Onwards and upwards…?

It is now accepted as a truism that the global P&C (re)insurance industry is in a hardening market, with premium rates rising significantly across a wide range of product lines. As a result of this, there is a “Class of 2020” range of new ventures being created, as well as capital being raised by existing businesses to take advantage.

Of course, the industry as a whole badly needs rate increases to offset what appears to be a rising trend in CAT losses, the financial impact of the pandemic on segments of its client base, and the damage caused to investment income by ultra-low interest rates.

If one looks at reported changes in available/achieved premiums, the Marsh Global Insurance Index rose 20% year on year to the end of September, the largest increase since its inception in 2012. Clearly, this is a good thing in itself from the industry’s viewpoint. However, what really matters is whether the underlying momentum can be sustained, given the habitual pattern of capital the flooding in, pricing competition increasing, and the rate of increase then declining and even reversing. (Re)insurers will need to maintain their underwriting and pricing discipline in the face of rising loss trends, the consequences of so-called “social inflation” increasing costs, and uncertainty over the impact of climate change. The potential gaps in coverage highlighted by the pandemic may mean that Insureds will seek more comprehensive coverages and so generate more premiums, but it remains to be seen whether this trend continues.

However, the days of “jam tomorrow” do seem to be over for now.

Nevertheless, the Third Quarter of 2020 was a difficult one for CAT writers, and the Fourth Quarter did not start well (and is not yet over). So, the question remains as to whether increased revenues will exceed rising costs, and across how many business lines.

And, as always, the headlines mask a wide divergence. Lines such as personal auto have actually benefitted on a net basis in terms of loss experience, so rates are flat to net down. Contrast this with what Marsh terms “FinPro”, in which rates are said to be up 40% year on year- a remarkable change, and almost certainly linked to the perception that claims will rise significantly as a result of the pandemic, because materially-affected corporates will eventually exhaust the patience of their lenders and investors and run out of liquidity. Not surprisingly, there is something of a frenzy amongst those trying to obtain, say, adequate D&O cover at renewal in a world which has changed out of all recognition in 8 months. No director wants to find himself or herself exposed to risk of ruin if cover is not obtained, as there is, to state the obvious, a positive (or negative correlation depending upon one’s point of view!) between availability and pricing, and the likelihood of a claim. Perhaps pricing has finally become truly risk-based?

At Awbury, with our demonstrable track record in the careful selection of business in the credit, economic and financial risks areas, such an environment offers some very interesting opportunities, without in any way lowering our standards, or changing our underwriting approach. Yet, it remains essential to ensure that one can properly analyze and understand a risk, and so avoid situations with binary outcomes, where a supposedly “attractive” premium level tempts the unwary, or where pricing has yet to catch up with reality.

The Awbury Team

Exit, Voice and Loyalty…

The title for this post is that of a book published some 50 years ago by economist/social scientist Albert (born Otto Albert) Hirschman, in which he explained the alternatives available to individuals who believe they have been let down, overlooked or otherwise mistreated:

– You can leave (“Exit”)
– You can speak up and try to effect a change (“Voice”); or
– You can decide do stay and put up with what is happening (“Loyalty”).

Of course, option two, has a more extreme version- Rebellion.

Now you may say; “But this is simply a statement of the blindingly obvious!”

It is.

However, the stated alternatives are also central components of organizational theory, and of corporate and institutional governance. They tend not to be given much conscious thought, precisely because they seem so obvious. Yet, a deeper understanding of how organizations (from governments, to businesses, to religions) either manage or ignore the three alternatives, and the consequences of doing so, is warranted.

In basic economic theory, Exit is seen as the most effective way of enforcing discipline- consumers do not buy, employees leave, shareholders sell, emigrants leave. It is unequivocal and direct. Hirschman acknowledged this, but argued that allowing individuals to exercise Voice was what underpinned the viability of an organization, and, in fact, concepts such as civil society. Voice creates reciprocity and also Loyalty. He posited that enabling and acting upon Voice was what give a deteriorating entity the chance of what he termed “recuperation”. Without it, Exit or Rebellion would likely ensue, with unfortunate consequences for all concerned. In effect, he was arguing for the effectiveness of an evolutionary approach, over revolution; although he understood that sometimes Voice would fail because of circumstances- such as increasing autocracy, or the presence of an “imperial” CEO. It is interesting to observe that the (re)insurance industry has not been immune to this tendency.

