So, what are we missing or ignoring…?

It is all too easy in this time of obsessive focus on the epidemiological and economic consequences of the Covid-19 pandemic to think that not much else is material in term of risks to be concerned about.

While, as result of the ways in which governments, agencies, businesses and individuals decided to act, the consequences of the pandemic, in economic terms are, in many ways, without precedent in terms of the speed,  sudden depth and breadth of their impact, it would be somewhat foolish to assume that all the other risks which existed prior to its appearance have decided to go on furlough.

We are reminded of a quotation by Thomas Schelling, a game theorist and nuclear strategist: “There is a tendency in our planning to confuse the familiar with the improbable. The contingency we have not considered seriously looks strange; what looks strange is thought improbable; what is improbable need not be considered seriously.”

Less than 3 months ago, Covid-19 would have been considered “improbable”; now it is familiar with a vengeance. Similarly, for (re)insurers, the idea of retroactive legislation intended to compel them to pay claims which they had even specifically excluded from the wording of a policy would have seemed ludicrous. Not now. So, are the previously “familiar” risks now “improbable”? Hardly.

Like a magician’s sleight of hand or misdirection of attention in order to perform a trick or illusion, the fact that attention has been diverted enhances the possibility that underwriters, CROs and risk managers will miss the obvious, or be misdirected down probability “rabbit holes”, and thus suffer “unexpected” claims, that are nothing of the sort.

As we have written before, it is the risk that you don’t see which is the one you should really worry about.

Of course it matters what the R0 (R naught) number or the true mortality rate of Covid-19 is, or how protracted the pandemic will be before it is contained, or at least becomes manageable; or what the likely rates of business failure are by industry or in the aggregate. However, the frequency of earthquakes or severity of hurricanes are not correlated with those outcomes; while geopolitical risks may well be exacerbated; and just because there is one coronavirus wreaking havoc and focusing attention does not mean that other endemic diseases have become less virulent- in fact, in a physically weakened or economically poorer population they may flare up even more at a time when government resources are already stretched or overwhelmed.

In such circumstances, a continuing and continuous healthy paranoia is warranted; because ignoring or downplaying other risks can be equally as fatal, if not more so,  than the current pandemic. One does not want a weakened corporate immune system to focus on one target, only to be surprised by others that hide within its shadow.

At Awbury, our focus is, of course, on credit, financial and economic risks; but that does not mean that we are indifferent or oblivious to the second and third order impacts of other contingencies or risks. Our institutionalized paranoia is in full force! We always wonder and think about what we might be missing. The improbable has the habit of becoming all too real.

The Awbury Team

O Liquidity, Liquidity; wherefore art thou Liquidity…?

Those familiar with Shakespeare’s Romeo and Juliet will recall that it did not end well.

As always seems to the case, it takes a crisis to ram home the point, yet again, that ultimately what matters to the survival of a business or market is the availability of timely and (more than) sufficient liquidity.

The speed and extent of the pandemic-induced recession (putting the D-word to one side for now) which most economies are now suffering provides stark evidence of the truism; “Lack of cash kills companies”. Not only that (unless you are a bank with access to a central bank’s discount window, or other undoubted liquidity-providing mechanism), preventive asset and liability management, in which your assets re-price and become available in cash faster than your liabilities fall due, is a fundamental and necessary skill. Several US mortgage REITs, which became functionally insolvent overnight when they could not meet margin calls, yet again proved that adage. As the FT’s Izabella Kaminska has written: “…the real economy has no lender of last resort”.

The unusually long economic expansion post-GFC, the fact of better-capitalized banking systems, and a search for yield by investors amid historically low interest rates and reduced spreads combined to create conditions in which a sudden economic shock, inducing what can only be described as a general and largely indiscriminate initial market panic, upended normal expectations in terms of the ability to adjust and prepare for a downturn.

It would be unfair to criticize CFOs and Treasurers for not foreseeing the reality and speed of the spread of the Covid-19 pandemic, even if there were partial precedents within recent memory. No business ever expects anything approaching an immediate cessation of most or all of its revenues.

Yet having access to sufficient cash and liquidity to meet unexpected shocks is something that could reasonably have been expected. Of course, it is the meaning of “unexpected shock” which has now been indelibly re-framed. Unfortunately, while large corporations do generally have access to significant bank lines, or the ability to negotiate more, many smaller businesses (SMEs) tend not to have that “luxury’ (in fact, necessity) –and they are the ones who employ the majority of individuals in most economies. Hence, the astonishing and unprecedented rising cascade of closures and unemployment across the world.

The behaviour of those who survive what lies ahead will undoubtedly change. One consequence is almost certain to be viewing a significant cash reserve, or paying for committed bank lines not as an opportunity cost or inefficient use of capital, but rather as an essential under-pinning of resilience.

It is also likely that manufacturing businesses will move away from “just-in-time” inventories and stockpile inputs to their processes, while re-examining their supply chains for true origin, diversity and hidden connectivities. All of this will increase the need for working capital and greater overall liquidity. At the same time, banks are likely to re-examine the scale and pricing of such products as Revolving Credit Facilities (RCFs) and “Swinglines”, or the like.

Amidst all this turmoil, it is worth pointing out that the Awbury Team has considerable experience in helping its clients with ways in which to enhance available liquidity and the efficient use of scarce capital.

We would be happy to discuss how we can help.

The Awbury Team

Pandemics in context- Part II- the longer view… Panic, Perspective, Quarantine and Resilience

In our previous post we mentioned the impact of the last acknowledged global pandemic, the so-called Spanish Flu of 1918/19, as being remarkably muted, primarily, it seems, because of the context in which it occurred.

However, if one wishes to understand the extent to which pandemics can, in fact, change the direction of human affairs, one needs to go back much further, understanding not only their relative scale, but also how a particular disease was viewed at the time.

