Uncritical belief can be dangerous…

The recent announcement of the actions of the SEC against various executives of Theranos (as well as the company) for alleged fraudulent behaviour towards investors had the Awbury team reminiscing about the various examples of corporate malfeasance that we have seen over the decades, and whether there are any common themes.

Of course, hindsight is a wonderful mental faculty; but, over the years, the Team’s members have learnt that, while some events come out of nowhere (Barings’ collapse in 1995 being a good example), others offer markers or warnings signs.

So, here are a few of our ”favourites”.

The smartest guys in the room were supposed to be from Enron, as they went about creating new business models and developing new financing structures. Unfortunately, it turned out that what was reported publicly was far from representing the true state of the company’s finances. Having essentially lost the trust of regulators and capital markets, the company was forced to file for bankruptcy in December 2001, and was subsequently broken up, while its auditor, Arthur Andersen, also did not survive the debacle.

A year later, Worldcom, a major US communications provider, imploded when its internal audit department uncovered massive fraud based on accounting manipulation of expenses (leading to underreporting) and inflation of revenues. Its CEO, Bernie Ebbers ended up in jail, and we have this scandal to thank for the Sarbanes-Oxley Act (SarbOx), beloved by all corporate executives.

For a little more exoticism, in 2003, it turned out that EUR 4BN of funds supposedly held in an account with Bank of America on behalf of an Italian dairy company, Parmalat, did not exist, which then led to the discovery that, at EUR 14.3BN, Parmalat’s debts were some 8 times what it had disclosed. A long investigation determined that there had been an elaborate scheme created by Parmalat’s senior executives to deceive investors about the true state of Parmalat’s finances. The irony here is that Parmalat was a decent business, which managed to survive and was eventually re-listed as a public company.

And naturally, we cannot resist mentioning that, also in 2003, Freddie Mac, one of the 2 entities that underpin the US residential mortgage market, was found by the SEC to have mis-stated earnings to the extent of USD 5BN, leading to the firing of much of its then senior management.

Perhaps the “poster child” for recent corporate fraud is the Madoff case- a scheme that would have made Ponzi proud- in which a long-respected and influential money manager managed to conceal that his investment management business had simply been paying investors returns out of their own capital or money from new investors. Disturbingly, he was only caught because he admitted what he had been doing to his sons, who turned him in to the SEC. With hindsight, the reason for his ability to generate smooth returns year-in-year out became blindingly obvious- they were fictitious.

In the case of Theranos, questions had been raised by investigative journalists about the true efficacy of its blood analysis systems, and the company also fell afoul of the FDA, so perhaps the writing was on the wall before the most recent disclosures, but it is telling that the company had still managed to retain the support of a roster of influential directors and advisers, yet had few medical professionals on its Board.

While each situation is different, there are some factors which seem to recur over time: one or more “charismatic” leaders; a lack of normal checks and balances; over-concentrated control; the use of or attempt to influence political actors and regulators; suspension of disbelief by those who should know better; over-complexity or a “story” that is a little too pat; greed and the misalignment of interests. Paradoxically, discovery often appears to be a relief for those involved, as the burden of pretense no longer has to be sustained.

The type of events described above are the stuff of nightmares for risks managers and underwriters, because they contravene the fundamental tenet upon which business is founded, which is trust. At Awbury, we are sufficiently skeptical and experienced to understand that, while one can never achieve certainty (and pretending such things is hubristic folly), one can try to minimize the risk of being caught by such events by focusing on alignment of interests, the validity and verification of track records, and the fact that if something looks too good to be true it probably is.

However, that still does not mean that we sleep soundly at night!

The Awbury Team


Good News is Bad News? Or is it the other way round?

With the “results season” for the (re)insurance industry now essentially finished, it is worth trying to discern whether there are any potential changes in direction or new trends in the long downward march in pricing on many commoditized product lines.

The good news is that the level of losses experienced in 2017 were easily absorbed and paid. The bad news is that not much has yet truly changed.

Clearly, after the third-highest Insured Loss year on record (at, say, USD 136BN) during 2017, there had been the hope that this would lead to a significant trend reversal in pricing, particularly in loss-affected lines. So far, the news is decidedly mixed, with only modest increases year-on-year during January renewals for unaffected lines, and few increases beyond the “teens” even in significantly loss-affected lines according to market intelligence and public statements from major participants trying to put a brave face on their environment. Of course, as most of the largest losses were in the US, its key July renewal timeframe could reveal a more robust trend. As Marsh stated in its overview of Q4/17 pricing, its global composite commercial insurance index may have increased in Q4/17 for the first time in almost 5 years, but that gain was only 0.8%.

So, the question has to be asked: why so little apparent change, at least so far?

