Bloody Thursday…or Piketty’s Revenge?

To the catalogue of days with the epithet “Bloody” must now be added Thursday June 23rd, 2016, after the shock outcome of the UK’s “Brexit” referendum; and the resulting market and political turmoil.

The debate on who should be blamed; and what the likely consequences will be- and not just for the United Kingdom- has begun, because the potential second order effects are likely to be more damaging in the longer term than the immediate and obvious first order ones.

While the outcome was something of a shock to most, its likely causation is consistent with trends seen across a number of jurisdictions, including the US, France, Spain, Italy and the Netherlands- that in societies which still actually permit something resembling a free and democratic electoral process there is increasing mistrust between the actual or perceived “elites” (whether political or economic) and much of the voting polity. Couple this with a mendacious distortion by those seeking political office of the tenets of managing news content and political discourse set out in George Orwell’s 70-year-old classic “Politics and the English Language” and one has the makings of a series of “surprises” yet to come.

So, in such a world, what is any self-respecting (re)insurance underwriter or risk manager to do?

– Firstly, do not panic; nor run around shouting: “The sky is falling, the sky is falling (unless one is Her Majesty’s current Prime Minister and First Lord of the Treasury). If necessary, self-medicate
– Secondly, re-examine your entire portfolio of risk for potential “fat tails”
– Thirdly, re-assess the business environment and determine whether there are, or will be, any material shifts
– Fourthly, look for the opportunities that will undoubtedly arise from turmoil and dislocation

In such an environment, careful risk selection and rational pricing remain key to avoiding unmanageable losses. If, as the Financial Times reported, global stock markets can fall in value by USD 2.1TN in a single day, someone is going to get hurt; and, with the second fiscal quarter ending in a matter of days, valuation processes will need to be both robust and transparent to be credible when data are finally reported.

Already AM Best has expressed concern about the impact of the Brexit vote on (re)insurers, as the so-called market consistent approach under Solvency II will transmit market volatility into (re)insurers’ balance sheets. Of course, a price is simply that. It is not the same as intrinsic value (as Warren Buffett would, no doubt, confirm); and so there will now almost certainly be a disconnect in certain sectors and the volatility will expose previously hidden weaknesses and unexpected exposures.

As always, Awbury, with its expertise in providing protection against credit, economic and financial risks stands ready to support its clients in managing their franchises and in mitigating the tail risks in their businesses.

The Awbury Team

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