It’s complicated…

To say that the timing, swiftness and apparent ferocity with which several of its neighbours recently ganged up on Qatar was something of a surprise would be an understatement, while the consequences are potentially de-stabilizing for the wealthy states that adjoin the western side of the Persian Gulf.

It is one thing for violence and mayhem to roil Syria or Yemen, in which complex proxy wars have caused untold misery and suffering; quite another for one supposed US ally (Qatar, which hosts a major US air base at Al Udeid) to be vilified and ostracized by several supposed other allies, including Egypt, Saudi Arabia and the UAE.

So, the questions that arise include: “Why; why now; and what will happen?”

Ostensibly, Qatar is accused of supporting terrorists and terrorism, and of being a little too friendly with the Saudi bete noire, Iran. However, there is more to it than that. The Al Jazeera network has long provoked the regimes of Qatar’s “neighbours”, while Qatar’s support of the Muslim Brotherhood (an example of political Islam) frightens those, such as the Egyptian autocracy which supplanted it. One of a new list of demands includes the closure of a Turkish naval base, leading the Turkish government (which is already helping the Qataris to evade the boycott) to state that it is contemplating “enhancing” its presence (with Turkish tanks recently parading through Qatar). Qatar is also being told to surrender all “designated terrorists” on its territory, which seems more like an attempt by various regimes, which have little respect for due process, to get their hands on annoying opponents.

One trigger may have been the alleged payment of a huge ransom to the kidnappers of a Qatari hunting party in Iraq, with the funds said to have been paid to terrorist groups; but one senses that this, even if true, is cover for the desire to bring to heel a regime that has proved rather too independent for its adversaries’ taste, and an attempt to curb the influence it has wielded as a result of the wealth generated by production from its enormous natural gas reserves.

Of course, whatever the true cause(s), (and one cannot say that Qatar is exactly an “innocent” in all this), what really matters is what the potential consequences are.

It seems unlikely that the Qatari regime will simply give in to the demands being made upon it, as the “blockade” is not yet that effective given Qatar’s ability to use alternative supply lines and the fact that the Turkish government is openly supporting it. Similarly, as its main source of wealth comes from giant gas fields operated jointly with Iran, it will not wish to jeopardize that relationship. The Trump Administration has, so far, given no real indication of its intentions (even if there is speculation that it tacitly encouraged the Saudis to take action) and certainly appears to have no interest in “banging heads” in order to resolve the stand-off. As a result, the chances are increasing that one of the numerous parties involved, directly or indirectly, will act in a way that triggers an escalation in the conflict, even if that is not the intention. A bilateral argument is one thing; a complex, multi-lateral one entirely another.

So, the situation bears watching closely because of its potential for causing armed confrontation between US allies, which will, no doubt, delight the Iranian regime and give it more latitude in its continuing proxy wars elsewhere.

At Awbury, we always monitor such events, because we are looking for second order effects, and are well-versed in how seemingly modest acts can create a cascade of outcomes that can change seemingly stable environments into chaotic ones.

The Awbury Team


Orthodox or Heterodox?

In the realm of business, there is a tendency to believe that every decision must be the result of a rational and explicable process, that is based upon a proper review of all the essential factors.

Would that it were so.

Many large bureaucracies and corporations appear to be managed on the basis of avoidance of regret or blame. As long as one does not stand out, one cannot be blamed or held responsible for an outcome- hence the tendency for “herding” in much of the financial industry. Similarly, what are actually emotion-driven decisions (the “gut” gone rogue) are rationalized ex post facto, because that is a classic human behaviour. Impulses become “decisions”.

And yet, ironically, if an entity miraculously, and after huge effort, becomes completely rational and efficient, it runs the risk of becoming too predictable in its behaviour and thus vulnerable to being out-competed and ultimately superseded by others. “Keep them guessing” is actually quite an effective tactic. So, there is a paradox (which may also have ramifications in the realm of Artificial Intelligence) in that human beings, no matter how rational they may appear or claim to be are somewhat random in their behaviour and decision-making; and if they become too rational and predictable they become more vulnerable.

This is not to excuse “corporate decision-making” that has no explicable basis; but rather to point out that, given that almost all corporations are still formed of individuals, with their own prejudices and biases, one should not expect, nor even desire “perfection”.

What then is any self-respecting CEO to do to reconcile the several contradictions? Should one be orthodox or heterodox?

If one looks at the nature of really successful organizations, they tend to have a structure, business model or culture which differs from that of their perceived peers or competitors, and which is focused on the longer- rather than the shorter-term, while also being adaptive. In many publicly-quoted businesses, the so-called shareholder value movement is actually detrimental to the business’s sustainable performance, because it tries to place constraints on the management of a business, and can lead to what amounts to sociopathic, or even psychopathic behaviour on its part. Ultimately, value is destroyed, not created.