One reason is surely that there is still an abundance of capital available in the reinsurance (let alone the insurance) industry, estimated at some USD 516BN at year end by Aon Benfield, with an ever increasing amount from “alternative” sources such as ILWs, CAT bonds and collateralized vehicles; and the events of 2017 do not appear to have diminished the appetite for such investment to any material extent.

Secondly, and paradoxically, the losses were not severe enough. Berkshire Hathaway’s Warren Buffett caught attention by stating that the group’s insurance businesses could withstand a USD 400MM “mega-CAT” hitting the overall market. Other market participants might be a little less sanguine about that; and wonder whether Nietzsche’s dictum that “what does not kill me makes me stronger” was something they might not wish to see tested. Of course, they might also wish to consider: “To live is to suffer, to survive is to find some meaning in the suffering”. It remains unclear whether there is a level of losses that would demonstrably cause a step-change in pricing.

A third factor, which is still whispered softly, is that perhaps demand for commodity NatCAT and other lines is not quite as robust as one might be led to believe; which then raises the spectre of too much competition for premium meeting too much capital – which usually ends badly.

Ironically, one factor that might at least begin to stem the inflow of alternative capital would be a significant rise in short to medium term interest rates, reducing the relative attraction of returns from CAT bonds, unless their own yields also rose significantly.

All of this should lead to the realization by any self-respecting reinsurer that it should be looking at premium flows which are not subject to the vagaries of NatCAT; are sustainable and predictable; and yet also provide a demonstrably superior risk/reward outcome.

At Awbury, this is our raison d’être, with our unflinching focus on credit, financial and economic risks across multiple sectors; which acts as the means of providing those sought after, longer term premium flows in areas which have minimal correlation with commoditized product lines, and continue to retain pricing power.

The Awbury Team


Artificial Intelligence- the need for Counter-AI

The term Artificial Intelligence (AI) has become something of a cultural trope in the past few years, with arguments over its potential, its dangers and the probability and likely timing of “the Singularity” (when AI overtakes human intelligence and becomes General AI) becoming more heated.

And now a report co-published by, amongst others, The Electronic Frontier Foundation (EFF- entitled “The Malicious Use of Artificial Intelligence”) sets out in some detail the ways in which those with malign intent could use and develop AI with the potential to cause great harm.

Of course, it is easy to express concern. However, the report makes cogent arguments that the risks of harm are increasing, because many AI capabilities, even now, are “dual-use”; meaning that not only can they be used for military as well as civilian purposes, but also that they have both offensive and defensive capabilities. Compounding the problem, some of the inherent characteristics of AI are that it is efficient, rapidly scalable and easy to diffuse- in that sense resembling existing software. However, various AI systems already possess capabilities beyond those of even the most capable human practitioner, let alone the average, whether in terms of speed, accuracy, or skill. So far, these systems have been constructed to be benign (or, at least, those disclosed are), but it is not hard to envisage AI systems being developed which are deliberately “weaponized” to affect digital, physical or political security.

Such issues should be of considerable concern to the (re)insurance industry, where cyber-risk is something of an obsession as a source of premium and AI could lead to more efficient processes, but where the risks posed by AI appear to have been given insufficient weight as a distinct threat vector which could affect multiple lines of business.

After all, it will be cold comfort if a “viral” video which purports to have been issued by an influential public figure and leads to, say, civil strife, property damage, or even terrorism, turns out to be a very skillful fake produced by an AI algorithm, whose sponsorship and attribution are unclear. Such occurrences are becoming ever more probable, as the impact of systems which use machine learning to create facsimiles almost impossible to distinguish from the “real thing” becomes ever more visible. It is the Turing Test gone rogue!

Additional areas in which malign AI is likely to proliferate include precision “spear-phishing”, in which individuals are targeted for sensitive information; impersonation through voice (and eventually appearance); or the creation of so-called “adversarial examples” in which those using AI (such as autonomous vehicles) are fed disruptive misinformation intended to cause damage or mayhem (e.g., car crashes.) In fact, the possibilities are probably only limited by the capabilities of the AI systems deployed.

In the face of such risks, we believe that, in the same way that counter-intelligence is a recognized discipline if the area of defence, the business world (including (re)insurance) needs to create an approach that we would term “Counter-AI”, which consists of rather more than the fashionable White Hats and Red Teams. It will require tools that can detect the onset of an AI-directed attacks in real-time, assess the nature and scale of the threat, and develop and deploy counter-measures, also in real time.

And, in the same way that (re)insurers currently audit and advise clients upon physical and cyber-security, they are going to have to extend that capability (out of self-interest, if nothing else) to try to control future loss experience, because one can envisage scenarios in which the use of malign AI could trigger a cascading series of events that could literally overwhelm the capacity of a (re)insurer to meet its obligations.

Naturally, at Awbury, given our focus on credit, financial and economic risks, we are constantly looking for evidence that the parameters of what were once “stable” assumptions are shifting, to make sure that the risks that we cover retain an appropriate risk/reward ratio.

The Awbury Team