Risk is what you don’t see…

The always thoughtful Morgan Housel (of the Collaborative Fund) recently wrote an article with the above title. Adding “or won’t” is equally instructive.

The point is, as most fundamental ones are, so simple and elegant; yet much of the (re)insurance industry (amongst all the rest) spends much of its time obsessing over the things it hopes it can measure and believes it can foresee. Obviously, in many product lines that is the rational and sensible approach, as many risks are, in the real world, bounded and constrained.

However, it is “in the misunderstood tail” that true risk lies. This being the first few months of a new decade (and we are not going to argue that point!), the media and what passes as thoughtful discourse (you know who you are, WEF Davos…) are full of “predictions”, risk surveys, incomprehensible network diagrammes and the like. This is presumably in the hope that the “naming of the risk”, or being part of a “knowledgeable consensus” will somehow make the risk less terrifying (as in “a trouble shared…”), because if it can be named or agreed upon we at least know what we are dealing with (or think we do).

So, as Housel points out: ”The same risks, repeated over and over, [occur in narrative] sometimes several years in a row”- elections, trade wars, climate change, nuclear war. Of course, there are existential risks. We have identified collectively a whole range of them. If they occur, it may well be “game over” for Humanity and “civilization”. Harsh as it may seem, and in no way diminishing the need to take them seriously, it is the ones that are unforeseen or not taken sufficiently seriously that tend to cause the most harm. They are “surprises”, by definition- even if, with hindsight, perhaps they should not have been (e.g., the Japanese attack on Pearl Harbor).

As we saw with the Great Financial Crisis (GFC), when a central tenet of belief (that US housing prices could not in aggregate decline significantly) proved to be unfounded, people were shocked and surprised. They panicked, with consequences that we still have to grapple with even now. With few exceptions (read Michael Lewis’s excellent book The Big Short), people could not contemplate that what happened not only could, but would.

Secondly, once surprised, and compounding the issue, people tend to extrapolate outcomes beyond the logical or probable, becoming (unduly) paranoid and pessimistic about the future, which often creates a worse outcome than if they had behaved rationally. It is useful to remind one’s self of that probability ex ante! Unfortunately, it is also hard to imagine any of today’s political “leaders” being seen as credible when uttering something analogous to Roosevelt’s: “The only thing we have to fear is fear itself”.

One could argue that such risks are “black swans” or “unknown unknowns”, but most are not. Naturally, one cannot plan for what one cannot imagine happening, but convincing one’s self that one has foreseen all the possible risks amounts to hubris.

From Awbury’s point of view, we are institutionally paranoid about risk. We know that we are not infallible or omniscient, and that the whole point of being in the (re)insurance business is to accept risk. However, we also aim to design our products and solutions in ways that not only meet our clients’ needs, but also contain mitigants and margins of error that minimize the likelihood of being surprised in a way or to an extent that causes ruin.

The Awbury Team

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