Interestingly, in the same way there is the Richter Scale to measure the force of an earthquake or the Saffir-Simpson one to measure the strength of a hurricane, there is actually one for broader disasters afflicting Humanity. This is the Foster Scale (created by Canadian geographer Harold D. Foster), which like the other 2 scales mentioned, is logarithmic in nature. A sense of what “disaster” means can be seen by the fact that only World War II ranks ahead of the Black Death, which between 1347 and 1352 is estimated to have killed a third of Europe’s then 75MM population (which, ignore the fact of all the deaths it caused elsewhere in the world). To say that this was generally-viewed as a portent of the end of the world, would be an understatement.

While debate continues about the true mortality rate of Covid-19, current estimates usually do not rise above low single digit percentages. The bubonic plague has an estimated mortality rate of up to 60% in populations which have no immunity. One can work out the impact which an equivalent pandemic would have on the Earth’s current 7.7BN inhabitants- and, of course, it would be worst in dense population centres in an urbanizing world. So, in relative terms, Covid-19 has less of an epidemiological impact; but the nature of our inter-connected and information-deluged world exacerbates the economic and behavioural outcomes.

Apart from the fact that the consequences of the Black Death led to the reconfiguration, at least in Western Europe, of feudal societies, and so laid the foundation for the world we know today, it also, even then, produced widely varying outcomes based upon how a particular population responded. Bear in mind this was an era which had no understanding of the plague’s source, vectors and modes of transmission.

The Republic of Florence lost 50% of its population.

La Serenissima, Venice, an international trading hub, up to 60%.

However, rather than succumbing to despair and sliding into irrelevance, the Venetians fought back. They noted that some other Mediterranean cities were showing that restricting access from the outside, and keeping incomers isolated, seemed to be reducing the plague’s effects. They did not know why, but they saw that the approach worked. So, they instituted a policy of rigid isolation- for 40 days. And the Italian for 40 is “quaranta”- hence quarantine. In one of those remarkable coincidences, the average period from infection with, to death from bubonic plague is now known to be 37 days!

The point of all this is not only  that uncertainty tends to makes human beings collectively fearful and panic-stricken (which is contagious in itself), but also that human beings are adaptive, curious, learning creatures, with remarkable resilience. We would not be here if we were not.

So, while the current economic and epidemiological outlook is at best uncertain, it is foolish and counter-productive to despair or “freeze”. Such behaviour only exacerbates negative outcomes. Much better, while recognizing and managing the risks of the situation, to be thoughtful, analytical, and proactive- which is the Awbury approach.

The Awbury Team

[Note: this post owes a debt to the always interesting and counter-intuitive Eric Barker- psychologist and author of “Barking up the Wrong Tree: How to be awesome at Life”]

 

Pandemics in context- the longer view…

There is barely anyone alive who remembers the last true global pandemic, the so-called “Spanish Flu” of 1918/19, which by most estimates killed over 50 million people (at least 3% of the then total world population) in the aftermath of World War One.

Many articles have recently been written about the human cost of that pandemic. However, it had surprisingly few long-term political or economic effects, because it occurred in a world already traumatized by destruction and the imperial convulsions in the aftermath of the war, and more than a little distracted by the continuing unfolding of the Russian Revolution, which (it is sometimes also forgotten) impacted a huge swathe of the Eurasian land mass from Archangelsk and Minsk to Vladivostok.

This time is rather different. While there was a lot of “noise” around various themes and issues, for most of the developed world at least economic conditions were still fairly benign, and so the noise and chatter were just that, with little real impact.

Covid-19 has upended what amounted to wary complacency. Yes, a recession of some sort was anticipated as the business cycle was unusually prolonged (this time was not different, so to speak); but no-one foresaw the economic equivalent of a train hitting the buffers.

As a result, even if the impending sharp economic contraction is relatively short-lived (which seems increasingly unlikely), the judgements made and behavioural effects are likely to linger. As Morgan Housel of The Collaborative Fund recently entitled an article: “Wounds heal, scars last”. The Great Depression had lasting effects on the behaviour of individuals. As a result, corporations and governments generally became more conservative in social and economic terms, deflating money supply and raising tariffs, even if those actions tended to compound the very problems of lack of growth and opportunity which they were trying to avoid. One can argue that it took at least a full generation for behaviour to become more relaxed and optimistic, and for “animal spirits” to return after the further trauma and upheaval of World War Two.

What is quite striking about current circumstances is that in barely 8 weeks “everything has changed”. Fear, disbelief and uncertainty stalk many lands; while government has gone from being the problem to the (hoped for) answer, even if the effectiveness of actions being taken is, as yet, barely  tested. As long as only relatively modest geographies, or “unimportant” populations were impacted by, say, SARS, MERS or Ebola, normality returned quite quickly.  As an aside, AIDs was (and still is in some areas) a pandemic, although it was never treated as such. Lessons may have been learned, but they were remarkably quickly forgotten. The world was manifestly wholly unprepared for what is now unfolding.

So, the question now arises as to whether this time will be different, because individuals and policymakers will finally realize that complex, interdependent systems transmit shocks much more quickly than assumed; and also create emergent behaviours, with non-linear and as yet unpredictable consequences.

In such circumstances, standing still or freezing, like the proverbial “rabbit caught in the headlights” is the worst possible action to take: it changes nothing, can have no positive outcome (wishing something were not so does not make it go away!) and actually destroys value. While acting defensively when necessary, well-considered, bold decisions are called for if the world in general, and the (re)insurance industry in particular, are to emerge from the current crisis without lasting damage to economies and franchises.

At Awbury, we constantly strive to be ready defensively to step up and meet the challenges faced, while going on the offensive when opportunity presents itself.

The Awbury Team