The company as a cult…

One could argue that the first significant example of the company as a cult phenomenon was in the early 18th Century, when the South Sea Company (while fraudulent) managed to transfix a population; destabilize government; and set back the progress of legal reform of corporate structures for many decades.

Since then, the phenomenon has appeared periodically, often at times of financial and economic change and disruption, almost as if investors and others are seeking for some form of confirmation of belief that “X” company is going to change the world.

While corporations are legally “persons” in most jurisdictions, that “personality” is abstract and dispersed, meaning that it often comes to be represented by one or more human beings- often a charismatic individual who created and built the business- or creates a culture that is designed to foster what one might call a cult mentality. So-called Multi-level Marketing companies (MLMs) such as Herbalife and Amway are examples of the latter form.

Of course, bankers, analysts and institutional investors tend to pride themselves on being cynical and clear-eyed. However, they are also (so far) human. This means that they can be lured into behaving as if members of a cult of “true-believers”, either by suspending judgement or by being manipulated into ignoring harsh realities.

Often this is not intentional, but the result of “herd behaviour”, in which it becomes awkward to take a contrary view.

Nevertheless, not all “corporate cults” are malign or fraudulent. While the early Ford Motor Corporation under Henry Ford; The House of Morgan under JP Morgan; or General Motors under Arthur Sloan were demonstrably inseparable from the characters of their founders, none could properly be regarded as deliberately “cult like”, although the way in which Sloan built GM arguably led to the modern cult of “management” as an end in itself. Even Standard Oil under John D. Rockefeller, ruthless as he was, essentially enabled much of the United States’ economic power.

More recently, the growth of the “technological age” has been led by a number of businesses which clearly achieved cult status at their peak- for example, Microsoft as lead by Bill Gates (who has managed to transition to the philanthropist role without too much opprobrium), or Apple under the late and legendary Steve Jobs. Both companies, while still powerful, no longer attract the same status.

At present, we would suggest that, in the US at least, two companies, Amazon and Tesla, have the makings of a “cult” (and compare Alibaba in the PRC under Jack Ma), while Google and Facebook, although powerful, simply do not attract the same perception.

There is little doubt that Jeff Bezos is a brilliant business man, nor that the company he created is inextricably identified with and gets the benefit of the doubt when its strategy or performance are opaque. Similarly, Tesla is inseparable from Elon Musk, who has demonstrably achieved cult status, because any other company which persistently underperformed both expectations and promises made would have been already consigned the remaindered section of history. This does not mean that Tesla will not ultimately succeed; simply that its CEO is able to persuade most investors and potential sources of funding that there will, most certainly, be “jam tomorrow”.

And if one wishes to observe perhaps that most enduring corporate cult, one only has to think of Berkshire Hathaway and the “Sage of Omaha”. The epithet says it all!

At Awbury, while we believe that a strong corporate culture is generally a good thing, and that a charismatic leader may also help, being of a naturally skeptical nature, and having been around for a sufficiently long time to have seen the consequences of the suspension of critical faculties in many areas, we take the view that a corporation’s actual performance, competitive position, financial capacity and liquidity are what really matter. We are very wary of unsubstantiated charisma.

The Awbury Team


Energy or Entropy…

There is, of course, much debate at present about the rate at which energy generation will switch from using hydrocarbon-based to other “alternative” forms, such as solar, wind and tidal- a so-called energy transition.

As a result, the work of a Manitoba-based Czech academic, Vaclav Smil, is gaining increasing attention; being already quietly influential amongst policy-makers. To paraphrase, Smil’s basic thesis, there have been three major energy transitions during the time of Humanity’s existence. First came mastery of fire (using energy from the sun stored in plants); second, farming (which converted solar energy into food); and, third, industrialization, which cycled through coal, then oil, then natural gas to power machines.

Now, according to Smil, we are struggling with the fourth transition, towards using energy sources that use the sun’s direct energy flows, rather than those trapped in hydrocarbon deposits, and do not emit carbon dioxide.

Ironically, whereas previously transitions have involved attempts to move towards use of more energy-dense materials- using Smil’s term- the current transition entails moving back down the power density spectrum. He considers nuclear power a “successful failure”, as it has become (with a few exceptions such as in the PRC) stalled by cost and safety concerns.