So, the thoughtful CEO has to create a structure in which the rational, process-driven, more formal approach to decision making is combined with a less structured more creative one, while managing the inevitable tensions that will arise, as different interests compete for dominance. While structure matters, flexibility and adaptability are essential. Of course, the less confident CEO may feel the need to call in the consultants to “validate” his or her approach, which ironically almost invariably leads to the outcome that should be avoided; namely, conforming to the consultants’ belief that “their” approach works, because it is “best practice”- thus creating an unfortunate “orthodoxy”.

At Awbury, we believe that the only real test of a particular approach is whether it demonstrably creates sustainable value; and differentiation from the crowd. We have built a business on being heterodox, not orthodox; because the latter approach has a tendency to produce “orthodox”, or mediocre outcomes.

The Awbury Team


Spanish Popular-ity…

Overnight on Tuesday 6th June, medium-sized Spanish bank, Banco Popular, having suffered a “run” on its deposits and notified its regulators that it would struggle to open for business, was swiftly declared to be in danger of failure; put into resolution; and sold for a nominal Euro to Banco Santander.

Apart from the fact that this was the first true exercise of the new EU bank resolution regime (even if some argue it was not the “full-on” version), a number of aspects of what occurred are interesting.

Firstly, the event occurred some 10 years after the onset of the Great Financial Crisis, demonstrating that, even in economies such a Spain, which have begun to recover from its impact, banks can still fail because of the burden of their legacy portfolios. So, not surprisingly, questions are being ask about whether and how the resolution mechanism should be applied to ailing banks in Italy.

Secondly, unlike the politicized and botched shambles that constituted the “rescue” of the Cypriot banking system (and let us not even talk about the Greeks!), in the case of Banco Popular, the process worked remarkably swiftly and smoothly, within a space of 24 hours (and not even over a weekend.)

Thirdly, regulators wiped out the equity holders of the failing bank and all Euro 2BN of its subordinated bond holders, yet the contingent capital or “coco” market barely flinched.

Fourthly, there are concerns now about the health of a much smaller Spanish bank, Liberbank- perhaps because some “scent blood in the water”, and are looking for the next target. Thus, it will be interesting to see how the Spanish Central bank and the ECB address the risk of contagion.

Banco Popular, is by European standards a relatively small bank, so one cannot say that the “too big to fail” concept was tested. Nevertheless, unlike Italy, where there remains a continuing reluctance to allow even small banks to fail (largely for political reasons), the Spanish authorities have demonstrated that they can and will take action.

Of course, the real test will come when the resolution of a bank requires not just losses being imposed on equity and subordinated debt holders, but further up the liability structure on senior debt holders, or even depositors. Nevertheless, the swiftness of the exercise (given the number of parties involved) and the avoidance of having to use public funds are commendable, even if one can properly ask questions about why regulators had not imposed capital-raising requirements earlier on Banco Popular.

Returning to Italy, time may be running out for 2 banks in particular, Banca Popolare di Vicenza and Veneto Banca; as, if agreement is not reached by the end of June between the Italian authorities, the ECB and the EU, they too may suffer the same fate as Banco Popular.

And before those in the UK become too smug, bear in mind that UK banks are still subject to the EU Bank Resolution and Recovery Directive (BRRD) and its stipulation of haircuts on bank’s liabilities of up to 8% of their total before public funds may be used; and that Co-operative bank is struggling to raise capital and impose losses on its bondholders, making it too vulnerable to being “resolved”.

At Awbury, we have long worked closely with banks in helping them manage their capital and address problematic portfolios, which is why we always pay close attention to such events, as well as the potential impact of political and regulatory actions.

The Awbury Team


Well, Tech me…

Everything seems to be acquiring a “-tech” suffix these days- perhaps in the hope and expectation of achieving that mythical “unicorn” valuation status? After all, what’s the odd billion dollars these days? 10 digits is so last year!

The (re)insurance industry has “insuretech” (or is it “insurtech”?), while reinsurers should perhaps try to popularize “re-tech”, but the definitions and scope are somewhat slippery, because it can be difficult to distinguish what is the truly disruptive from the merely incremental.

Certainly, business models are having to adapt, or risk becoming obsolete, but what should the test be to distinguish evolution from revolution- the “It’s (re)insurance, Evan, but not as we know it” moment?

It seems to us that any major (re)insurer CEO should already be paranoid, and trying to create an in-house “skunk works”, populated by those who possess a range of aptitudes and knowledge, and who are given licence to challenge and question received wisdom. Of course, managing and controlling such an operation will be an interesting exercise in avoiding bureaucratization, while at the same time channeling outputs in ways that can be profitably harnessed and developed.

More to the point: what should the focus be?

