Management and the art of satire…

For those of a certain “maturity”, and who remember watching the event “live”, it is a sobering thought that in a year’s time we shall be celebrating the 50th anniversary of the first manned landing on our Moon. Perhaps less noticed, will be the 50th anniversary of a book that was supposed to be satire, but then created a term of art- The Peter Principle by Laurence Peter (an academic) and Raymond Hull (a playwright), with Hull the primary author using Peter’s research.

The Principle states: “In a hierarchy every employee tends to rise to his [or her] level of incompetence.” In other words, at the heart of organizational management lies a paradox: people who are perceived as the best in a particular role tend to be promoted until they no longer perform well in a subsequent role- at which point they become stuck (in their Final Placement, having reached Peter’s Plateau). Less often quoted is Peter’s Corollary: “In time, every post tends to be occupied by an employee who is incompetent in carrying out its duties.” One can see the consequences of such an eventuality!

What was not expected to be taken too seriously has become (albeit sotto voce) almost dogma in certain quarters. Any laughter will have an edge of knowing acceptance. However, like dogma, belief is not the same as evidence. In reality, the heart of the issue is the extent to which skills which engender success in one particular role or function are transferable and applicable further up the hierarchy (and most large, complex organizations are hierarchies)- can specialists become managers?

The authors also created other terms. How about “percussive sublimation” (a.k.a. being “kicked upstairs”) or a “lateral arabesque” (being moved “out of the way” and given a longer job title- or perhaps, in the current age, a meaningless one); or “hierarchical exfoliation”- a fate destined to befall those who are either super-incompetent or super-competent- who are fired. Such actions are clearly intended to preserve an organization’s Bell Curve of mediocrity!

So, when 3 researchers (economists Alan Benson, Danielle Li and Kelly Shue) recently published the results from a study of 53,000 employees working in sales environments, across 214 companies, and involving over 1,500 promotions, the key question was whether or not their research would confirm the thesis of the original book.

In short, it did.

The best sales people were likely to be promoted to managerial roles; yet, once they became managers, the teams they were managing performed more poorly. All this begs the question of how to stop the rot and how to design processes that are not counter-productive. One approach posited by the study’s authors would be to reward those who are excellent in their existing roles with greater pay, rather than promotion. Another, as at Microsoft, for example, would be to create dual tracks (with equal compensation potential and prestige) for technical and managerial roles. Of course, the classic corporate progression (at least in Western managerial practice), for those deemed to have “potential”, is to move them from role to role with increasing levels of responsibility until finally they realize that “potential”. However, more rarely is this combined with “up or out”. As Peter and Hull predicted, people become “stuck”, creating bottlenecks. Even fewer organizations appear to practice an approach in which promotion followed by “failure” is followed by a suggested re-assignment to the prior role in which competence was demonstrable.

Interestingly, in “the old days”, a number of financial institutions actively to try to develop individuals who would become “general managers”, running the institution as part of a team. Such an approach appears to have fallen victim to the rise of the hyper-specialist.

Where does all this leave the art (science still smacks of far too much “certainty”) of management? Perhaps at the start of a cycle of deciding that was old is new again! After all, we have not even mentioned the management consultants…!

The Awbury Team


Seems like only yesterday I left my mind behind…

The fact that just over 2 years have now passed since the shock outcome of the UK’s Brexit Referendum emerged, brought to mind the above-quoted line from the Bob Dylan song (performed iconically by Joan Baez) “Love is just a four letter word”. After all, the island of Great Britain and “the Continent” have had an unsettled relationship for much of recorded history, with the current imbroglio being yet another iteration of “will they, won’t they?”

So, it is worth taking stock and asking: “Where are we now?”

Frankly, seemingly not much further on in terms of progress towards resolving the numerous key (let alone mundane) issues that will make the difference between a rational “divorce” with continuing amity, and the semi-scorched earth policy of a “hard Brexit”, especially in light of the recent tumult in the ministerial ranks of the Conservative Government and repeated sparring in Parliament, in which the government has to wonder whether and by whom it will be ambushed next in votes related to Brexit, compounded by mixed signals during President Trump’s recent visit over the attitude of the US Administration. And don’t even mention the mental gymnastics required to solve the “Northern Island Border Question”!