As Smil points out, it is all very well deciding to replace hydrocarbons with other sources, but generating the equivalent levels of energy to maintain current economic output could entail using 100 and perhaps a 1,000 times more land area to do so, which will create its own concerns and negative economic and political consequences.

So, predicting the rate and scale of the fourth transition is much more difficult than many forecasts (even those with a range of outcomes) assume, because the core hydrocarbons (coal, oil, natural gas) still supply 90% of primary energy, a level which is actually higher than in 2000, when nuclear energy and hydro-power were more important contributors than they are now. In other words, assumptions that hydrocarbon dependency can rapidly decrease are simply wrong, with generations rather than decades the more likely timeframe for a significant change to occur.

Naturally, such issues cannot be divorced from those of climate change and the impact upon it of a relentless desire for growth, which underpins all modern, fossil-fueled economies. More growth requires more use of hydrocarbons, as well as of fertilizers, particularly as developing economies move up the energy use spectrum, while at the same time demanding more resource intensive foodstuffs, such as meat. These factors mean that, in the absence of what one might term a fundamental change in approach, the chances of any material near-term reduction in global hydrocarbon use actually occurring are quite remote. Some fresh breakthrough in energy technologies such as cheap and reliable energy storage would be required to shift the transition.

In reality, all predictions and models of the future energy sources and uses are inherently unstable, and better seen as no more than indicative of likely trends. Requiring or expecting certainty is simply foolish.

At Awbury, we are constantly updating our own view of over-arching trends that can have wide impact, recognizing that one has to build uncertainty and redundancy into any risk model if one is to avoid being “mentally captured” by a particularly plausible and overly neat paradigm. In other words, we have learnt to deal with entropy.

The Awbury Team


Uncritical belief can be dangerous…

The recent announcement of the actions of the SEC against various executives of Theranos (as well as the company) for alleged fraudulent behaviour towards investors had the Awbury team reminiscing about the various examples of corporate malfeasance that we have seen over the decades, and whether there are any common themes.

Of course, hindsight is a wonderful mental faculty; but, over the years, the Team’s members have learnt that, while some events come out of nowhere (Barings’ collapse in 1995 being a good example), others offer markers or warnings signs.

So, here are a few of our ”favourites”.

The smartest guys in the room were supposed to be from Enron, as they went about creating new business models and developing new financing structures. Unfortunately, it turned out that what was reported publicly was far from representing the true state of the company’s finances. Having essentially lost the trust of regulators and capital markets, the company was forced to file for bankruptcy in December 2001, and was subsequently broken up, while its auditor, Arthur Andersen, also did not survive the debacle.

A year later, Worldcom, a major US communications provider, imploded when its internal audit department uncovered massive fraud based on accounting manipulation of expenses (leading to underreporting) and inflation of revenues. Its CEO, Bernie Ebbers ended up in jail, and we have this scandal to thank for the Sarbanes-Oxley Act (SarbOx), beloved by all corporate executives.

For a little more exoticism, in 2003, it turned out that EUR 4BN of funds supposedly held in an account with Bank of America on behalf of an Italian dairy company, Parmalat, did not exist, which then led to the discovery that, at EUR 14.3BN, Parmalat’s debts were some 8 times what it had disclosed. A long investigation determined that there had been an elaborate scheme created by Parmalat’s senior executives to deceive investors about the true state of Parmalat’s finances. The irony here is that Parmalat was a decent business, which managed to survive and was eventually re-listed as a public company.

And naturally, we cannot resist mentioning that, also in 2003, Freddie Mac, one of the 2 entities that underpin the US residential mortgage market, was found by the SEC to have mis-stated earnings to the extent of USD 5BN, leading to the firing of much of its then senior management.

Perhaps the “poster child” for recent corporate fraud is the Madoff case- a scheme that would have made Ponzi proud- in which a long-respected and influential money manager managed to conceal that his investment management business had simply been paying investors returns out of their own capital or money from new investors. Disturbingly, he was only caught because he admitted what he had been doing to his sons, who turned him in to the SEC. With hindsight, the reason for his ability to generate smooth returns year-in-year out became blindingly obvious- they were fictitious.