Should it be on products; the uses of AI; re-engineering processes, such as claims; enhancing risk selection and pricing; cost reduction; or risk management? “Framing” is likely to be an issue, as true disruption and innovation tend to come from those who are able to think without constraints and truly imagine something that does not yet exist. On the other hand, the current state of the industry means that there are surely plenty of “soft” targets that should provide the opportunity for creating value. After all, it is surely madness that costs in the London Market exceed 41% of every 100% of premium paid, or that literal “manuscripting” still exists.

And yet, (re)insurance is a very large and complex industry; and, like banking, an essential component of any modern advanced economy. So, can the potential disrupters challenge the industry as a whole, or just segments of it? And who is likely to have the more defensible business model? Clearly, those who are able to harness “insuretech” to improve their processes and returns will prevail over those who do not or cannot. In that sense, resistance is futile, but being part of the collective is likely to be a losing proposition.

One key question is whether the new participants will be seen as competitors or partners; as the established companies will probably struggle to distinguish between the two. Quite clearly, at the one extreme, a start-up such as Lemonade is a direct competitor, whereas a firm that focuses on part of the value chain, such as claims-processing, is more a partner; and, as we have written before, what if the likes of Alphabet or Amazon make a serious effort; Facebook aims to create “affinity” groups; or Tesla bundles insurance into a service package? And what of all the intermediaries who still proliferate and aim to take their cut? Many of those seem likely to be dis-intermediated!

Ultimately, the factor that is most likely to distinguish between those who survive and prosper and those who fade away, or are replaced, is the ability to create value that addresses the client’s needs. People will aim to pay as little as possible for something they can “buy” anywhere (such as commoditized covers in the P&C realm), but will pay a healthy premium (in both senses) for products, solutions and structures that enhance their competitiveness, or mitigate their risks in ways that have hitherto not been possible.

At Awbury, while being a true value-added insurance company, we are also generators of intellectual property- just like the “techies”.

The Awbury Team


Wash my car…

The “Lava Jato” (Car Wash) bribery and corruption saga continues to unfold in Brazil, with its impact and scope seemingly ever wider, giving the impression that corruption must be endemic throughout the Brazilian economy. Debate continues as to whether it is merely the largest corruption scandal in Brazilian history, or in the world.

The catalogue of politicians and business leaders who have been implicated or toppled from power is, indeed, extraordinary, with the current President at some risk of being impeached and removed from office because of his own alleged involvement in at least condoning bribery.

And all this has taken place against an economic background that has seen Brazil suffer its worst recession since the Great Depression. So Brazil must be an economic and political “basket case”, não?

Well, not so fast. The Brazil of today, with all its faults and issues, is not the hyperinflationary and autocratic state it once was, well within living memory.

Firstly, in spite of seemingly never-ending setbacks, the economy has begun to crawl its way out of recession in the last quarter, growing by 1% after 8 consecutive quarters of contraction, helped by a bumper soybean crop.

Secondly, the state’s government and governance structure has not collapsed. While the extent of political corruption may be astonishing, the judiciary has become relentless in investigating and punishing it; while those in power have not been able or effective in thwarting due process, even if some have tried. The previous President was impeached and her iconic predecessor, Lula, was himself unable to resist investigation for corruption.

Thirdly, in a world in which demand for protein in all its forms is rising inexorably, Brazilian agribusinesses produce what the world wants, even if they can fall victim to scandals over tainted meat, or the vagaries of commodities pricing.

Fourthly, the Federal Government has begun to reform the ridiculously expensive pensions system, and other areas of government expenditure. There are no certainties, but the fact that the attempt has been made in the face of political turmoil, recession, and a complex parliamentary ecosystem does show that there is room for some sense of “what needs to be done” to prevail.

Fifthly, Brazil is much less vulnerable than most to a currency crisis, as barely 2% of its sovereign debt is denominated in foreign currency.

Sixthly, the central bank is competent and appears free from political manipulation.

Of course, none of these factors means that the future is certain; but, as always, the negative weighs upon perceptions more than the positive, affecting judgements made and actions taken. We would never say that there is no risk in Brazilian exposure, but we do believe that one has to take into account all relevant factors to create an informed decision.

At Awbury, we are constantly monitoring, assessing and re-assessing the key political economies across the globe, looking for connections and correlations that could have an impact on the business we write, so that we can create effective mitigants that will minimize the risk of an unexpected outcome. It is all part of our obsession with effective risk management.

The Awbury Team


So, you think you are real…

So, you think you are real…

The phrase “but in the real world” is one that is intended to convey that the speaker is asserting that his or her knowledge and experience are in contrast to a statement that contradicts or ignores reality.

Yet, what is reality?

In a world in which artificial intelligence and “virtual reality” are being incorporated into ever-widening roles or functions, how can anyone be certain that they are dealing with “the real”? What are the boundaries? After all, the famous Turing Test posits that, if a computer can convince a human interlocutor that its behaviour is indistinguishable from that of a human, it has, at least to some extent, artificial intelligence.

