A different lens…

We wrote recently about the World Economic Forum’s 2018 Risk Report. Now along comes another favourite, the US intelligence agencies’ annual “Worldwide Threat Assessment” (WTA), as perceived from a US-centric viewpoint. Of course, given that this is a public document, one might wonder what is left undisclosed. However, the document is instructive as, if nothing else, a signaling document.

Along with the now customary invocation of North Korea’s possession of nuclear weapons as an “existential threat” to the US, and the frequent mention of the various threats posed by Russia and China, some additional items are worth noting.

The lead-off topic was “Cyber Threats”. While much of the concern relates to criminal, state, and non-state actors trying to influence behaviour or policy, it is worth noting that attacks on commercial targets are also expected to increase significantly, as malign capabilities develop and spread (and this is in a world in which the Internet Of [connected] Things is becoming a reality). Therefore, while (re)insurers desperate to increase premium flows are focused on building their “cyberrisk” books of business, it is probable that the frequency and scale of losses will continue to increase, leading to the question of whether companies will be able not only to price for the true level of risk, but also identify and manage their aggregations effectively.

Another topic which is given less prominence, but is also of considerable interest to the (re)insurance industry is “emerging and disruptive technologies”, such as Artificial Intelligence (AI), biotechnology (e.g., artificial gene synthesis) and the creation of advanced materials, including nanotechnologies. While of great potential benefit, the scope for misuse and the lack of controls or understanding are likely to lead to new types of “events”, causing difficulties in realistic pricing and the management of such risks. There is going to be a premium upon underwriters with “hard”, specialist knowledge for those companies intending to make a serious commitment in these areas.

Interestingly, DNI Coats also went on the record expressing concern that the level of US government debt and the rise in the fiscal deficit as a result of the latest Federal Budget, coupled with political “fractiousness”, represent a serious threat to the long term ability of the US to defend itself and achieve its policy aims. “Unsustainable” was the term used. Of course, this is hardly a new sentiment or criticism directed at Congress, but the language used is unusually blunt. And one should bear in mind that, arguably, the demise of the former Soviet Union was hastened by its rising economic instability. No-one is suggesting yet that the US is going to “implode”, but the warnings are instructive; and, naturally, the outcomes that such a trend can create, if not addressed, are of considerable interest to (re)insurers, including Awbury, who are focused on credit, economic and financial risks.

Naturally, at Awbury, our focus on longer tenor business means that we are constantly conducting our own threat assessment, aiming to winnow the “interesting but implausible” from the “real and probable”, so that we can avoid “fat tails”, and continue to provide our clients and partners with value-added solutions to complex issues that benefit from the application of a different lens (or approach) to the industry.

The Awbury Team

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Nothing lasts forever…

Which former US corporate icon was founded by a legendary inventor in 1892; almost failed to survive its first year; and had been, until recently, an admired stalwart of US business? It is, of course, GE.

Yet, during the Great Financial Crisis, this corporate behemoth, once an “undoubted AAA”, had to be supported by the Federal government, and the Warren Buffett imprimatur (which helped save a few more institutions during the panic and turmoil), because its financial “evil twin”, GECC (which was backed by the holding company) had become so large and over-extended that a sudden liquidity crisis threatened to cause it to implode, dragging down the industrial businesses, and threatening corporate bankruptcy. The truism that “lack of liquidity kills companies” almost claimed another victim.

Such an outcome would have shocked the entire US corporate establishment, because, if anything, GE was associated with the quality, longevity and “interoperability” of its executive cadres, graduates of the company’s famed Crotonville management training centre, whose approach and seeming success others aspired to. The belief was that a GE management education equipped one with the ability to manage anything. Perhaps, someone should have pointed to the example of Robert McNamara (one of the products of Ford Motor Company post-WW II “Whiz Kids” generation) as an indication that there are limits to such capabilities, and that very few individuals are true “practical polymaths”.