In the case of Theranos, questions had been raised by investigative journalists about the true efficacy of its blood analysis systems, and the company also fell afoul of the FDA, so perhaps the writing was on the wall before the most recent disclosures, but it is telling that the company had still managed to retain the support of a roster of influential directors and advisers, yet had few medical professionals on its Board.

While each situation is different, there are some factors which seem to recur over time: one or more “charismatic” leaders; a lack of normal checks and balances; over-concentrated control; the use of or attempt to influence political actors and regulators; suspension of disbelief by those who should know better; over-complexity or a “story” that is a little too pat; greed and the misalignment of interests. Paradoxically, discovery often appears to be a relief for those involved, as the burden of pretense no longer has to be sustained.

The type of events described above are the stuff of nightmares for risks managers and underwriters, because they contravene the fundamental tenet upon which business is founded, which is trust. At Awbury, we are sufficiently skeptical and experienced to understand that, while one can never achieve certainty (and pretending such things is hubristic folly), one can try to minimize the risk of being caught by such events by focusing on alignment of interests, the validity and verification of track records, and the fact that if something looks too good to be true it probably is.

However, that still does not mean that we sleep soundly at night!

The Awbury Team


Good News is Bad News? Or is it the other way round?

With the “results season” for the (re)insurance industry now essentially finished, it is worth trying to discern whether there are any potential changes in direction or new trends in the long downward march in pricing on many commoditized product lines.

The good news is that the level of losses experienced in 2017 were easily absorbed and paid. The bad news is that not much has yet truly changed.

Clearly, after the third-highest Insured Loss year on record (at, say, USD 136BN) during 2017, there had been the hope that this would lead to a significant trend reversal in pricing, particularly in loss-affected lines. So far, the news is decidedly mixed, with only modest increases year-on-year during January renewals for unaffected lines, and few increases beyond the “teens” even in significantly loss-affected lines according to market intelligence and public statements from major participants trying to put a brave face on their environment. Of course, as most of the largest losses were in the US, its key July renewal timeframe could reveal a more robust trend. As Marsh stated in its overview of Q4/17 pricing, its global composite commercial insurance index may have increased in Q4/17 for the first time in almost 5 years, but that gain was only 0.8%.

So, the question has to be asked: why so little apparent change, at least so far?

One reason is surely that there is still an abundance of capital available in the reinsurance (let alone the insurance) industry, estimated at some USD 516BN at year end by Aon Benfield, with an ever increasing amount from “alternative” sources such as ILWs, CAT bonds and collateralized vehicles; and the events of 2017 do not appear to have diminished the appetite for such investment to any material extent.

Secondly, and paradoxically, the losses were not severe enough. Berkshire Hathaway’s Warren Buffett caught attention by stating that the group’s insurance businesses could withstand a USD 400MM “mega-CAT” hitting the overall market. Other market participants might be a little less sanguine about that; and wonder whether Nietzsche’s dictum that “what does not kill me makes me stronger” was something they might not wish to see tested. Of course, they might also wish to consider: “To live is to suffer, to survive is to find some meaning in the suffering”. It remains unclear whether there is a level of losses that would demonstrably cause a step-change in pricing.

A third factor, which is still whispered softly, is that perhaps demand for commodity NatCAT and other lines is not quite as robust as one might be led to believe; which then raises the spectre of too much competition for premium meeting too much capital – which usually ends badly.

Ironically, one factor that might at least begin to stem the inflow of alternative capital would be a significant rise in short to medium term interest rates, reducing the relative attraction of returns from CAT bonds, unless their own yields also rose significantly.

All of this should lead to the realization by any self-respecting reinsurer that it should be looking at premium flows which are not subject to the vagaries of NatCAT; are sustainable and predictable; and yet also provide a demonstrably superior risk/reward outcome.

At Awbury, this is our raison d’être, with our unflinching focus on credit, financial and economic risks across multiple sectors; which acts as the means of providing those sought after, longer term premium flows in areas which have minimal correlation with commoditized product lines, and continue to retain pricing power.

The Awbury Team


Artificial Intelligence- the need for Counter-AI

The term Artificial Intelligence (AI) has become something of a cultural trope in the past few years, with arguments over its potential, its dangers and the probability and likely timing of “the Singularity” (when AI overtakes human intelligence and becomes General AI) becoming more heated.

