Retaining mastery is not easy…

It seems so long (1987!) since Tom Wolfe mordantly mocked the then “Masters of the Universe” in his novel “The Bonfire of the Vanities” (which in turn derived from an event that Savonarola instigated in 1497 in late Quattrocento Florence, in which objects considered sinful were burned. Ironically, he ended up burnt at the stake). Of course, Masters of the universe come and go; and the term these days would probably be considered to refer to those controlling huge pools of hedge fund or alternative capital.

Whatever their origins, these individuals seek to exploit economic, market and other discrepancies to compound wealth over time. Some opportunities last for years, if not decades, while others disappear almost as soon as they arise.

However, any Master of the Universe would have to be foolish to believe that change will not come; even as the economics on which they rely is still struggling with the fact that its models very often do not accord with reality. Even the acolytes of the dismal science cannot agree upon what exactly it is a “science” of, and which are the most appropriate models to create and use.

At least part of the problem would seem to be that, rather strangely, money itself (and, by extension, much of finance) is often largely ignored- almost as if the “Masters” hardly existed- while economic models also tend to be linear.

It is certainly arguable that in the real world the economy is quantum and indeterminate in nature (until measured), with many discontinuities.

Interestingly, some 90 years ago, Keynes himself (JMK Vol 10, p262) wrote: “…the whole is not equal to the sum of the parts, comparisons of quantity fail us, small changes produce large effects, the assumptions of a uniform and homogeneous continuum are not satisfied.” It would seem that he recognized that economies are inherently subject to discontinuities and dislocation. Bear in mind that this was stated before the onset of the Great Depression.

The situation is compounded by the fact that economic theories generated by those seen as being authoritative can become quite pervasive, particularly if they seem to benefit a powerful constituency- Neoliberalism and Monetarism being prime examples in. This can lead to them persisting, little questioned, until the onset of the next discontinuity or heterodoxy (which brings to mind The Byrds’ iconic anthem “Turn, Turn, Turn” from 1965) leads to them being overturned. As Max Planck famously said: “A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it.”

To continue to prosper, the Masters must constantly refine their business and economic models, as their environment changes. Complacency is the “kiss of death”.

At Awbury, we would in no sense regards ourselves as Masters of the Universe. Instead, we sustain and build our franchise by understanding that, while our product lines are designed to retain their value for the long term, there will always be discontinuities; and that we need to maintain our vigilance at all times in order to avoid disappearing into the proverbial black hole.

The Awbury Team

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It’s All Connected…Grey Rhinos and Black Swans…

Of course, we could be referring to Gaia Theory, but we are not. Rather, it is the time of year when the World Economic Forum’s (WEF) Global Risks Report (GRR) appears (http://www.oliverwyman.com/content/dam/mmc-web/Global-Risk-Center/Files/the-global-risks-report-2018.pdf), containing graphics that look like bricks in a wall or psychedelic mandalas.

In fact, the document is a useful one in a number of ways. Firstly, it provides some evidence of how others are thinking about risk; secondly, it contains an extensive catalogue of risks in terms of their potential impact and severity; and, thirdly, it allows the reader to consider not only whether he or she agrees with what is set out, but also what may have been missed or mis-categorized. There is always the danger of being caught by “framing” issues and failing to think beyond the Report’s contents; but, at Awbury, we aim to challenge the “usual approaches” and assumptions.

The Report does emphasize a key point; namely that one should not look at risks in isolation. This may be a truism, but the tendency towards “silos” within the (re)insurance industry (and many others) appears to be as strong as ever. In one sense, that is rational, as focused expertise should produce better outcomes in a particular business. However, an unwillingness also to consider factors beyond those clearly a component of a particular risk can lead to unfortunate outcomes, as connections or linkages are missed, often because of our cognitive biases.

For example, on the one hand we may obsess about a perceived risk because it comes immediately to mind and worry about Black Swan Risks which, by definition are not predictable, while on the other discounting Grey Rhino Risks (a term given recent currency by author Michele Wucker). The latter are risks which should be obvious (but are often neglected), can appear swiftly and are high-impact. The potential fragility of the PRC’s financial and housing markets is certainly one “rhino” that gives its government pause, but the question remains as to whether it will be willing to tackle the underlying causes effectively, or employ the tactics of another member of the financial menagerie, the Ostrich.

Rising income inequality is another “rhino” candidate. One can argue that the period following World War II was an aberration in terms of a more equal wealth and income distribution and the reduction in absolute levels of poverty. However, in our inter-connected world perceptions matter, because they can now be transmitted (and acted upon) almost instantaneously. Political systems appear to be stable and predictable (all those “checks and balances” and “social contracts”, or long-standing autocratic norms), until they are not.

And what of the fact that it is still “too quiet out there”? In the face of repeated surprises and shocks, one might expect financial market volatility to be higher, yet many measures remain at or near their lows, and equity indices march ever upward, beckoning more momentum trades, or Fear of Missing Out. If new narratives have to be developed to explain the “reasons” (remember the Dotcom Bubble?), it is unlikely to end well once sentiment changes, giving a different meaning to The Thundering Herd.

