Donald Rumsfeld was once much mocked for his parsing of risks into categories such as “known knowns”; “known unknowns” and “unknown unknowns”. Yet he had a point. There is really no excuse for allowing known risks to overwhelm one’s capital or business model; while accepting risks one can identify, but which are difficult to assess or quantify, is somewhat inadvisable, as many financial institutions have found out the hard way through misaligned incentives and imperfect models.
So, what about “unknown unknowns”? Objectively, one does not even know that one does not know. Consider “cyber risk”. Fifty years ago, that would have probably counted as an “unknown unknown”, because the products, systems and software that have created the risk did not exist- even if some might have been foreshadowed in the works of various science fiction authors. And what of the still-running asbestos saga? One could lay reasonable odds that none of the original underwriters foresaw what would happen, or that the risk existed.
In a broader context, into which category should the recent actions of the Saudi Crown Prince “MbS” be placed? Expropriation for political or financial gain is nothing new, but the event was considered unforeseen, as could be gauged by the reactions. So, a Grey Swan perhaps, being charitable?
The point of all this sophistry is that the ability to survive and prosper in any business, including (re)insurance is based upon being able to detect, avoid and mitigate risks before they reach unmanageable proportions. However, the quality of risk detection capabilities appears to vary widely: it requires a willingness to be proactive in “thinking the unthinkable”; which, frankly, many find difficult because it can lead to some uncomfortable conclusions and requires being both contrarian and disciplined. FOMO is not a viable approach!
Consider the risk of nuclear confrontation- most likely involving North Korea (altho’ both India and Pakistan are nuclear powers, with muddled military doctrines and a long history of enmity and mistrust). Lobbing the odd low-yielding ICBM across the Pacific Ocean is not likely to be a good survival technique for the Kim dynasty, which leads into a consideration of the potential behaviours of other actors as they try to gauge responses. The risks of miscalculation are probably higher than they have been for more than a decade, made more dangerous by the rapidly-increasing nuclear weapons capabilities of the regime in North Korea, and they are no longer negligible. This then requires thinking about the consequences of a nuclear weapons exchange. MAD (Mutually Assured Destruction) might not apply in this case in the literal sense, although tens of millions of Koreans would rather not see the hypothesis tested, but the increased probability might cause underwriters to take another look at the wording of their Nuclear Exclusion clauses.
Of course, this is a “known known” risk, but it requires mental effort that many may not wish to take, which practically speaking could push it into another category.
Turning back to “unknown unknowns”, worrying about them is counter-productive. They are, by definition, currently “unknowable”. One should instead focus on risks that can be detected and then decide where they sit upon the spectrum of probability and severity; and whether they are sufficiently capable of being measured, and so priced and managed. At Awbury, while we are always surveying our environment for new and unexpected risks, we continue to emphasis our ability to provide our clients with products and techniques for managing their “known knowns” and “known unknowns”.
The Awbury Team