And now a report co-published by, amongst others, The Electronic Frontier Foundation (EFF- entitled “The Malicious Use of Artificial Intelligence”) sets out in some detail the ways in which those with malign intent could use and develop AI with the potential to cause great harm.

Of course, it is easy to express concern. However, the report makes cogent arguments that the risks of harm are increasing, because many AI capabilities, even now, are “dual-use”; meaning that not only can they be used for military as well as civilian purposes, but also that they have both offensive and defensive capabilities. Compounding the problem, some of the inherent characteristics of AI are that it is efficient, rapidly scalable and easy to diffuse- in that sense resembling existing software. However, various AI systems already possess capabilities beyond those of even the most capable human practitioner, let alone the average, whether in terms of speed, accuracy, or skill. So far, these systems have been constructed to be benign (or, at least, those disclosed are), but it is not hard to envisage AI systems being developed which are deliberately “weaponized” to affect digital, physical or political security.

Such issues should be of considerable concern to the (re)insurance industry, where cyber-risk is something of an obsession as a source of premium and AI could lead to more efficient processes, but where the risks posed by AI appear to have been given insufficient weight as a distinct threat vector which could affect multiple lines of business.

After all, it will be cold comfort if a “viral” video which purports to have been issued by an influential public figure and leads to, say, civil strife, property damage, or even terrorism, turns out to be a very skillful fake produced by an AI algorithm, whose sponsorship and attribution are unclear. Such occurrences are becoming ever more probable, as the impact of systems which use machine learning to create facsimiles almost impossible to distinguish from the “real thing” becomes ever more visible. It is the Turing Test gone rogue!

Additional areas in which malign AI is likely to proliferate include precision “spear-phishing”, in which individuals are targeted for sensitive information; impersonation through voice (and eventually appearance); or the creation of so-called “adversarial examples” in which those using AI (such as autonomous vehicles) are fed disruptive misinformation intended to cause damage or mayhem (e.g., car crashes.) In fact, the possibilities are probably only limited by the capabilities of the AI systems deployed.

In the face of such risks, we believe that, in the same way that counter-intelligence is a recognized discipline if the area of defence, the business world (including (re)insurance) needs to create an approach that we would term “Counter-AI”, which consists of rather more than the fashionable White Hats and Red Teams. It will require tools that can detect the onset of an AI-directed attacks in real-time, assess the nature and scale of the threat, and develop and deploy counter-measures, also in real time.

And, in the same way that (re)insurers currently audit and advise clients upon physical and cyber-security, they are going to have to extend that capability (out of self-interest, if nothing else) to try to control future loss experience, because one can envisage scenarios in which the use of malign AI could trigger a cascading series of events that could literally overwhelm the capacity of a (re)insurer to meet its obligations.

Naturally, at Awbury, given our focus on credit, financial and economic risks, we are constantly looking for evidence that the parameters of what were once “stable” assumptions are shifting, to make sure that the risks that we cover retain an appropriate risk/reward ratio.

The Awbury Team


A different lens…

We wrote recently about the World Economic Forum’s 2018 Risk Report. Now along comes another favourite, the US intelligence agencies’ annual “Worldwide Threat Assessment” (WTA), as perceived from a US-centric viewpoint. Of course, given that this is a public document, one might wonder what is left undisclosed. However, the document is instructive as, if nothing else, a signaling document.

Along with the now customary invocation of North Korea’s possession of nuclear weapons as an “existential threat” to the US, and the frequent mention of the various threats posed by Russia and China, some additional items are worth noting.

The lead-off topic was “Cyber Threats”. While much of the concern relates to criminal, state, and non-state actors trying to influence behaviour or policy, it is worth noting that attacks on commercial targets are also expected to increase significantly, as malign capabilities develop and spread (and this is in a world in which the Internet Of [connected] Things is becoming a reality). Therefore, while (re)insurers desperate to increase premium flows are focused on building their “cyberrisk” books of business, it is probable that the frequency and scale of losses will continue to increase, leading to the question of whether companies will be able not only to price for the true level of risk, but also identify and manage their aggregations effectively.