And if an artificial intelligence is a form of artificial mind, and virtual reality is an artificial world, and we humans interact with both, arguably we are making them real, because we are incorporating them into how we act, think and behave in what we term the real world. Descartes used his “evil demon” thought experiment to raise the possibility that everything that we think is real is, in fact, an illusion; while there are a number of high profile individuals in the world of technology who also raise the question of whether our entire world is a construct of some vastly superior civilization- think The Matrix on a cocktail of LSD and steroids!

To add to your sense of disassociation, if a simulated world is just a world produced by digital information, and human beings are the product of the digital information encoded into our DNA, to what extent can we say that we are “real”? If we are simply “code”, then that code could be uploaded into a different environment. After all, work is already under way on giving an individual the chance of immortality by uploading his or her mind into an electronic storage system, enabling an emulation that would supposedly run much faster than it does on the messy biological version we have now (now, apparently, the “meatspace”). Of course, all this begs the question of “Quis custodiet ipsos custodes”- who will keep an eye on those in charge of the process?

Before, Dear Reader, you think that the Awbury Team has completely “lost it”, there is a serious side to all this seemingly hallucinogenic sophistry.

All reality, including yours and ours, is grounded in information. Whether we live in a Newtonian or quantum mechanical world, the underlying physics is grounded in information, yet also real; based upon models created by individuals and validated by observation and empirical testing (until a better representation refutes it!) However, as more and more economic and social activity switches to the “virtual and cyber world”, the boundaries between what is real and what is not become increasingly blurred. As such, the nature of risks will become increasingly “virtual”; influenced by events or environments that may not be “real” at all, or only partially so.

Therefore, Awbury’s ability to continue to succeed and remain relevant is based not only upon remaining grounded in the real world, understanding its nature and boundaries, but also in being able to conceptualize “virtual” risks, and construct, manage and understand the appropriate range of models that will enable us to identify and assess opportunities and risks in all their forms. We just have to avoid allowing the models to appear so elegant, self-referential and perfect that they distract us from the fact that our world, whether real or not, has limitations and boundaries in terms of what we humans can perceive. Some factors may simply not be capable of observation, so one has to make assumptions grounded in reality- whatever that is!

The Awbury Team


Comparative Advantage or Cumulative Disadvantage…

The Ricardian concept of comparative advantage (now some 200 years old) is a long-standing component of economic models; and supports many elements of public policy, such as the benefits of international trade making all the parties involved ultimately better off.

In contrast, the economists Angus Deaton and Ann Case have begun to articulate what one might be termed (with apologies to them both) a theory of cumulative disadvantage, as the result of which whole segments of a population group are effectively condemned to perpetuate a cycle in which its members are constrained from reaching their potential by a range of cultural, societal, educational and health factors.

Perhaps fancifully, we thought we would consider these two concepts in the context of the (re)insurance industry; and highlight some potential contrasting outcomes. Sentiment as to whether companies should specialize, or seek to provide as broad a range of products as possible tends to go in cycles; but what, in a (re)insurance company is a true comparative advantage? We would argue that it is the ability to write business that consistently generates high quality, risk-adjusted premium income, where losses are carefully controlled and manageable. Sadly, as results over the past few years have shown, as in 2016 when the US industry suffered a cumulative underwriting loss, far too many businesses are unable to differentiate themselves, with the result that a “good outcome” is now being able to keep one’s Combined Ratio below 100%. If one thinks about it, it is rather odd that a business should consider itself lucky to break even in the application of what is supposed to be its core competence. Where is the comparative advantage in that?

And to compound the lack, in most cases, of a comparative advantage, we shall move on the cumulative disadvantages now “enjoyed” by most (re)insurance industry participants. The continuing surfeit of capital seems to compel many to find a use for it, or contort their business model so that they do not “lose out” (think of the asset management industry’s obsession with “Assets Under Management”), which leads to erosion of discipline and being picked off in terms of pricing available in commoditized business lines. Add to this a byzantine and often opaque cost structure, which can consume an inordinate share of the revenue stream; the potential for disruption by actors who have no attachment to received wisdom and are willing to ignore “standard practice; plus uncertainty about the likely loss experience of new business lines, such as “cyber” and one has a reasonable facsimile of cumulative disadvantage.

How then to break the cycle?

Comparative advantage is only relevant if the underlying activity in which one engages is sustainably profitable. Clearly, it makes no sense to be the best there is in a particular industry if the core activity results in value destruction, or fails to earn its true cost of capital . So, the need exists for the P&C (re)insurance industry to consider some deep and fundamental changes to its business model if it is to overcome cumulative disadvantage.

We’d be more than happy to explain our interpretation of comparative advantage!

The Awbury Team