A Dystopian “Reality”…?

Just in case anyone was thinking of entering 2016 in an alcohol-enhanced glow of good-feeling, augmented by thoughts of getting hold of an Oculus Rift (or equivalent) virtual reality product , we thought we’d provide a look at Dystopia- stiff drink to hand! Scrooge is a “has been” when it comes to pondering Christmas Future…

We have written a number of times about the risks and possible implications of Big Data and Artificial Intelligence (AI) both in general, and in how they may impact the (re)insurance industry; but now consider those posed by Virtual Reality (VR) and Augmented Reality (AR.)

While the level of impact remains debatable and controversial, there seems little doubt that the rise of what one may term the digital component of our world in all its myriad forms is beginning to influence human behaviour and cultural practices, and often not in a positive may (at least for the curmudgeonly, Grumpy Old Men amongst us!) What if we move beyond a world in which the phrase “couch potato” and concern about rising obesity, to one in which a form of eugenics streams humanity into “meatbags in a pod” and those who are “as gods”? Think of The Matrix crossed with Soylent Green, and add a leavening of Brave New World, with a soupçon of Blade Runner…- the anti-Hunger Games!

One of the problems that we humans face is that we tend to crave stimulation and excitement, yet many probably lead lives of quiet desperation [Yes, we are in a very dark place at present!] VR and AR, coupled with the other aspects of digital technology, provide a mechanism for satisfying that craving, while husbanding scarce or increasingly expensive tangible resources, or even intangible “goods”, such as education or clean air. If your existence and “reality” are circumscribed by a screen or a headset, how much individual living space do you really need- a 20 foot container crossed with a Japanese love hotel…?

So, swiftly returning from the Slough of Despond to the Broad, Sunlit Uplands of (re)insurance, consider the potential consequences:

– Rising morbidity
– Significant shifts in demand for tangible products
– Shifts in the need for particular skills
– Behavioural changes, including the addictive
– The extent of regulation of new risks
– New product lines yet undreamt
– Ever faster decision-making processes (via augmented reality, for example)
– Political manipulation

No doubt the Emerging Risks teams within firms’ Enterprise Risk Management functions are already trying to understand and work through the issues we have described. If they are not, they should be. After all, potential outcomes will affect both sides of the firm’s balance sheet, as well as the processes of the entity itself; and there will, therefore, be the need for a truly holistic approach if the analysis, and the decisions that flow from it, are to have any real value, as opposed to amount to simply ticking a box and living in hope.

By now, Dear Reader, you will have gathered, that, at Awbury, we are trying to discern and judge the impact of trends that may, at first glance, appear to be tangential to our focus on E-CAT (the management of complex economic and financial risks), precisely because, in our view, experience in the real world teaches that it is the unexpected or the unanticipated risks and events that cause the most harm- and we have no intention of being complacent about, nor dismissing out of hand, issues that are only beginning to be discussed and are, as yet, barely understood.

And just one final thought: how do you know that you are real? [Philosophy 101…]

The Awbury Team

Standard

The Fallacy of Diversification and Other Perils

(Re)insurance is as susceptible as other industries to fads and fashions, which can lead to the equivalent of “herding” and the “crowded trade”, as directors and managers seek to “keep up” with their peers and competitors.

One example is the return of the mantra of “diversification”, where once specialization was all the rage. The continuing wave of M&A activity in the industry largely stems from the belief that scale and diverse revenue streams are essential to survive in a soft market, still awash with capital. The danger is that, apart from execution and cultural issues, diversification will distract a business’ managers from those product lines in which it has a sustainable competitive advantage and lead to the sub-optimal allocations of capital and resources to areas which are more likely to produce weak returns or even losses. A related risk is that of the “winner’s curse”; in which, in a competitive situation, the “winner” overpays because it believes that it is uniquely placed to derive value from an acquisition. While this may occasionally be so, more often than not value is destroyed rather than created.

Similarly, being a dedicated follower of fashion can lead to entering areas in which knowledge and understanding are lacking, but management convinces itself that it has to be present and have a position “because everyone else does”. Cyber-risk, while clearly an area of growth, is a product line which, we suspect, is somewhat less understood than admitted, such that there will be “accidents” and negative surprises. Financial firms tend to experience unexpected losses in areas that are removed from their core business, or in which the Insured knows more about the true nature of the underlying risks than the Insurer, leading to an increasing probability of adverse selection.

Of course, product development is a fundamental requirement for any business to survive and prosper over the long term, as more and more areas of (re)insurance become commoditized, with marginal participants becoming increasingly irrelevant because their capacity is simply not needed. However, as “big pharma” has found, successful R&D is not simply a function of money and resources, but depends much more on intellectual capacity and flexibility, as well as having the appropriate culture and governance to facilitate the creative process.

At Awbury, we remain focused on our core E-CAT (Economic and Financial Catastrophe Risk) franchise, not only because it offers wide scope, attractive risk-adjusted returns and non-correlated risks, but because it is an area that we believe we understand very well and in which, therefore, we have a sustainable competitive advantage. Naturally, being also somewhat paranoid, we continually question such beliefs and assumptions, because being complacent and self-satisfied is another well-demonstrated route to finding one’s self irrelevant or uncompetitive- an outcome which we very much intend to avoid!

The Awbury Team

Standard

You have Free Will, correct?

Most, if not all of us like to think that, as intelligent, sentient beings, we have the capacity to exercise Free Will in our lives, both professional and personal. At Awbury, we take no position as a business on religious or political matters; and firmly believe that these are matters for the individual.

