Forward to the Past (again)…

It seems to us that the Iron Chancellor, Prince Otto von Bismarck, would recognize the current world more than one might expect. We have written before about the risk of the so-called “Thucydides Trap” in which the PRC challenges US hegemony, with unfortunate consequences for both sides.

However, the ratcheting-up of tensions recently between the US and PRC also echoes the end of the first era of globalization, which was cut short by World War I in 1914, as has been highlighted in a fascinating paper, “Beijing’s Bismarckian Ghosts:”

While history may not repeat itself, and it is always dangerous to draw the same conclusions about likely outcomes, the description of how a newly-reunified Germany challenged the then global superpower, the UK, and its Empire, is remarkably consistent with the range of methods the PRC has been using for the past several decades. While, in the same way that the “Kremlin’s” opacity in terms of decision-making kept US political analysts guessing for decades, the deliberation in Beijing’s Zhonhanhai produce the same effect. Are the parallels coincidence or deliberate re-use of the Bismarckian “playbook”?

Some points to consider:

• A rising autocracy, with a state-protected economic system, challenges an established democracy with a free-market economic system
• While they threaten and bluster at each other, they have significant interdependence in trading terms, with the rising power using exports as an engine of growth and “turning all her forces to the systematic conquest of external markets” (to quote Henri Hauser, a French economic historian writing during WW I)
• The hegemon is adamant that the rising power has been “cheating” and using illicit means to gain knowledge of new and important technologies
• Each side argues about the appropriate standards to be used in new technologies (the telegraph and radio then; the internet and 5G now)
• The rising power seeks to build influence and economic advantage through the creation of huge infrastructure projects (the Berlin-Baghdad Railway then; the Belt and Road Initiative now)
• Investment in basic research and advanced education becomes an obsession of the rising power
• Each side tries to gain an advantage through influence on, control or manipulation of the global financial system, and the wielding of financial tools as a weapon
• The rising power feels threatened and hemmed in by it geography, and seeks to challenge the hegemon’s control of vital global sea lanes
• The hegemon starts wielding tariffs as a means to curb the rising power’s mercantile expansion

With its authority unchallenged, the Chinese Communist Party is able to play “long game”; and is quite clearly a student of the ways in which great power rivalry is conducted, and the tools and techniques that should be used.

However, what remains to be seen is the extent to which it is willing to push and consolidate any advantages it gains in the various realms of competition, how the hegemon responds- which brings us back to the Thucydides Trap- and whether the CCP is willing to stand its ground when challenged.

As we said above, assuming that the past will inevitably repeat in the future is dangerous. However, being aware of the currents and eddies of history is essential to being able to create the informed scenarios that enable Awbury to continue to build its franchise in the management of complex credit, financial and economic risks. These do not exist in isolation, but are profoundly influenced by the interplay and rivalries of geo-politics, so awareness and understanding are a key to managing risk.

The Awbury Team

Hard and Fast…?

For what seems like forever, (re)insurers have been forecasting the return of the industry’s nirvana of a sustained and sustainable hard market. After the significant CAT events of late 2018, many hoped that such a market would follow. However it turned out to be much like the “Curate’s Egg”, good in parts.

Now, in the wake of the pandemic, there is new hope that there will be a broad-based rise in premia, at least in part to off-set an expected significant rise in claims in certain business lines.

Much public “hand-wringing” has occurred over how the negative consequences of the pandemic could be an “existential threat” if worst-case scenarios occur- such as the legislative or judicial compulsion of the payment of supposedly excluded Business Interruption (BI) claims from businesses shut down by government (and so administrative) fiat.

Off-setting this, there are now said to be clear signs that pricing is hardening significantly across a number of business lines, including D&O, BI, and NatCAT, sometimes doubling; while the increasing amount of fresh capital being raised indicates that at least some executives believe that attractive new opportunities exist.

On the face of it, this is a welcome development for (re)insurers. Yet, paradoxically it comes at a time when many insureds are least able to absorb such increases because of the impact of the pandemic on their underlying business.

This combination is going to require a careful balancing act within the industry. On the one hand, premia are the lifeblood of any (re)insurer; on the other, that is not of much use if the client cannot afford to, or will not pay the level of increases demanded.

In addition, in some lines, such as auto, companies are expected, if not required, to rebate premia received because less driving means fewer accidents. This, objectively, is a good thing in terms of the welfare of society, but it yet again reduces premium flow.

And if, as in the case of BI, insurance buyers perceive that they are not being covered for something which they believed they were, they may simply stop buying insurance lines that are not mandatory, even if that is actually counter-productive.

All these competing factors mean that the outlook over next few months and years for the (re)insurance industry as a whole is still rather murky in terms of whether and, if so, how the recent negative trends in underwriting outcomes will reverse. One can try to increase pricing, but that will not “stick” if insureds cannot or will not pay such prices. Compounding this is the clear damage caused to the NII and asset side of many (re)insurers’ balance sheets by both market volatility and low and falling nominal interest rates.

In this context, Awbury is, as always, able to provide high quality, large scale premium flows, which, by definition, come from motivated insureds, who see the value in what we do. At the same time, we can help our partners manage the volatility of the asset side of their balance sheets.

The next few years are, in our opinion, going to lead to a further “winnowing” of the industry’s ranks, in which risk selection, value-based products and pricing, and the ability to dampen volatility will prove ever more necessary.

