Going with the Herd…?

In less than a year since the full onset of the pandemic (an astonishingly short period of time), scientists have been able to create not just one but multiple vaccines with high efficacy in protecting an individual against infection by the COVID SARS-2 various.

This is a remarkable achievement; rightly celebrated, and anticipated as the gateway to the return to some resemblance of economic and social normality.

However, it is also important to recognize that the path to “normality” is unlikely to be linear, as there are a number of factors that are both key and still uncertain.

Firstly, because by definition, there is no available history, it remains unclear how long any of the vaccines will provide immunity

Secondly, the pace and scope of vaccination will affect how quickly a particular population (and ultimately Humanity’s 7.9 billion or so individuals) achieves herd immunity- the crucial point beyond which, while the virus may affect particular sub-groups who have not been vaccinated, or do not respond to it as expected, its transmission through the general population is curtailed. At present that is clearly not the case in most countries. To state the obvious, one has to have both a sufficient supply and the ability to administer the vaccine. The former relies upon foresight, money and manufacturing capacity; the latter upon sophisticated logistics, unbroken cold-chains of varying complexity, and mechanism to register and vaccinate individuals using some form of protocol based upon priority of need.

Thirdly, and linked to the second point, the level of the herd immunity threshold (HIT) for the virus- needs to be established, and then achieved- i.e., which percentage of the population has either been infected and survived (and so acquired at least temporary immunity against re-infection) and/or been vaccinated. This is an absolutely critical number. Unfortunately, and not surprisingly, the answer to that question remains unclear. Initial published forecasts of COVID-19’s HIT ranged from 50 to 67%, but the mutation of the virus into more easily transmissible forms means that the percentage could be as high as 80 to 90% (bordering on the same level as measles).

Fourthly, in a networked world, in which people need and wish to travel and interact across borders, the geographic pattern of vaccination will matter. In the absence of clear herd immunity being achieved in, say the US, and likely even then for reasons of public policy and perception, allowing incoming cross-border travel without continuing controls will be unfeasible- thus prolonging the negative economic impact on the global economy. Eradication, or suppression, of a pandemic virus is, therefore, a public good if it is not to become endemic and so continue to disrupt lives and economies.

It also remains to be seen whether or not the Developed World (which should soon have access to adequate supplies of multiple vaccines) will be willing either to share its surplus, or support the purchase of local supplies, for poorer countries. And this ignores the likelihood of logistical challenges to effective levels of vaccination in many Developing World countries.

At Awbury, we are not epidemiologists or biostatisticians. However, we do believe it is, and will remain, essential to understand the interaction and impact of the factors described above if we are to be able to model potential economic and political scenarios over the near and medium term. In reality, while hoping for the best in terms of the HIT of COVID-19 being reached, we must plan for delays and setbacks. To do otherwise, would be irrational. We currently take the view that 2021 is likely to be rather more volatile in macro- and micro-risk terms than many hope for, even if, on the balance of probabilities, the outlook becomes increasingly favourable.

The Awbury Team

CRO to go…

The role of a Chief Risk Officer (CRO) within a (re)insurance business is critical. That is an axiom. However, it is arguable that the scope of the role requires regulare re-examination, as the range of issues which (re)insurers have to face in managing their businesses and portfolios continues to expand.

To enumerate a few:

• Continuing pandemic consequences
• Low interest rate environment and asset price volatility
• Risk aggregations and correlations
• Geopolitical shifts
• Still inflexible cost bases
• Cyber-risks
• Climate change- in (re)insurance claims, regulatory and investment terms
• Legacy systems…
• One could go on.

In fact, one could argue that the role is a lynchpin, without whose informed input executive management and directors are essentially “flying blind”, and not in a position to judge the continuous risk/reward calculations which any complex business faces in any structured or effective way.

The role of CRO came into greater prominence in the wake of the Great Financial Crisis, and its scope was initially defined in terms of the “Enterprise Risk Management” concept (of which the rating agencies and regulators were and are so fond) as the means to provide necessary control(s) and limit downside risks.

All that, of course, remains important and necessary, but is no longer sufficient. The role has become one that should provide both perspective and guidance on strategic business risks, rather than on “tactical minutiae”, to ensure that financial, reputational and overall organizational health and viability issues are both known and addressed in a timely and proactive manner. In some ways, the CRO has to be able to “play red team” as well as “blue team” in order to be most effective; and is essential to the ability of any (re)insurance business to achieve sustainable and consistent growth, rather than just try to avoid negative outcomes.

To achieve this, an effective CRO will need to have the ability to create, monitor, manage and communicate the output of iterative high-frequency stress tests across a (re)insurer’s entire portfolio and business model, incorporating relevant economic data and scenarios, including leading rather than lagging indicators. This must include both sides of the balance sheet, as well as profitability metrics. Some may argue that this is more the province of a CFO. However, while responsibilities need to be defined in a way that avoids unnecessary duplication, conflict and confusion, a CRO should provide a broader perspective, not one that is more focused on “meeting the numbers”.

As the pandemic has demonstrated the effectiveness of what are distributed workforces, it has also emphasized the need for robust, flexible and layered defences against malfeasance, cyber-attack and fraud. So, CROs will need to design processes that create protections, while at the same time avoiding stifling creativity and productivity. This is no easy task, but fits with the shift from a reactive “compliance” approach to one which promotes growth.

Underlying all these tasks is ensuring that a business’ decision-making and governance frameworks are fit for purpose, tempering speed and agility with consideration of all relevant  factors. If an organization’s risk culture and governance are not appropriate for its environment, the existence of beautifully-designed controls, models and systems is all rather pointless!

