Choke Points and Points of Failure…

At Awbury, we are always interested in understanding more about factors that can cause disruption and failure, or cause forecasts to require material revision, as well as how they may interact across economic, financial and governance systems.

The pandemic has certainly highlighted interdependencies and the impact they can have on policy effectiveness. For example, the ordering, production, distribution of vaccines has proven the reality that even members of a supposedly aligned entity (the EU) can make decisions with the best of intentions that prove counter-productive and divisive, a situation then exacerbated by the fact that the world’s largest manufacturer of vaccines is India’s Serum Institute, whose own operations are subject to the dictates of the local government’s “vaccine nationalism”. Thus, a new choke point appears in terms of pandemic suppression.

Or consider the Suez Canal, which, like the Panama Canal, is an obvious chokepoint when it comes to global trading in goods, accounting for an estimated 12% of the total by volume. Clearly, if it becomes blocked, that is a problem. In recent years, ships have run aground for various reasons, but been re-floated relatively quickly. Now, however, not only has another ship run aground, but it just happens to be one of the world’s largest container ships, and fully laden; while no-one yet fully understands why the grounding occurred. Naturally, queues are building both within the canal, as well as at its entrances, and there are wildly varying estimates as to how the ship will be re-floated, and when. What was a “manageable” chokepoint, just became potentially unmanageable for ships the size of the Ever Given.

Of course, once one starts looking for potential chokepoints, one sees them everywhere! While the immediately obvious consequence of the recent Texas winter storm was in terms of disruption to power generation and supplies of natural gas, because facilities were not “winterized”, the unexpected lingering effect was on the petro-chemicals industry, many of whose hugely-complex plants experienced a so-called “hard shut-down”, meaning that their operations were stopped abruptly, rather than in a controlled manner. As a result, the return to full operation may take months, resulting in disruption of supplies to global supply chains of key products such as polypropylene, polyethylene and PVC, with significant increases in prices another consequence.

And (as we have alluded to before), in a world which depends on ever more complex computer “chips” to build and advance its technologies, the security of supply from Taiwan-based “fab”, TSMC, is of critical importance because it is not only dominant in terms of scale but also in the capabilities of its products. The destruction of its plants or diversion of supplies would vividly demonstrate what a point of failure looks like- particularly when supply disruptions are occurring already.

One paradox that all the above examples reveal is that, no matter how much we may think that the world is now digital and de-materialized, we cannot avoid the physical, because that still underpins everything else, and is sometimes surprisingly vulnerable, and we need to be ever-vigilant in identifying and assessing how, where and why a choke-point or point of failure may be created.

The Awbury Team

Approaching Nirvana, or Another False Dawn…?

Approaching Nirvana, or Another False Dawn…?

After years of weak pricing across most product categories, 2020 produced some signs of the long-fabled “hard market” for P&C underwriters.

According to the Marsh Global Insurance Market Index pricing rose by an average 22% year-on-year for the last quarter of 2020, with the trend having accelerated since the end of 2018, when it was only 2.1%. And the average masks some wide disparities- 7% in Casualty, 20% in Property and 47% (sic) in Financial Lines.

To say that such increases are needed would be an understatement. The industry as a whole has been barely profitable at the underwriting level (although with wide company-level disparities) over the past decade, meaning that reported profitability has depended on investment results, which have been somewhat more stable, albeit decreasing also. Of course, 2020 demonstrated how volatile such returns can be quarter-by-quarter, with the possibility of rising US interest rates threatening at least “interim pain” in investment portfolios heavily weighted towards bonds and other fixed income products, before re-pricing begins to occur. As Warren Buffett said recently: “Bonds are not the place to be these days.” He could be wrong, but adding the perception of higher investment risk to underwriting uncertainty must give senior industry executives pause for thought.

Of course, the question arises as to how much of the increase in premium rates will flow through to the Combined Ratio on a net basis. After all, “social inflation” remains endemic, while costs for managing claims are also rising. Add to that persistently elevated numbers of catastrophe events (whether “natural” or not), as well as uncertainties around the true scale of risks such as cyber, and concerns that greater climate risk represents a “new normal”, and one has a combination that makes forecasting underwriting outcomes increasingly difficult.

The events of 2019 and 2020 have, in predictable fashion, created a new “Class of 2020/21” cohort of entrants into the P&C (re)insurance arena, all promising to be disciplined and selective in their underwriting, and claiming to benefit from “cutting edge”, technology-driven approaches, free of legacy liabilities or systems. We welcome their entrance, and will watch with interest as to how many of them produce underwriting results which confirm that they truly have a sustainable “edge” (given that most of them have been founded by long-standing industry stalwarts), or demonstrate that they have well-controlled and flexible cost bases in an industry notorious for their lack.

Furthermore, in an era in which the industry should now have the ability to parse its wealth of historical data to produce much more granular and truly risk-adjusted pricing, even in the face of rising uncertainties in certain categories, we also hope to see evidence of that in underwriting results by class of business, and that underwriters will be able to avoid seeking volume at the expense of discipline (an abiding sin) simply because nominal prices have risen significantly. After all, most industries would be more than happy with an average 22% year-on-year increase in realized pricing!

