A Quantum of Solace…?

It appears that a number of the largest US commercial and investment banks (such as Citi, JP Morgan and Goldman Sachs) as well as European banks (such as Barclays and BBVA)  are ramping up their research into the potential applications of so-called quantum computing (a derivative of Quantum Theory’s articulation of superposition and quantum entanglement, amongst other exotica)- a technology which, if it can be tamed and harnessed, promises to revolutionize many areas of business and finance which depend upon the swift analysis and computation of huge datasets.

Because of its architecture, quantum computing may make the power of modern “supercomputers” seem to be from the days of ENIAC (in the 1940s), opening up the possibility of designing and applying algorithms and models currently beyond the dreams of all but the best-funded entities.

Not surprisingly, banks are exploring “use cases” for quantum computing, the most obvious of which is in risk management, where the speed and power of the technology will significantly enhance their ability to analyze probabilistic outcomes, not only more quickly, but also more broadly, giving a boost to the long-standing Monte Carlo simulation and C-VaR methodologies. Other areas include speeding up the Machine Learning systems that underlie Artificial Intelligence (AI). Of course, banks are hardly alone in investigating what quantum computing might do. We would be shocked if the largest hedge funds and alternative asset managers were not also undertaking or commissioning their own research. When market advantage can be measured in microseconds or less, anything that can speed up analysis and execution, or examine and process a wider range of data is enticing.

That said, no financial institution has yet publicly stated (perhaps for reasons of maintaining an understandable discretion) that it is beyond the initial research phase, (although IBM claims to be testing quantum algorithms for pricing of European options and portfolio optimization) and there is continuing debate over the extent to which and when a stable and reliable quantum computer will be constructed.

Turning to the (re)insurance industry, there are a number of similar “use cases” that can be identified, such as in the area of modelling complex, unstable systems such as weather and climate, or in enhancing actuarial models to enable more accurate pricing and risk selection. Sompo International has already stated that it is examining the potential application of quantum computing in a world driven by 5G communications technology.

However, as well as the benefits, (re)insurers should be aware (as banks are) of the threats posed by quantum computing in the area of data security and transfer. Data are currently primarily secured by so-called “prime number encryption”, which remains effective because of the time-prohibitive nature of computing all possible combinations. With quantum or qubit systems, their ability to assess factor combinations very quickly would render prime number encryption obsolete. Not only that, but the properties of quantum entanglement apparently open up the possibility of intercepting quantum information in transit without detection- which would be the worst nightmare of any institution tasked with maintaining confidentiality.

As yet no-one really knows, or is admitting to when appropriately-scaled and reliable qubit computing will make its debut (and one can be sure that state actors will want to keep their capabilities hidden). Nevertheless, at Awbury, we believe in being aware of technological developments, so that we can constantly assess and update our own risk analyses. We may not seek quantum supremacy, but we do aim for quantum understanding.

The Awbury Team

Blessed are the Economists, for They shall inherit (what is left of) the Earth…

It is a truth now universally acknowledged that an economist trying to understand a problem, must be in search of a model. Unfortunately, many of them no longer seem to work.

This is a point that Robert Skidelsky (a British economic historian, generally considered the definitive biographer of Keynes) makes in his recent, essentially polemical book “Money and Government: The Past and Future of Economics”.

It is almost an axiom that the upper policy levels of most governments are riddled with economists, as are central banks. They may not obviously be in charge, but they are very influential.

Unfortunately, as Skidelsky points out, many of them are captives of intellectual orthodoxies which, while no longer able to explain the world as it is, nevertheless permeate their thinking. The classic example is inflation. Above a certain level, inflation is considered (quite reasonably) a “very bad thing”- something to be managed and tamed- as the late Paul Volcker famously did in the early 1980s as Chairman of the Federal Reserve. Therefore, in the wake of the Great Financial Crisis (GFC), there was (and still is) great concern that the printing of money by central banks, their monetization of government debt (cf. Japan), and repetitive “quantitative easing” (done in one form or another by most major central banks) would cause a rapid and potentially uncontrollable rise in inflation. That has demonstrably not happened.

Similarly, NAIRU (the Non-Accelerating Inflation Rate of Unemployment) and the so-called Phillips Curve (plotting the relationship between inflation and unemployment) remain tenets of economic orthodoxy, even when, as in the US and the UK, levels of unemployment are at very low levels without visible signs of changes in levels or expectations of inflation.