Another topic which is given less prominence, but is also of considerable interest to the (re)insurance industry is “emerging and disruptive technologies”, such as Artificial Intelligence (AI), biotechnology (e.g., artificial gene synthesis) and the creation of advanced materials, including nanotechnologies. While of great potential benefit, the scope for misuse and the lack of controls or understanding are likely to lead to new types of “events”, causing difficulties in realistic pricing and the management of such risks. There is going to be a premium upon underwriters with “hard”, specialist knowledge for those companies intending to make a serious commitment in these areas.

Interestingly, DNI Coats also went on the record expressing concern that the level of US government debt and the rise in the fiscal deficit as a result of the latest Federal Budget, coupled with political “fractiousness”, represent a serious threat to the long term ability of the US to defend itself and achieve its policy aims. “Unsustainable” was the term used. Of course, this is hardly a new sentiment or criticism directed at Congress, but the language used is unusually blunt. And one should bear in mind that, arguably, the demise of the former Soviet Union was hastened by its rising economic instability. No-one is suggesting yet that the US is going to “implode”, but the warnings are instructive; and, naturally, the outcomes that such a trend can create, if not addressed, are of considerable interest to (re)insurers, including Awbury, who are focused on credit, economic and financial risks.

Naturally, at Awbury, our focus on longer tenor business means that we are constantly conducting our own threat assessment, aiming to winnow the “interesting but implausible” from the “real and probable”, so that we can avoid “fat tails”, and continue to provide our clients and partners with value-added solutions to complex issues that benefit from the application of a different lens (or approach) to the industry.

The Awbury Team


Nothing lasts forever…

Which former US corporate icon was founded by a legendary inventor in 1892; almost failed to survive its first year; and had been, until recently, an admired stalwart of US business? It is, of course, GE.

Yet, during the Great Financial Crisis, this corporate behemoth, once an “undoubted AAA”, had to be supported by the Federal government, and the Warren Buffett imprimatur (which helped save a few more institutions during the panic and turmoil), because its financial “evil twin”, GECC (which was backed by the holding company) had become so large and over-extended that a sudden liquidity crisis threatened to cause it to implode, dragging down the industrial businesses, and threatening corporate bankruptcy. The truism that “lack of liquidity kills companies” almost claimed another victim.

Such an outcome would have shocked the entire US corporate establishment, because, if anything, GE was associated with the quality, longevity and “interoperability” of its executive cadres, graduates of the company’s famed Crotonville management training centre, whose approach and seeming success others aspired to. The belief was that a GE management education equipped one with the ability to manage anything. Perhaps, someone should have pointed to the example of Robert McNamara (one of the products of Ford Motor Company post-WW II “Whiz Kids” generation) as an indication that there are limits to such capabilities, and that very few individuals are true “practical polymaths”.

In fact, one could argue that, partly because of the lack of trenchant criticism of its conglomerate approach, and the intimidating reputation of GE leaders such as Jack Welch, those who should have questioned the rate of growth and over-leverage of GECC, were unwilling to do so: the facts spoke for themselves, until they didn’t.

And now, following the recent debacle of its need to create billions of dollars of reserves and charges in respect of its legacy reinsurance exposure to US long term care obligations (GECC strikes again- a sting in the tail, if ever there were one!), the once unthinkable is being contemplated- the break-up of GE into 3 or more businesses.

However, anyone who feels a touch of schadenfreude at such a potential outcome, would be remarkably foolish. Adapting to change and carefully managing risks are essential for long term survival in any entity; and GE has survived at scale and through successful adaptation for far longer than most (although it is not remotely the world’s longest surviving business). However, its more recent history shows that, when there is a loss of focus and discipline, bad things can happen; with seemingly invincible enterprises forced to face the possibility of painful restructuring, fragmentation, or even demise. Their executives no longer have the unquestioned “magic touch”.

Awbury Group is only in the second half of its first decade as a business, and we certainly have no illusions of grandeur. Rather, in order to create a sustainable business model, we are relentlessly focused on honing what differentiates us from commoditized (re)insurance businesses, recognizing that adaptable specialization is one way of maintaining an edge, yet remaining paranoid about avoiding complacency and shifts in our operating environment.

The Awbury Team