At Awbury, we believe that properly-informed, value-added pricing, based upon rigorous underwriting, is key to building and maintaining our franchise; and that being lured by the potential chimera of much greater business volumes is simply foolish. So, we shall continue upon our path of an incremental, iterative and adaptive increase in scale, being inherently skeptical that this time the pricing cycle is somehow different for the industry, even though we shall be delighted if it proves to be so.

The Awbury Team

That was the Pandemic that was…?

So, even though we now know that the SARS-COVID-2 pandemic had its origins sometime in late 2019, if not earlier (hence COVID-19), this past week marked the anniversary of the WHO (after considerable procrastination) declaring it a global pandemic- and we all know what happened next, because we are still living through its consequences.

From the point of view of (re)insurers, one can perhaps point to a few lessons that are worth thinking about and internalizing, even if many may seem obvious, because the “obvious” is often overlooked or underestimated because it is given little attention:

– Risk models are only ever a work in progress
– Your past experience can lead you to make and apply the wrong assumptions
– As the philosopher Franz Brentano said: “What is at first small is often extremely large in the end. And so it happens that whoever deviates only a little from truth in the beginning is led farther and farther afield in the sequel, and to errors which are a thousand times as large”. In other words, seemingly small errors can compound
– One really does have to plan for the worst case. That should be a truism for any (re)insurer, but sometimes no-one wishes to believe that worst cases really can and do happen
– It is not always just about the data. Perceptions and beliefs matter because they affect behaviours, which then have consequences. The pandemic demonstrated that very clearly
– It is not just the scale, or political composition of a government that matters, but rather its quality and competence. The same would apply to any bureaucracy
– Speed of decision-making matters, but the process must be clear, unambiguous, and not easily manipulated. While the perfect is the enemy of the good, irreversible decisions must be recognized and identified as such and given proper attention in case they lead to poor outcomes
– The clarity of policy wordings matters. Whatever the merits of the arguments that have taken place in the past year over, say, Business Interruption coverage may have been, the number, content and variation of policy wordings involved led to an outcome which it is highly unlikely anyone wished for
– Governments can act within their powers, and one can have no practical recourse if those decisions harm you or your business
– How much balance sheet volatility is tolerable? Can you control and manage it, or simply absorb it? Reacting and then regretting is to be avoided
– Always look at the other party’s motivation and incentives, ensuring interests are aligned to the extent possible
– Those who cannot, or will, not adapt and learn, will fail.

In human terms, the pandemic has been devastating for individuals, families, whole industry categories, and societies. (Re)insurance ultimately exists to help individuals manage the risks in their lives, whether directly or indirectly. Any entity is based upon individual effort and capacity, even though it may be described in the abstract. The industry forgets that at its peril. However, it also worth pointing out that it has demonstrated its robustness in the face of the greatest economic crisis in several generations; and can rightly be proud of that.

The Awbury Team

Schelling Point as Selling Point…

You may think the title is a play on words. It is- but with a purpose.

In Game Theory (as developed by John von Neumann and Oskar Morgenstern), Nobel Prize winner Thomas Schelling subsequently described what became known as Schelling Points. These are Focal Points, or places where people tend to go in the absence of being able to communicate directly. The classic example in New York City would be the information kiosk at Grand Central Station for 2 people who had arranged to meet, but had then lost contact. It might not work, but it would be the option that would be most likely to. Another way of looking at a Schelling Point would be as the “default setting”, or place/product to which people tend to gravitate almost without conscious thought. And what were and are markets if not places to “meet” and communicate, even if not always physically?

In some ways a Schelling Point is also a form of capital, as it confers an advantage in terms of salience and importance. Consider, for example, the world of venture capital and business start-ups. Anyone asked the question about where one would wish to go first (at least in the US) as a start-up entrepreneur would be most likely to answer “Y Combinator”, which has built an extraordinary franchise over the past 15 years, serving as the starting point for now famous businesses such as AirBnB, Stripe and Instacart, to name a few. Why? Because it became the accepted focal point.

Of course, the fact that “X” acquires such a status can become the source of stagnation if no adjustments or improvements are made as the world changes around it. One has always to guard against complacency, and Schelling points are not necessarily static.

Nevertheless, clearly there is a value in being one.

If one looks at the realm of (re)insurance, at one point the Lloyd’s Market would have been the most obvious place anywhere to go to obtain insurance, and its wordings the standard, which vastly decreased frictional costs for Insureds. Since then, competition and commoditization have led to a much more diversified industry, yet at the same time often an underperforming one in terms of its core purpose of effective underwriting, with cost structures that are no longer fit for purpose, and in which needless and heedless complexity is pursued as a means of “differentiation”. The constant search for a competitive edge is the basis for innovation, but it comes at a price. There is a constant tension between competition and monopoly, as is increasingly visible in the “Tech” world. If there any Schelling Points, they are probably the London Market (for insurance) and Bermuda (for reinsurance).

So, whatever your business model or segment may be, the goal should be to become known as the most obvious and effective Focal Point for fulfilling the needs of your intended customer base. If you do, you stand a better chance of building and compounding scale and effectiveness. In other words, seek to be “front of mind”, so that the idea of reaching out to you becomes an obvious one, and almost automatic.

The Awbury Team