The Awbury Team

A societal experiment, or Brave New World…?

The economic consequences; governmental actions (or lack thereof); and behavioural changes wrought by the current pandemic are likely to have many as yet unforeseen outcomes.

One of these may well be the realization that how our societies are currently constructed and function will need to change to make them more resilient against future disruptions, while at the same time recognizing that not all of its members are equally-equipped to adapt, or may not wish to.

First, as a statement of the obvious- human beings are remarkably adaptable; although they tend not to practice that unless forced to. Nevertheless, consider that the (re)insurance industry in most countries “went virtual” within days in the second half of March, with no obvious deterioration in functionality, but clear changes in risk appetite. The industry “adapted”, but its behaviour changed.

However, second, any society is a network, with patterns formed by billions of interpersonal connections, decisions and actions. At the macro scale, its behaviours can sometimes be predicted with a reasonable degree of certainty, in the absence of discontinuities; but, as the pandemic itself demonstrates, or such “surprises” as Brexit, or, a century before, the Russian Revolution, it is the discontinuities one has to focus on. And, at the micro or individual level, modelled demographic averages do not apply, nor necessarily provide any protection against adverse outcomes to individuals.

Therefore, while changes will only occur if behaviours adjust and are adopted at the macro level, the benefit to the many may harm the few.

So, the question arises as to how to balance conflicting impacts.

On the one hand, controlling, suppressing and eliminating the SARS-COV-2 virus demands society-level collective action; on the other, as we have seen, it can destroy the value and meaning of many individuals’ and sub-groups’ lives and livelihood. Bentham and Mill vs. Hayek and Rand.

In essence, the pandemic has created the circumstances, as this post’s title suggests, for a global-scale societal experiment. What do human beings regard as the fundamental, non-negotiable components of their societies, and what are they prepared or willing to discard? What will they resist and what will they accept?

Certainly, so far as the “distributed workforce” is concerned, there will need to be both a retained critical mass for it to become the norm, or at least part of a hybrid model, with the conventions and infrastructure to support it. In many cases, it may work as a temporary “fix”, but it is not a viable solution for space-constrained, child-burdened families without some sharing of incremental costs and recognition of needs. New “learned behaviours” require time to become habits or conventions, so the longer the Great Cessation continues, the more likely new paradigms are to be created and become embedded. Ironically, rather than going “back to the future”, we may be heading “forward to the past”, when workforces were much more fragmented and widely distributed.

Yet even if the workforce does become more distributed, what of the longer term effects on, for example, public transport, or mental health? If people do not travel, and when they do, are more likely to use a personal mode of transport, what then? And human beings are social animals. Working long-term in isolation is likely to have an adverse impact on mental health. It is also not effective for many forms of necessary communication, and for establishing sufficient levels of trust, let alone its potential impact on innovation. Chance encounters and conversations are often a source of new ideas.

As students of history and assessors of the future, the Awbury team continues to monitor the actual and potential impact of the pandemic on our societies, because assuming that the past simply continues into the future unchanged and undifferentiated is the height of folly.

The Awbury Team

Mind the Gap…

To re-state the obvious, we are in the midst of the Great Cessation and Yearning-to-Re-open, in which both the demand and supply sides of the economic equation have been significantly impacted. As a result, debate is re-surfacing about what the nature and extent of the “output gap” will be once the world, or at least most of it, starts clawing its way back to something resembling normality- even if it is to the “new normal”.

In basic terms, the “gap” is the difference in an economy between its actual output (or GDP) and its potential output (or GDP). This gap matters, because it is linked to many other factors, such as employment levels and inflation.

In an ideal world, governments and their central banks want there to be as small a gap as possible between the demand and supply side consistent with a low and stable rate of inflation (and people’s expectations for it) and low unemployment, with most developed economies having what is seen as a sustainable level that allows GDP to grow in real terms over time.

In the case of the pandemic, the starting assumption is that GDP growth will recover relatively quickly to its former trajectory, with “quickly” meaning something like “within a year to 18-months”, rather than the 10 years it took output to catch up with potential in the wake of the GFC. However, this assumes that both available capacity and sustainable demand have not been impaired, which seems less and less likely the longer the Great Cessation continues.

Unfortunately, the longer economies are stalled, the greater the likelihood there will be permanent damage to businesses that supply capacity, which reduces the rate at which an economy can grow, assuming the demand is there, and represents a significant opportunity cost.

Conversely, it seems likely that the nature and scale of demand will also be impacted, especially when no longer propped up by governments’ fiscal stimulus- and that assumes that individuals will spend, rather than save because of the “psychological scarring” they have just suffered.

All this amounts to the introduction of even greater levels of uncertainty into economic forecasting and business planning. Does a manufacturer, say, re-tool and adapt, or wait to see what the “new normal” may be? What if service businesses have to try to function in a way that constrains that service, or suppresses demand?

And what of inflation? Is it kept in check because the output gap remains wide, or given a shock to the upside because of both money supply growth and unexpected tightness caused by greater than expected supply destruction?

In this context, with the only certainty being uncertainty, Awbury continues to be prudent in sourcing, analyzing, structuring and pricing risks based on ensuring a margin of safety and on building and testing a thesis which will survive extreme downside shocks and volatility of the sort which we are all now witnessing. Any risks that do not meet our “prudential test” will continue to be discarded, because one cannot be paid adequately for them.

The Awbury Team