Next year marks the 500th anniversary of the first publication of Thomas More’s “Utopia”. Of course, the author’s end was rather unfortunate, after he found himself on the wrong side of the argument with Henry VIII, as did the then Catholic Church in England. And debate has raged ever since as to whether his stand was principled, or simply stubborn. Was he a martyr or a fool?
We mention this, because we have been wondering about the characteristics of a rational (re)insurance market (Yes, a fantasy, of course); and whether its key decision-makers will adapt, or cling stubbornly to an old, familiar paradigm. We have also been thinking in the same context about the impact of the economic reality of capital abundance, as that interplay is likely to be crucial to the future of the (re)insurance industry and its ability to continue to be fit for purpose.
In a rational market, participants should seek to maximize their returns, while minimizing their risks. Yet, in the NatCAT market, we observe seemingly ever declining returns being earned in the face of accepting greater risks- with this reality currently masked by reserve releases, and a lull in the occurrence of major catastrophic events. A rational allocator of capital would be patient until appropriate risk adjusted returns were present; and simply refuse to do business if pricing were irrational.
Yet, the business models, ownership structures and cost bases of most market participants seem to reinforce a reluctance to act rationally in many product lines in the desire to earn that “last dollar of premium” and achieve (decidedly short-term) targets or expectations. Perhaps they should remember something that the late Yogi Berra said: “Nobody goes there anymore. It’s too crowded”. Except that they do.
It seems ironic that an industry that should be capable of planning for the long-term (after all its USP is being there to pay any valid claim well into the future) seems, as so many others do, to focus on meeting “expectations” in the hope that things will turn out well. At Awbury, we do not believe in “hope” or “expectations” when it comes to business and risk management; but in dispassionate, evidence-based analysis, which our proprietary business model then allows us to convert into cost-effective and capital efficient products.
Perhaps at Awbury, we are simply naïve to expect otherwise of the industry as a whole. However, in our, very real, world, we consider the following points are key:
Firstly: if you know that you are “reaching” to justify something, should you not walk away and avoid it?
Secondly: recognize that the tail risks are often greater than the models predict
Thirdly: be wary of back-testing and “fitting” outcomes to desires
Fourthly: precision and clarity in terms matter greatly; and can make the difference between an excellent risk and a “catastrophic” one
Fifthly: capital should be fungible and be allocated where the best risk-adjusted returns lie.
We also do not believe in fantasies, but in reason, logic, discipline and realism, coupled with adherence to principle- but not to stubbornness.
So, why not come and share your own concerns and problems with us? We will not create Utopia, but ways in which you can actually address those risks which seemed difficult, impractical or even impossible to manage.
The Awbury Team