Now we are not, of course, advocating that the involvement of economists in policy-setting and -management should be avoided (having a weak spot for the Bank of England’s Andy Haldane); but rather that, as in most areas of political economy, a diversity of views and rigorous empiricism should be encouraged. Repeatedly stating that something should work, when it manifestly does not, is both fatuous and harmful.

The problem is that, if the orthodox economists (and their educational approach) remains dominant, nothing changes; and hand-wringing or bluster are hardly effective in terms of economic management. Certainly, there remain “orthodoxies” that do hold true, such as the fact that high or arbitrary levels of tariffs are not only harmful in a macro sense, but also a hidden tax, with little, if any, offset in terms of domestic job creation. Nevertheless, change is sorely needed.

In reality (and hardly alone in this respect), many economists and the policy makers they advise are focused on yesterday’s “battles”; blithely ignoring or downplaying the issues that matter in the real world, such as how to identify why levels of productivity change; how to deal with a potential decline in the sustainable demand for labour; the impact of demographics on demand; or the changing landscapes of the financial industry.

At Awbury, we are strong believers in the potency of studying and trying to understand the world as it is and may become, not as we might wish it to be. Some models are always necessary; but becoming in thrall to any particular approach is something we aim to avoid. What always matters is exploring, testing and incrementally enhancing what demonstrably works!

The Awbury Team

“People tend to overestimate what can be done in one year and to underestimate what can be done in five or ten years”

The above is a quotation (from 1965) by Joseph Licklider (usually referred to as “Lick”), an American psychologist and computer scientist, who was considered by most of his peers and famous successors, to be the visionary architect of much of what we now take for granted as part of modern technology and systems.

Skeptics should consider this (from 1960): “Computers are destined to become interactive intellectual amplifiers for everyone in the world, universally networked worldwide” from a paper entitle “Man-Computer Symbiosis”. Lick was not writing science-fiction (although to most of his then readers it much have seemed so), but deploying his intellect and knowledge to formulate a new concept, which to him must have been obvious. Bear in mind that the integrated circuit which still forms the core of almost all computers (except those of the nascent quantum design) was only invented in 1958 by Jack Kilby of Texas Instruments.

While the world’s population may now amount to 7.8BN people, and intellectual capacity is theoretically normally distributed across it, the impact of exceptional talent is non-proportional. The late Steve Jobs was notorious for applying this approach, making real Robert Taylor’s dictum (who ran the legendary Xerox PARC computer science laboratory): “Never hire “good” people, because ten good people together can’t do what a single great one can”. Taylor was quite ruthless: “…if you can get rid of people who are not so good, the spirit of the place is improved.”

In essence, Taylor was trying to create an environment in which closely connected and properly incentivized individuals, would co-operate in research that would literally change the world. Normal it was not; nor short-term.

To quote at some length another computer scientist (and Turing Award winner), Alan Kay: “Because of the normal distribution of talents and drive in the world, a depressingly large percentage of organizational processes have been designed to deal with people of moderate ability, motivation and trust… [A]dministrators seem to prefer to be completely in control of mediocre processes to being “out of control” with superproductive processes. They are trying to “avoid failure” rather than trying to “capture the heavens””. One can see this in the real world in the guise of the truism that no-one is fired for being as equally wrong as everyone else.

Clearly, such statements are easy to label as “elitist” and disparaging. However, whether one looks at social structures, bureaucracies or commercial enterprises, most of the value is created or produced at the far right tail of the distribution. It is mathematically impossible for the majority to be above average, and this applies as much to (re)insurance as to anything else, as we have written about previously.

Circling back to the title quotation, creating sustainable value stems from a combination of vision, application and persistence. Its immediate impact may not be obvious, and often there are failures or necessary adjustments along the way. Nevertheless, the goal remains always in sight, and significant change is possible within the medium term.

At Awbury, whatever the circumstances, our aim is always to try to create demonstrable value over time for all our clients and partners by avoiding “normal” frameworks and standard approaches. Paradoxically, to us that just seems normal!

The Awbury Team

Another Year, Another Decade…

The past decade has seen Awbury grow from what one might term a “glint in the eye” of its founders into an established specialized insurer, focused on helping its expanding client base find solution to their complex credit, economic and financial risks.

Building a business from scratch is both an exhilarating and humbling experience: exhilarating because one has to address multiple issues “in real time”; humbling because, no matter how experienced one is (and the Awbury team has a market memory covering more than four decades), there is still an unrelenting torrent of data and information to absorb as markets, economies and products change over time.