Such uncertainty matters, and is increasingly weighing upon the perceptions, decisions and actions of major sectors of the UK economy, as well as causing concern amongst the UK’s interlocutors in the EC/EU.

The recent UK government White Paper was an attempt to provide a framework for negotiating an “exit” and a transition period before the invocation of Article 50 causes the UK to crash out of the EU at 11pm on March 29, 2019. As we have written before, negotiations of such complexity and consequence usually take years, not months; and the timeline is, in reality, even more truncated because of the need to obtain the necessary approvals from both sides of the negotiations before the witching hour.

Every day that passes without clear progress increases the risk of an un-negotiated “hard” Brexit, with financial regulators in the UK chastising their charges for inadequate contingency planning and preparation for such an eventuality. It is perhaps not surprising that one gets the sense of a significant level of denial in many quarters that the worst could happen, leading to decision-avoidance and paralysis.

In the (re)insurance realm, firms that need to be able to conduct business across the EU and the UK have, of course, taken steps, through the establishment of subsidiaries where necessary in jurisdictions outside the UK, to ensure continuity of business; but the question of business transacted between the post-Brexit UK and the EU remains unresolved, with the only clarity being that the Government is not currently seeking to remain in the “single market” for services and so, once the UK exits the EU, “passporting” will end. Not surprisingly, few in the industry are happy with this because of the level of uncertainty it creates (including on matters such as contract continuity) and even those who profess to be supportive are probably whistling past the graveyard.

Of course, all the current Sturm und Drang may be the prelude, finally, to rational negotiation this autumn, as both parties realize that a “hard” Brexit is in neither side’s interests.

At Awbury, we continue to review the spectrum of possible outcomes, including the worst cases, because that has to be at the core of any effective risk management. One can hope for and expect the best; but should always be prepared for the worst.

The Awbury Team


If you ain’t got talent, diversity, reputation and relationships, you ain’t got nothing…

We had the pleasure of attending ABIR’s recent 25th anniversary celebration seminar, and of hearing from many of the pioneers and current leaders of the Bermudian (re)insurance community on a range of relevant topics.

In listening to and thinking about what we heard, we believe there are a number of key points that were made and should form the basis of any thoughtful and well-informed analysis of how to maintain Bermuda’s pre-eminent status. None is unexpected, but they are often forgotten, overlooked or downplayed.

Firstly, to thrive, any business needs to attract and retain the most talented people, because in a world in which the value of whole industries is based upon intangible rather than tangible assets (such as intellectual property), the differentiator between businesses which are able to adapt and those which wither and disappear will be the intellectual capacity which they can deploy. As one speaker said: capital does not attract talent; rather talent attracts capital and then more talent. The development of the Bermuda (re)insurance industry is a classic example of that truism, with the pioneers of the industry able build businesses around themselves and the teams they recruited, matching and melding both local and global talent.

Secondly, the idea that focusing on the recruitment of one particular “type” of individual can sustain a business over the long term is misguided and increasingly untenable. The more diverse a talent pool is, the greater the likelihood (provided it is effectively managed) that it will be able to create new intellectual capital and be open to new ideas. “Groupthink” by a collection of individuals who all fit the same basic profile is one reason why both risks and opportunities are missed, with unfortunate consequences. Apart from questions of fairness and equity, recruiting from a narrow base is simple wasteful of human potential.

Thirdly, one can have talent and capital in abundance, but still be shunned; not because of one’s own reputation, but because of the environment in which one is perceived to operate. Several ABIR speakers made the point that the reputation of the Bermuda market has been hard won through a conscious effort by the industry, government and regulators to hold themselves publicly to the highest standards, after the debacle suffered in the 1980s. As Warren Buffett said: “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

Fourthly, relationships matter. We are supposed to live in a world in which more and more interactions can be and are “de-materialized”; and, clearly, the (re)insurance business as now constituted could not function without the efficiencies and economies of scale afforded by modern technologies and telecommunications. Nevertheless, the (re)insurance business remains one in which direct personal relationships between a relatively small cohort of individuals are fundamental to the completion of large, complex transactions, because the parties involved know, trust and respect each other. In the case of Bermuda, its small size enhances the ability to create and maintain such essential relationships, with the proviso that the talent pool has to be high quality, diverse and constantly replenished.