However, we are beginning to wonder whether we should all be rather more careful when considering how we may be being manipulated subconsciously, when using tools that are now a fundamental part of our lives, both professional and personal.

As we have mentioned before, some of the Awbury team can remember a time when personal computers and the Internet did not exist; and research was actually a physical experience, involving books, libraries and newspapers, and talking to people. Those days are long gone; and now we can “Google” for information, or read it via any number of competing “apps”. EDGAR is a wonderful thing!

Even though it is not exactly a secret, the dominance of Google’s search algorithms has a potentially insidious effect on thought processes and behaviours. However, what prompted our giving further expression to our concerns, was a fascinating article in “Politico” by a respected research psychologist, Robert Epstein, entitled: “How Google Could Rig the 2016 election”; whose content should give any reader pause for thought.

In essence, Mr. Epstein argues (based upon rigorous experiment and analysis) that Google (or “Alphabet”) has now amassed more power and influence than Western Union in 1876 (sic)- read the article- in terms of managing and directing the political process- because of its control over what is termed the “Search Engine Manipulation Effect”, or SEME, and the demonstrable impact of search engine rankings on actual behaviours. Because Google tweaks it search algorithms frequently, but in secret, it is hard, if not impossible, to discern how the changes it makes affect search results or rankings.

What was disturbing about the experiments that Mr. Epstein and his colleagues conducted was that key factors such as trust, liking and voting preferences could demonstrably be shifted by manipulating the outcomes of the searches that those participating were asked to undertake about political candidates.

And there is a certain Orwellian quality to Google’s official response on SEME (as quoted by Mr. Epstein): “Providing relevant answers has been the cornerstone of Google’s approach to search from the very beginning. It would undermine the people’s trust in our results and company if we were to change course.” The “the” is a nice touch… They would say that, wouldn’t they?

Of course, reason would also dictate that it would be detrimental to the company’s interests to use its capabilities and reach to manipulate an outcome; but bear in mind that this is the company that auctions ad rankings for search results; and most of whose processes are deliberately obscured- while corporates collectively spend billions on influencing political decisions.

By now, Dear Reader, you are probably wondering: “But what does this have to do with the world of (re)insurance? Isn’t this all a bit arcane- and paranoid to boot?”

Well, consider this: if you rely (as most of us do, in the West at least) on Google as the initial source of much information (at least as a screen), what a search produces and how the results are ranked cannot help but have an influence upon how you view a particular question or issue and, therefore, on underwriting and risk management decisions. Search engines are now inextricably part of how information is obtained; but that does not mean that we have to take what they produce as responses at face value. Reading the fine print and the detail still matters, as does verifying authenticity and provenance; and having a suitably questioning and skeptical mind.

So, be careful what you search for; and how.

The Awbury Team

Standard

Till a’ the seas gang dry…

Climate change is (if you will pardon the pun) a hot topic at present, and about to be the focus of a major international meeting in Paris.

Of course, whether or not the Anthropocene truly is a new epoch, and whether or not trends in temperature and weather-related events are the result of global warming caused by rising emissions of so-called “greenhouse gasses” remains a matter of some controversy; because, even though it seems clear that the balance of scientific evidence demonstrates a causal connection between human action and changes in many aspects of the earth’s climate, there is still scope for “deniers” to claim that the link is not proven, but the result of some dark conspiracy. As such, the situation reminds us of the tobacco industry and its fight to discredit or obscure the connection between tobacco consumption and rates of cancer development.

Naturally, this topic is of huge interest and relevance to the (re)insurance industry- and not just in terms of the frequency and scale of natural catastrophes, such as hurricanes or flooding.

As the Governor of the Bank of England, Mark Carney, pointed out in a recent speech delivered to the Lloyd’s Market, we are faced not only with long-standing issues related to the “tragedy of the commons” (such as over-fishing), but also now face the “tragedy of the horizon”, because the impact of climate change will be felt primarily over a timeframe well beyond a generation, or even a human life-span, making it even more difficult than usual to address the sort of intertemporal issues so beloved of economists. Of course, with climate change, negative outcomes are not just potentially economic, but existential.

So, if, as Mr. Carney stated, monetary policy tends to have a horizon of 2 to 3 years; management of financial stability a bit longer; and a credit cycle most likely no more than 10 years, how can one expect individuals and enterprises that are too often driven by short-term considerations to act sooner rather than later and to address a seeming tail risk, for which, if one is “wrong”, the sunk costs will be huge?

Clearly, the risks as well as the opportunities for the (re)insurance industry are potentially of a scale that may well dwarf anything else, affecting not just the liability but the asset side, as well as the capital account; perhaps finally putting to productive use the still-rising surfeit of capital that bedevils much of the industry.

Old assumptions and mindsets will be challenged, and underwriters and risk managers will have to assess, analyze and select risks in a much more holistic way, as will their peers on the asset management teams. Boards and executive management, who determine strategy and allocate capital, will need the skills, experience and resolve to make decisions that will have long-term consequences, while being able to absorb and deploy new information as it becomes available. There will be pain, anger, controversy and often fundamental disagreement; so the quality and effectiveness of a firm’s governance will be a key competitive advantage.

At Awbury, we believe that being intellectually open, honest and flexible; and being able to understand and distil the management of complex risks into elegant and effective solutions will remain core characteristics of our approach to building our business and supporting our partners and clients. Intellectual capital will become increasingly valuable, as we navigate the opportunities and threats to come. You should challenge us to evidence that!

The Awbury Team

Standard