Everyone should have a “Plan B”

As the tragedy that is the mis-management of the Greek economy and the burgeoning EU “protectorate” continues (in spite of the supposed recent “agreement” and disbursements of cash in what amounts to a bureaucratic version of “3-card monte”), one comes across behaviour that makes one wonder whether one is observing a socio-economic collapse, or a somewhat surreal Greek soap opera.

Much publicity surrounded the revelation that Greece’s former Finance Minister, Yanis Varoufakis, was working, at the request of the Greek Prime Minister, on a so-called “Plan B” to address, inter alia, how Greece’s payments and taxation systems could continue to work in the event that the country’s banking industry shut down and Greece was ejected from, or no longer had access to either the Euro, or the ECB’s Eurosystem. Accusations of schemes to “hack” the computers of the independent revenue service and copy both code and taxpayer information have been levelled. As Mr. Varoufakis explained, the aim of one part of the project was to build a system for enabling the offset of debits and credits between the state and a taxpayer; as the government suffers from under-collection of taxes and consequently owes billions of Euros to domestic creditors, which exacerbates illiquidity. This seems to us to be a rational project from a public policy viewpoint, even if the supposed methodology was somewhat unorthodox.

However, in all the temporary furore and political posturing, it seems to us that a couple of points have been over-looked:

  • Firstly, it would have been rather odd if there had been no preparation for a “Plan B”; and
  • Secondly, that the existing level of oversight of the Greek government by the dreaded Troika (IMF, ECB and EC) is remarkable- and clearly considered highly offensive by many within the Greek government and bureaucracy, leading, not surprisingly, to attempts to find ways to circumvent controls.

In essence, whether one agrees with the approach taken or not, democratically-elected ministers were considering scenarios that were clearly foreseeable and within their areas of competence; and taking steps to deal with issues that would have to be addressed should the “Grexit” scenario occur. To be taken to task for this seems more than hypocritical; it seems naïve.

At Awbury, we take very seriously the need to identify and understand all the possible scenarios faced by our business model and portfolio of risks, as well as the factors that determine success or failure; and to plan accordingly. Therefore, to us, having a “Plan B” is not an idle term, but fundamental to our approach to managing and building our business; and to protecting our clients and partners, proactively, not retro-actively. Frankly, in the rapidly changing (re)insurance markets, assuming that one’s “Plan A” is the optimal and only approach feasible is likely to be a recipe for obsolescence, if not extinction.

Not an outcome that we have any intention of enabling or accepting. What’s your “Plan B”?

 

– The Awbury Team

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Trouble in t’Well…

The continuing ructions and volatility within and surrounding the world’s oil and gas industries provide endless opportunity for pontificating about “The Saudis vs. Shale,” or speculating upon when and if the Russian kleptocracy will be forced to distract a restive population from the economic consequences of the regime’s crippled tax and revenue bases, and contracting GDP, by pursuing further foreign adventurism against its serried ranks of “enemies” – sightings of little green men will rise and spetsnaz camouflage will be so “in.”  No doubt the next great Existential Oil Novel is already being written – unfortunately “There Will Be Blood” has already been thought of!  Perhaps: “The Lost Rigs of the Bakken,” or “How Far Is It From Spindletop to Marcellus?” And as for visual entertainment, “Dallas” will have nothing on “Wild in Williston.”

Of course, it is easy to mock the commentariat’s output, or the doom-mongering prevalent in some quarters. But consider this: oil still matters. The Saudis may already have indicated that they are planning for a post-hydrocarbon world (a nuclear Saudi Arabia, anyone? Reactors in Riyadh…), but oil (or natural gas) still makes the wheels on most buses go round and round; and will almost certainly have to continue to do so for decades to come. Hydrocarbons are not going to become stranded assets just yet, in spite of the hopes of the renewable energy advocates (and we are not in any way disparaging the latter.)

There may be over-supply globally (currently estimated at up to 3MM BOE/day by the IEA), causing a potentially sustained imbalance, with weakening demand in the short term. Over-leveraged or inefficient operators will default- they already are- and hundreds of billions of dollars worth of projects are being and will continue to be cancelled; but both oil and natural gas E&P remain huge, capital- and operationally-intensive industries, with multiple components, each of which has its own risk factors and particular needs. And bear in mind that there are many other significant industries that exist to serve the E&P core- service providers, pipelines, refineries, shipping companies, construction specialists, let alone all the others that only exist because of our hydrocarbon-based economy.

At Awbury, we try to spend at least some of our time in identifying themes and trends that will have a material impact in our E-CAT (Economic and Financial Catastrophe) risk arena, and provide opportunities for us and our partners to underwrite profitable risk-adjusted business in areas whence many, if not all, the “sane” people- and by “sane” we mean those who have mental “framing” issues, because perceived wisdom deems “x” to be a Bad Idea- have fled.

Therefore, to us, the current dislocations, risk aversion and declines in capacity that a truly essential, far from monolithic or homogeneous, industry faces represent an opportunity to analyze the various industry sub-sectors and the financial products they find essential (such as  P&A bonds), but in increasingly limited, or rather more expensive supply; and to structure programmes that will enable those participants that have a sustainable business model to continue to thrive, prosper and absorb their weaker competitors.