And we could not close this post, without mentioning another factor that makes Bermuda such an effective forum for global (re)insurance business: the quality and openness of its regulatory framework; and that the fact that one can have a direct relationship with the BMA team and obtain quick and responsive decisions and guidance. This is a key competitive advantage for any regulated business.

The Awbury Team


The Evolutionary Memory Palace…

KBRA, a “non-legacy, non-Big 3” rating agency recently published an interesting short note, entitled “Counting on Evolution”. In it, KBRA argues in the context of the banking industry in particular that since the Great Financial Crisis (GFC) there have been sufficient changes as a result of “learning” (in effect, adaptation and evolution) that developed banking systems such as those in the US now represent less rather than more risk than prior to the GFC. Therefore (according to KBRA), the fact that, almost invariably, the ratings applied to the major US banks are currently several notches below those applicable pre-GFC is misguided and overly conservative. Naturally, KBRA “aspires to get to the right rating.”

Such thinking is, on the face of it, not unreasonable. However, it begs or omits a number of questions:

– The ratings, pre-crisis, were appropriate
– Published ratings are easily comparable in terms of assumptions made
– That the Directors and senior executives of said banks (as well as their regulators) have truly learnt (i.e., evolved) as a result of the GFC and have stored the appropriate facts in their individual and institutional memory palaces
– That these “evolved” institutions are no longer vulnerable to market spasms and panics

Let us consider each of these points in turn.

Firstly, given that none of the 3 dominant “legacy” rating agencies forecast the credit consequences of the GFC ex ante, their ratings process demonstrably failed the test of providing any meaningful predictive power of credit quality, particularly in respect of the monoline “doom loop” or systemic failings within the banking system. Of course, hindsight is a wonderful thing, but arguably there was serial “over-rating” going on pre-GFC.

Secondly, in the dim and distant past, ratings scales were relatively simple and essentially unified, with each main agency arguing that a “AAA was a AAA was a AAA”- in other words ratings across different obligor categories were essentially directly comparable. Now there are enough different scales, modifiers and suffixes to make one’s head spin. On the one hand, this indicates that precision about assumptions is critical; but, on the other it, the increased complexity tends to reduce the informational quality of what is published.

Thirdly, while one would expect that rational self-interest would cause bank executives to modify their behaviour (i.e., adapt) in order to avoid the possibility of another GFC, the continuing misalignment of incentives and general lack of accountability make one somewhat skeptical that lessons truly have been learnt. Similarly, post-GFC, regulatory agencies significantly toughened and enhanced requirements for their charges, which should have at least have increased the “survivability” of individual banks and the financial system which depends upon them. Nevertheless, signs of relaxation of these rules have appeared, so one might question how vigilant regulators will actually be if standards within what remains a highly-leveraged, inter-connected system erode.

Finally, all banks within a fractional reserve system are vulnerable to “runs, panics and spasms”; and every time one hears or reads “but this time is different”, one knows that, sooner or later, there will be another financial crisis in which commercial, for-profit institutions will, yet again, try to socialize risk, even if regulators and politicians will, ex ante, be adamant that “this time” major banks will be allowed to fail and that they have the tools necessary to cauterize and confine the risk of contagion.

So, while KBRA may have a point that institutions and systems evolve (as one would hope!), and thus current public ratings are unduly harsh in relative terms, one needs to be cautious that this “evolution” is irreversible.

At Awbury, we believe strongly in analyzing risk based upon an exhaustive fundamental and quantitative analysis. While we respect the service performed by the rating agencies, we prefer to operate without reliance upon the convenient crutch of public ratings, which are simply another piece of information.

The Awbury Team


The Fat Tail and Feedback Loop at the End of the World…

In these somewhat strange times, we have been musing about how individuals and enterprises still have a habit of trying to avoid contemplating “the end of the world” (as opposed to coping with the “news”), even if the (re)insurance industry exists at least in part to mitigate extreme risks for it clients.