What then are some lessons learned that are worth distilling? Here are ten:

Firstly, to paraphrase von Moltke The Elder, “No business plan survives contact with the market”. In other words, no matter how well-researched, debated and thought through one’s initial business plan is, its execution will inevitably encounter circumstances that require adjustment. That being said, Awbury has never wavered from its stated purpose, nor been tempted to “pivot” into other product lines. Doing so would be a distraction and dilute our resources for no good reason. However, the ability to adapt remains critical

Secondly, size is not everything, Being the biggest is not a sensible goal for a business built upon the ability to create intellectual capital. Much better to pursue targeted, patient, careful growth

Thirdly, a consistent, definable and effective culture matters. This is much easier with a smaller team, in which everyone knows and interacts regularly with everyone else

Fourthly, the ability to identify replicable and scalable business products is important in terms of creating sustainable income streams

Fifthly, being unsentimental and intellectually ruthless are essential in selecting transactions with the best probability of both execution and a compelling risk/reward ratio

Sixthly, the perfect is the enemy of the good (to slightly adapt Voltaire). What matters is effective execution; not designing some aesthetically perfect artefact

Seventhly, relationships matter. Our business is based upon creating and maintaining long term relationships based upon trust, respect and mutual benefit. Win-Win is always the best outcome

Eighthly, ensuring the proper alignment of interests and incentives underpins effective risk management

Ninthly, selection of the right professional partners means that one can focus on the factors that create and sustain value and success

And finally, never believe your own propaganda! Self-confidence and intellectual humility are not incompatible.

Through the past decade we believe we have built a franchise which is structured to remain effective, relevant and valuable to our client base, as well as a source of high-quality premium flows to our partners who help provide our capacity.

We could not have done this without them; nor without our roster of trusted advisors. To all of them, and to our clients, we offer our gratitude.

We look forward to the new decade- both its challenges and its opportunities.

The Awbury Team

13 Ways of Looking at (Re)Insurance…

The title is a tongue-in-cheek homage to Jane Smiley’s excellent book analyzing the origins, history, structure and impact of the novel, “Thirteen Ways of Looking at the Novel”- a literary form which is now so embedded in our culture that very few give much thought to anything other the content of the particular book they are reading.

In a similar way, the business of re(insurance), because it is simply “there” and generally works very well in meeting its primary goal of honouring valid claims, tends to be seen as rather mundane.

So, we thought we would enliven matters a little by using Smiley’s clock analogy (see p 179 of her book) to view (re)insurance through different lenses by employing some of her categories, and adding some of our own:

• History: Insurance as a construct, even if it was not called that, has a history going back thousands of years, to the Babylonian era pre 2000BC; while the first recorded stand-alone insurance contract was written in Genoa in 1347
• Tale: Think of the classic film noir “Double Indemnity”, based upon James Cain’s 1943 novel of the same name. It was all about the insurance
• Joke/Humour: We’re not sure that (re)insurance has a humorous side. It is a very serious business. However… How many actuaries does it take to change a lightbulb? Well, how many did it take last year?
• Gossip: In its original form, Lloyd’s Coffee House would have been rife with gossip. One might almost say that the London Market was founded upon it; but, of course, rapidly evolved to insist upon “utmost good faith” and ”my word is my bond”
• Diary/Letter: The bane of any compliance department is the manuscripted policy, whose creator has failed to enter its full terms into the system
• Confession: Do depositions count?
• Travel: Just think of the opportunity to be an underwriter in Bermuda
• Polemic: We all know that those 1/1 renewals can become a little fraught
• Essay: For those studying for a degree in insurance and risk management, a form of mental cruelty, but “character-building”
• Epic: Just think of Jarndyce vs. Jarndyce in Charles Dicken’s novel “Bleak House”. Someone should have bought a litigation cover
• Dynamic: The industry  prospers on being able to respond to fresh challenges and adapting to provide new products and seek new forms of capital. Those systems which do not adapt, cease to have a purpose
• Balanced: That Combined Ratio could go either side of 100%. Almost a random walk
• Composition: The industry is going the way of so many others- scale versus specialization. The formerly great middle continues to be hollowed out.

We trust that our readers will forgive us for being a little “unserious”!

And may we take this opportunity to wish all our partners, advisers, and clients good fortune in 2020.

The Awbury Team