In fact, one could argue that, partly because of the lack of trenchant criticism of its conglomerate approach, and the intimidating reputation of GE leaders such as Jack Welch, those who should have questioned the rate of growth and over-leverage of GECC, were unwilling to do so: the facts spoke for themselves, until they didn’t.

And now, following the recent debacle of its need to create billions of dollars of reserves and charges in respect of its legacy reinsurance exposure to US long term care obligations (GECC strikes again- a sting in the tail, if ever there were one!), the once unthinkable is being contemplated- the break-up of GE into 3 or more businesses.

However, anyone who feels a touch of schadenfreude at such a potential outcome, would be remarkably foolish. Adapting to change and carefully managing risks are essential for long term survival in any entity; and GE has survived at scale and through successful adaptation for far longer than most (although it is not remotely the world’s longest surviving business). However, its more recent history shows that, when there is a loss of focus and discipline, bad things can happen; with seemingly invincible enterprises forced to face the possibility of painful restructuring, fragmentation, or even demise. Their executives no longer have the unquestioned “magic touch”.

Awbury Group is only in the second half of its first decade as a business, and we certainly have no illusions of grandeur. Rather, in order to create a sustainable business model, we are relentlessly focused on honing what differentiates us from commoditized (re)insurance businesses, recognizing that adaptable specialization is one way of maintaining an edge, yet remaining paranoid about avoiding complacency and shifts in our operating environment.

The Awbury Team

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Retaining mastery is not easy…

It seems so long (1987!) since Tom Wolfe mordantly mocked the then “Masters of the Universe” in his novel “The Bonfire of the Vanities” (which in turn derived from an event that Savonarola instigated in 1497 in late Quattrocento Florence, in which objects considered sinful were burned. Ironically, he ended up burnt at the stake). Of course, Masters of the universe come and go; and the term these days would probably be considered to refer to those controlling huge pools of hedge fund or alternative capital.

Whatever their origins, these individuals seek to exploit economic, market and other discrepancies to compound wealth over time. Some opportunities last for years, if not decades, while others disappear almost as soon as they arise.

However, any Master of the Universe would have to be foolish to believe that change will not come; even as the economics on which they rely is still struggling with the fact that its models very often do not accord with reality. Even the acolytes of the dismal science cannot agree upon what exactly it is a “science” of, and which are the most appropriate models to create and use.

At least part of the problem would seem to be that, rather strangely, money itself (and, by extension, much of finance) is often largely ignored- almost as if the “Masters” hardly existed- while economic models also tend to be linear.

It is certainly arguable that in the real world the economy is quantum and indeterminate in nature (until measured), with many discontinuities.

Interestingly, some 90 years ago, Keynes himself (JMK Vol 10, p262) wrote: “…the whole is not equal to the sum of the parts, comparisons of quantity fail us, small changes produce large effects, the assumptions of a uniform and homogeneous continuum are not satisfied.” It would seem that he recognized that economies are inherently subject to discontinuities and dislocation. Bear in mind that this was stated before the onset of the Great Depression.

The situation is compounded by the fact that economic theories generated by those seen as being authoritative can become quite pervasive, particularly if they seem to benefit a powerful constituency- Neoliberalism and Monetarism being prime examples in. This can lead to them persisting, little questioned, until the onset of the next discontinuity or heterodoxy (which brings to mind The Byrds’ iconic anthem “Turn, Turn, Turn” from 1965) leads to them being overturned. As Max Planck famously said: “A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it.”

To continue to prosper, the Masters must constantly refine their business and economic models, as their environment changes. Complacency is the “kiss of death”.

At Awbury, we would in no sense regards ourselves as Masters of the Universe. Instead, we sustain and build our franchise by understanding that, while our product lines are designed to retain their value for the long term, there will always be discontinuities; and that we need to maintain our vigilance at all times in order to avoid disappearing into the proverbial black hole.

The Awbury Team

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