So, to sum up, without an experienced and effective CRO, particularly now, a (re)insurer is vulnerable to becoming becalmed and rudderless is a sea of risks, with any “life vests” merely providing a false sense of security.

The Awbury Team

To catastrophize or not to catastrophize, that is the question…

We hope, dear Reader, that you survived 2020 relatively unscathed, if perhaps a little emotionally-exhausted! To say that the year just passed was one for the record books is an understatement.

Perhaps (re)insurers should choose R.E.M’s “It’s the end of the World”, or Rainer Maria’s “Catastrophe” (opening lines: “All the dams will give at the end, at the end, at the end of the world”) as their ironic theme song? After all, it is human to be fascinated by catastrophes, as long as they do not happen to you, or, as in the case of a NatCAT underwriter, they do not mean that you suffer a claim!

Of course, the word catastrophe itself comes directly from Ancient Greek (καταστροφή); and originally meant simply a sudden turning, or overturning- a reversal in fortune- beginning to acquire its current meaning in English (of some form of disaster) in the Sixteenth Century.

One could argue that its original meaning is equally useful in the sense that, for a NatCAT underwriter, the true catastrophe occurs when his or her underwriting model proves inadequate and its expected parameters are overwhelmed by a truly unforeseen event.

Human beings are, paradoxically, notoriously prone to “catastrophizing”- imagining that an event is, or will be, far worse in terms of its consequences than it is ever likely to be- and such behaviour is often a symptom of anxiety or depression. This begs the question of what exactly should be the temperament of a risk manager charged with avoiding the risk of ruin, particularly in the midst of a global pandemic!

As is often the case, we would argue that a rational, middle way is required. Following the approach of Dr. Pangloss in Voltaire’s satire Candide (that all is for the best in this best of all possible worlds) is irrational and very likely to lead swiftly to ruin; yet the reverse outlook based upon emotion is equally foolish. Instead, one should balance the need to rely upon often complex models, and to accept that they are only an approximation of “reality”, with the understanding of what the potential boundaries are of the risk being analyzed and assessed. Even catastrophes usually have limits, and, if they do not should one even be accepting them into a portfolio? After all, not only the pandemic, but numerous other events have shown that catastrophes happen much more frequently than we are often prepared to accept.

Consider, for example, the recent SolarWinds hack, almost certainly an example of state-sponsored action. If such an act can penetrate even supposedly “hardened” and sophisticated defences, where can a cyber-risk underwriter drawn the line in terms of coverage if no-one is truly safe? In such circumstances, imagining “beyond the worst” is actually rational, as the boundaries have shifted yet again in terms of reach and scale. At what point does the supposedly insurable become uninsurable?

At Awbury, we are strong believers in avoiding catastrophizing, while recognizing that we cannot foresee all eventualities. So, we focus on ensuring that the risks we underwrite and accept are truly bounded; with a highly remote, and carefully mitigated, probability of ever exceeding our models’ parameters.

We most certainly do not wish a catastrophe to turn into a tragedy!

The Awbury Team

Well…!

So, what did we see; and what should we have learned?

First, if you think you have seen everything, you haven’t! No rational CEO or CFO would have expected to be confronted by the risk of their company’s revenues going to zero (or as good as) because of government diktat, and have no recourse to change the outcome. The risk was foreseeable in the sense of possible, yet unlikely to have been in any CRO’s collection of “emerging” risks. He or she would probably have been laughed at in any strategic planning meeting held during 2019 for suggesting such an eventuality as posing a potentially existential risk.

Second, the speed of decline and the reversal of market prices across most asset classes were also unprecedented. No previous “crash” or “recovery” saw such a violent “V” shape.

Third, governments in many cases almost “threw” money at their economies to stave off a meltdown and depression, and in ways and quantities that were simply breath-taking. There was little debate, because the problem was seen as so grave and unbounded.

Fourth, hope is a powerful force. Stock markets are quite clearly functioning based upon the swift delivery and successful administration of effective vaccines. That is a reasonable prediction, but still merely a probability, not yet a certainty.

Fifth, “normal” became a nuanced label. Hitherto, while people may have accepted and understood that economies and behaviours are far from static, most (even the self-described “disruptors”) would have expected a gradual evolution. Instead, in many areas, we “fast-forwarded” to the future, as the time-scale for change in areas such as the adoption of remote-working, or tele-medicine truncated significantly.

Sixth, just when you think a particular scenario and outcome has now assumed a reasonably certain shape, it changes yet again- witness the sudden impact of the B 1.1.7 COVID SARS variant upon expectations for vaccine effectiveness, speed of transmission, and case management, with all the knock-on effects that may have in health and economic terms.

Seventh, as we wrote recently, experience in the credit markets in terms of defaults and bankruptcies has been distinctly odd, with their level generally declining significantly year-on-year in many jurisdictions.

Eighth, human beings are both remarkably resilient, and yet vulnerable. Most societies have continued to function effectively in the face of lockdowns and sometimes arbitrary governmental actions. However, the true cost, for example, in terms of mental health or educational attainment is yet to be tallied.

Ninth, much of the (re)insurance industry has had a year it would rather forget, as the combination of the pandemic, greater frequency and scale of “ordinary” NatCats, low investment returns and asset price volatility continues to weigh on results and underwriting performance, even in the face of a hardening market across many product lines.

Tenth, competence, and the constant application of proven techniques, coupled with iterative adaptation, make the difference between success and failure, whether in controlling pandemics or in building franchises.

At Awbury, our business model and franchise have proved resilient, which has enabled us to manage the impact of the pandemic, seize new opportunities and plan for further expansion.

In closing, may we take this opportunity, Dear Reader, to wish you a healthy and prosperous 2021!

The Awbury Team