Nassim Nicholas Taleb has made a career out of pointing out the risks of “fat tails” and unexpected events, with a series of books which remain essential reading, even if one does not agree with all of his views or conclusions. In addition, Mr. Taleb has run investment vehicles intended to protect against scenarios in which systemic fragility overwhelms the financial markets.

And now, in a more easily accessible form, Algebris Investments (a UK-based investment manager) has announced the launch of its own “end of the world fund”, officially a “Tail Risk Fund”.

The firm points out, quite reasonably, that after a decade of a generally benign overall investment climate in which those adding risk have been rewarded, a number of large investors have begun to seek mechanisms to limit potential portfolio losses. As Hyman Minsky wrote: “Stability leads to instability. The more stable things become and the longer things are stable, the more unstable they will be when the crisis hits.”

Given all the noise around the likes of Argentina, Turkey and Italy; Middle East conflicts; the recently failed G7 summit; US/PRC trade tensions (we could go on!), one might well ask: “But how can you say the markets are stable?”

This is a fair question. However, it remains the fact that there have been no real market breaks, nor stampedes for the exit as yet, minimal “tantrums” (outside country-specific ones), and the appetite for risk shows little sign of abating, which begs the question of what happens when sentiment changes (as it surely will at some point.) At that point, George Soros’ Theory of Reflexivity is likely to get another workout, as the thinking (panic) of market participants feeds on itself, creating negative feedback loops and further increasing instability, uncertainty and volatility.

The Great Financial Crisis is beginning to recede into memory, and one is led to believe that regulatory and macro-economic steps taken since then have significantly reduced the probability of a recurrence. While it may be reasonable to assume that the causes of the next GFC will be different from those of the last, to assume that there will not be another extreme financial crisis (whether or not correlated with a political one) is the height of foolishness.

At Awbury, of course, our business is based around our E-CAT franchise (providing protection against high severity/low frequency credit, economic and financial risks). So, we are always scanning the horizon for the first signs of factors that could generate the next GFC, as well as idiosyncratic and seemingly isolated events that can cascade into something systemic. It is why our clients and Insureds seek out our bespoke coverages, backed by our diverse panel of (re)insurers, whose ability to withstand systemic shocks has been amply demonstrated over many decades, and why the Awbury team also works hard to build structural and economic mitigants into those coverages in order to continue to deliver a highly attractive risk/reward ratio to its reinsurance partners.

The Awbury Team


The end of oil will/may arrive, but when/how…?

The Oil Age has had quite a run over the past 100 years or so, and its possible demise is a source of constant debate, as competing forecasts and scenarios try to illuminate when and how such factors as alternative energy sources; non-ICE*-powered vehicles; and concerted action on “climate change” will cause a significant decline in use of oil-derived fuels.

What seems sometimes to be overlooked is that a) forecasts are usually wrong in terms of timing and scale; b) one has to have the appropriate assumptions; and c) there are often unexpected linkages or factors that can significantly affect actual outcome(s).

So, let us think about some of the variables involved, and how they might affect the supposed outcome:

Firstly, while the rise of the EV** may seem inexorable and rapid, Bloomberg recently forecast that the displacement of oil usage by EVs would be some 7MM bpd by 2040. Compare this figure with current global oil production of c. 100MM bpd. An incremental change over the next 20+ years will not happen in isolation, and it is hard to take into account how demand for more ICE vehicles in so-called emerging markets may rise over the same timeframe, offsetting likely declines in terms of generating capacity and industrial processes. Yet even in the case of industrial processes, demand for petro-chemicals is likely to continue to rise for the foreseeable future, absent a radical re-think or rapid replacement of those same processes.