The interesting thing about Loyalty (which is generally seen as a “good thing”) is that, in reality, it can have a very dark side. If one thinks of a corporation, it is merely a collection of individuals who, at a particular point in time, are applying their skills, talents and time towards a particular goal. Properly managed, corporations are very effective at wealth generation, as well as providing their employees with a livelihood and purpose. It is when that loyalty is taken for granted, or manipulated or abused, that things start to unravel. Because human beings are social animals, and generally reluctant to be seen as dissenting from the “collective view”, they can be manipulated into acts which are against not only their self-interest, but that of the corporation and society as a whole. Examples are too numerous to count. The wise and perceptive leave; the gullible and weak stay. As a result, what can appear to be a modest problem, can suddenly become an existential one. Exit becomes disintegration; Voice becomes disruption or Rebellion. No-one benefits.

So, from the point of view of corporate governance, there is real value in being able to balance the weight given to each of the three elements appropriately to maximize an organization’s effectiveness. Failure to do so amounts to willful blindness. Unfortunately, one often wonders whether corporate governance “experts” or Boards truly think deeply, or are even aware of what we have described. We hope they are- in a systematic, rather than casual way.

The Awbury Team

It ain’t necessarily so…

As underwriters, it is all too easy for our thought processes to become rather “hard-wired” or linear; because, through passage of time and accumulation of experience and knowledge, we begin to assume that we “know the answers”, or that our predictive abilities are more accurate than they actually are.

While, quite clearly, there are parameters and boundaries around many outcomes, or, given a sufficiently large portfolio, one can take a stochastic approach (again within a likely range), there is always the risk of a surprise or significant outlier.

As human beings, we operate as prediction engines in literally everything we do. Our brains can only function through the veil of our sensory perceptions. Nothing is direct, or un-mediated. Naturally, this creates issues that extend into all areas of our lives, including that of trying to make predictions and decisions as an underwriter- and there is no escaping that. After all, each of us “sees” a different reality, because our minds are physically isolated- we are not the Borg!

Of course, as human beings, we have developed very sophisticated verbal and symbolic communication systems, although our ability still to misunderstand each other or miscommunicate is remarkable! After all, where would lawyers be if the meaning of a specific wording was always absolutely clear and unarguable?

So, underwriters (like everyone else) are always dealing with problems of ambiguity and uncertainty- and even when they are “100% sure” they are often wrong.

Neuroscience is beginning to provide some tentative explanations of what is going within our “wetware” (or brains). For a start, as mentioned above, we are prediction engines. It is how we function. In that sense, the brain is Bayesian, always updating what it believes it knows with further observations or inputs. In that sense, when an underwriter assigns a probability to an outcome, he or she is simply performing explicitly what the brain does implicitly.

However, there is a potential and interesting “wrinkle” to this: that, in processing and updating its “knowledge”, the brain may often “privilege” what it already knows versus the additional information it subsequently receives- in other words, assigning a greater weight to its existing knowledge. Quite clearly, this could cause conflict, or cognitive dissonance. It is easier to follow the well-worn paths than to try to create new ones.

The consequences of this would be that our prior expectations sculpt how data are processed and weighted in forming conclusions or taking action. In essence, because our brains have a view on how they expect things to turn out, they can have an unrecognized bias in terms of predicting future outcomes.

One can see the risks of this, as amply demonstrated by the continuing consequences of the pandemic.

At Awbury, one of our institutional defence mechanisms against bias or complacency is always to ask ourselves: “But what if we are wrong? How extreme an outcome is feasible?”

We find that it definitely helps to be intellectually humble, rather than assuming that what we expect is what will happen.

The Awbury Team