Perhaps you should call us?

 

– The Awbury Team

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Don’t stress it? Er, well, perhaps you should…

The UK’s PRA recently favoured its general insurance charges with the requirements for a periodic stress test.  Those of a nervous disposition should look away now!

Of course, at Awbury, we make a virtue of trying to out-think the unthinkable… so, naturally, we read the document with some interest, to see whether it might further portend the end of (re)insurance as we know it, or perhaps envisage the London Market subsiding into the Thames.  Perhaps ironically, one of the scenarios is a severe flood event lasting 6 days across most of southern England and Wales.

We were not too disappointed, because, beyond 9 “standard” scenarios (including the above-mentioned “Great Flood”), none of which would particularly surprise anyone used to Lloyd’s standard loss scenarios, the PRA added 2 more, which are more likely to cause furrowed brows and management angst, as they require evidence of some actual imagination.  Specifically, the FCA asked firms to address:

  • A “worst case own- 1-in-200 [year] insurance loss stress test (insurer specific)”. In other words a “1-in-200 year net aggregate insurance loss over a one year period.”  Regulators seem to be fond of the 0.5% probability over a 1-year horizon. Oh, and it cannot be one of 9 “standard” scenarios.

Most, if not all, large P&C (re)insurance groups will have a team (probably part of their Enterprise Risk Management function) focused on scenario analysis and identifying so-called emerging risks.  Therefore, it will be interesting to see what each of the respondents decides is its “worst nightmare” (absent the end of the world!), the extent to which there is correlation across the industry, and whether any potential 1-in-200 year event is enough to cause insolvency.  Of course, the banking industry is (in)famous for failing to understand and identify its tail risks properly; whereas, so far, the (re)insurance industry as a whole has managed to survive extreme events.

And the second:

  • A “reverse stress test (insurer specific)”

This is interesting, because it requires management to contemplate scenarios and circumstances that would “render its business model nonviable.”  Your business can fail; and you have to try to identify circumstances where this might occur.  Note that such an outcome could arise well before a business is insolvent, or has exhausted its regulatory capital.  You don’t have to be insolvent to be out of business!  The market simply no longer wishes to deal with you, because your vaunted, “best-in-class” underwriting team may simply have decided to de-camp for a better offer, or hackers “totaled” your ramshackle IT system and dumped all your data into the public domain.  Perhaps you were “Googled” and your cost base cannot cope with the price competition?  As has been said before: “only the paranoid survive.”

So, what is your worst nightmare in business terms?  Will your sociopathic CRO finally take the business down with him/her?  Or will his/her ruthlessness, drive and intellect help think the unthinkable, bamboozle the PRA,  and outsmart the competition?

 

– The Awbury Team

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Dreading the Next Recession…

We have written before of our respect for the ability of Andrew Haldane, Chief Economist of the Bank of England, to express in readily understandable ways, ideas that others cannot or will not.  So, we were delighted to read his latest speech (“Stuck”, published on June 30th), in which he discussed the relevance to the currently “stuck”-on- the-floor level of policy interest rates of “dread risk”, an elevated perception of risk which can persist for long periods, affecting human behaviour in a variety of ways.  As an aside, we would suggest looking at Chart 5, which purports to show that current interest rates are the lowest in recorded history, over a timeline dating back to 3000 BC (sic!).  At Awbury, we really enjoy looking at the sweep of economic and financial history, not that any of us can recall quite that far back!

However, what is important about Mr. Haldane’s speech is his evidence that “dread risk” and the resulting paradox of thrift and caution have lingering and non-benign consequences; not only holding back productive investment, but creating something of a mania for supposedly “safe” assets, in which demand has consistently overwhelmed supply. The Great Recession is in many ways the Great Depression Redux, as economic recovery has been sluggish and interest rates stay close to (or even below) the zero-bound floor.  Psychological scarring heals only slowly (one only has to look, in  a broader sense, at the aftermath of 9/11); while events in the Eurozone merely serve to exacerbate risk aversion. In spite of record low nominal interest rate levels, and real rates also close to zero in much of the world, investment levels are below trend, further compounding the effect of slower rates of economic growth.  In short, much of the world is in a “funk” and reluctant to invest or spend.

Paradoxically, this is not necessarily irrational.  In another section of his speech, Mr. Haldane points out  and evidences that the probability of a further recession within any 10 year period on a cumulative basis is almost 90% since 1870; and 80% since 1970.  So, depending upon how one dates the nadir of the Great Recession, the probability of another one across those areas which have so far avoided Euro-malaise or specific local factors (such as Brazil) is not insignificant.  After all, the Great Moderation turned out to be something of an illusion in terms of its outcome!

The problem, of course, that central banks face is that, when the next recession comes, the traditional tool of lowering interest rates may not be available; and (a further paradox), raising rates in the near term (as the Fed is increasingly likely to do), may actually increase the probability of another recession (or at least decline in rate of GDP growth) occurring.

It is, indeed, a strange world in which we find ourselves – one in which the “traditional” tools of monetary policy increasingly do not work; but in which no-one has yet come up with realistic alternatives.

– The Awbury Team”

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