficiently predictive (including addressing tail risks) to enable them to select and price risks effectively.

Somewhat disconcertingly, a dichotomy became visible in terms of the perceived importance of data analytics (with 70% of a 2014 PwC survey stating that these have changed the way they make decisions and 93% of CEOs believing it to be more strategically important than any of digital technology) and the value ascribed to them (40% seeing limited benefit in their role).  Perhaps more tellingly, more than 30% of participants apparently believe that “senior management lacks the necessary skills to make full use of the information”!  This begs the question of whether execution and implementation will match intent.

At Awbury, we believe that the ability to obtain, understand and apply relevant data to all aspects of our business model is an essential core competence – and that includes those of us whose working lives pre-date the introduction of the PC…!

– The Awbury Team