Secondly, the rise in demand for EVs is unlikely to be smooth, as it creates its own economic and geopolitical consequences and risks. Consider the days when the Middle East completely dominated oil production, and the fact that now mining house Glencore is seeking to expand production of cobalt (essential for most EV batteries), when over 50% of reserves come from the chronically unstable DRC; or that it seems quite clear that the PRC has set its sights on controlling the supply of the lithium (another essential component) needed to support its own push towards EV usage. And what of copper? While its mineable resources may be more widely spread geographically, the amounts required to create clean energy infrastructure are so large that it seems likely that there will be a push to consolidate that market.

Thirdly, all those new EVs will require a network of charging stations in the same way that ICE vehicles now have gas/petrol stations, leading to disruption in real estate markets as those seeking prime locations (which cannot be replicated) are constrained by lack of supply. The ICE re-fueling network is hardly going to be re-purposed that easily. And more EVs will lead also to increased (not lower!) demand for reliable 365/24/7 electric power generation from baseload sources. While oil itself may form a smaller part of the fuel for such capacity, its “sibling” natural gas is likely to see demand rise.

As Sanford Bernstein pointed out in a recent report (The Future of Oil Demand) “…the pace and the path of ending an extractive industry [i.e., oil] are measurably slow and uncertain.”

Therefore, it seems that the probability of any near-term “death of oil” has been greatly exaggerated. Decline over the forthcoming decades may at some point become first relative and then absolute, yet many of us are likely to be in our dotage (or worse!) before the end of oil arrives.

As always, the Awbury team constantly assesses key scenarios such as the future demand for oil to ensure its ability to make appropriately-informed judgements on existing and future portfolio risks and opportunities.

The Awbury Team

*Internal Combustion Engine
**Electric Vehicle


Vollgeld or Fool’s Gold…?

On June 10th the good burghers of Switzerland will vote in a federal popular initiative (referendum) that is causing some consternation amongst the country’s banking institutions, including the Swiss National Bank (SNB), the central bank. The proponents of the referendum seek to end the system of fractional reserve banking within Switzerland, through which local banks (as in all other major global banking systems) in effect create so-called “private money” when they create new assets through lending, and hold only a fraction of their reserves in “central bank money” as created by, e.g., the SNB (or the Federal Reserve, ECB, or Bank of England) and backed by the full faith and credit of the sovereign.

This may all seem rather arcane, but the reality of the modern world is that most “money” in an advanced economy (often over 90%) does not consist of notes and coins, but rather exists because of the activities of its banking system as it makes loans and takes deposits. “Runs” on banks occur (with the film It’s a Wonderful Life being the paradigm in popular culture) when a bank’s customers all want “their money” back (in the form of true cash) at once- something which no modern bank can do because of its inherent leverage. The entire system is based upon confidence.

The idea of having at least some sectors of the banking system (usually those which deal with individuals or small businesses) operate more as utilities with a “full reserve” model is not new (President Roosevelt rejected the Chicago Plan in 1933, creating the FDIC instead), but the Vollgeld referendum proposal represents an extreme version in that it would require the SNB to become the sole provider of Swiss Francs to the financial system, as all Swiss Franc sight deposits (some CHF 555BN at end-March 2018) would be required to be held at the SNB. This has caused the usually apolitical institution to characterize the referendum as a “dangerous experiment”.

In effect, if the referendum were to pass (which still appears unlikely, although certainly a “fat tail” risk in an era of populism), the SNB would determine the amount of money provided to the Swiss economy, effectively controlling directly one of its key levers. Of course, historically, central banks have used various mechanisms to control money supply and lending (who can forget the Bank of England’s “corsets”?), but have stopped short of being the sole source of money, allowing regulated banks to create the above-mentioned “private money”.

While implementation of the Vollgeld Initiative would be unlikely to cause the Swiss banking system or the economy to seize up, it would increase friction with unforeseeable consequences, as the “experiment” has not been tried before in a developed economy. As such, in a world in which economic stability is often hard won, and easily disrupted, the Initiative represents another factor potentially adding volatility and uncertainty.

At Awbury, the existence of the Vollgeld Initiative counts as a “known unknown”- an observable potential event, but one with as yet uncertain parameters in terms of outcomes. As such, we shall continue our monitoring of it as another factor in the ever-changing risk matrix that makes life as underwriters of credit, economic and financial risks so “interesting”!

The Awbury Team