One needs to avoid availability bias (things that immediately come to mind, or are recent) and remember Sun Tzu’s aphorism: “If you know yourself and know your enemy, you need not fear the result of a hundred battles”. Risks do not usually exist in isolation, nor arise in convenient sequence, so one always needs to maintain vigilance and look for the connection between the seemingly disparate.

The Awbury team is definitely battled-tested, and we would welcome the opportunity to share our ideas.

The Awbury Team

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Look out for the Technicals…

No, we are not thinking of the improvised and brutally effective instruments of war popular in the Horn of Africa, but rather the ever-present issue of whether or not pricing in the (re)insurance markets adequately reflects the risks being accepted, or have sunk below the “technical” levels at which even the (re)insurers’ models say that a net underwriting loss is more than likely.

After the surge in insured catastrophe losses in the second half of 2017 (with Swiss Re Sigma and Munich Re tallying overall 2017 insured losses at around USD 135BN), there had been some hope amongst beleaguered and battle weary underwriters (suffering from PTSD- Premiums [are] Tanking Still, [we’re] Doomed) that the “1/1” renewal season would see sustained increases across the board in NatCAT pricing. However, this has proved to be largely a chimaera.

Ironically, the fact that ILS and other alternative capital sources (estimated by AON Benfield at some USD 82BN at end of Q3/17) responded in a timely manner, when coupled with more than adequate “traditional” reinsurer capital of some USD 518BN (so, USD 600BN in all), resulted in buyers often being able to call the bluff of underwriters holding out for significantly improved rates. There is now certainly a case to be made that ILS and other sources of “alternative capital” are to “traditional” (re)insurance as US tight (or shale) oil are to OPEC- i.e., the new form a swing producer, setting a cap on the ability of the market as a whole to sustain prices outside a range.

There were some exceptions, but most non-affected business lines appear to have stabilized at best in terms of pricing, with rates for severely-impacted North American policies managing to eke out increases, but even “double digit” increases hardly compensate for the loss of, in some cases, years of profits within such a short space of time.

Of course, NatCAT (re)insurance did exactly what it is supposed to do, providing capacity in an orderly, if at times, frenetic renewal process. However, that is cold comfort for managements and investors whose visions of the long bear market in rates ending appear to have been badly disappointed, as initial reports from leading brokers such as Willis, Aon Benfield and JLT have consistently emphasized- and this in an environment in which investment returns on the standard, fixed-income-heavy P&C asset base remain constrained; and in which the ability to continue with reserve releases is also diminishing.

All this then begs the question of how (re)insurers will respond. The search for new premium sources is likely to continue unabated; sub-scale businesses with no comparative advantage are likely to continue to be “prey”; and, yet again, executives will mouth platitudes about maintaining their “disciplined” underwriting processes, as they seek desperately to differentiate themselves from the average (which is still close to the median.)

New thinking and paradigms are desperately needed if the industry is to move, in developed markets, away from its strong correlation with overall GDP growth. Can Bitcoin Re be long in coming?

At Awbury, we are fortunate in having no “legacy” issues or processes, but our success continues to be based upon delivering to our partner (re)insurers, significant high quality, non-correlated premiums with excellent loss experience, and upon our ability not to be constrained by traditional approaches.

We cannot be a panacea, but we can help provide new sources of business.

The Awbury Team

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But what if I’m wrong?

This phrase should be emblazoned on a plaque placed on every risk underwriter’s wall, and used as a mantra to guard against the complacency and the smugness that can come from being far too comfortable with one’s intellectual prowess, and the knowledge which one has gained through long experience.

As Socrates is supposed to have said (as attributed in Plato’s Apologia): “…he thinks he knows something when he does not, whereas when I do not know, neither do I think I know”.

We seem to live in a world in which it is essential to have an answer (the answer- and immediately) to every issue, problem or question; with any uncertainty or hesitation being seen as a sign of weakness. All too often, underwriters and senior executives can become caught by the fear of seeming weak and indecisive if they do not project certainty and confidence, when everyone else thinks “X” is a good risk. After all, if “everyone” thinks so, it must be, mustn’t it?

It takes courage to admit doubt and to go “contra the herd”.

So, we have a paradox. On the one hand, being self-questioning is a key attribute in developing sound judgement; yet, on the other, one is expected to move rapidly towards an effective decision.

In this context, it helps to establish a framework of mental models and techniques that one can apply to overcome both the hubris of certainty and the spectre of decision paralysis, while minimizing the risks of a really poor outcome. Call it a form of mental triage.

The legendary Charlie Munger is a vocal proponent of the need to have a framework of mental models readily available in order to maximize one’s ability to make the right decision. And, as his partner Warren Buffett also said: “Outstanding long-term results are produced primarily by avoiding dumb decisions, rather than by making brilliant ones.”

Of course, the catalogue of such models is very extensive. However, at least in the realm of (re)insurance, a handful would appear particularly relevant.

Firstly, inversion. Rather than asking what is the best or most likely outcome; ask instead what would automatically produce the worst outcome and try to avoid it. One would hope that any risk manager considering aggregations would find this approach useful, in fact essential. A corollary of this is maintaining objectivity by challenging one’s initial opinion by seeking evidence that would disconfirm it.

Secondly, emergence. The interaction of lower-order factors or components can often lead to the emergence of an outcome that is non-linear, and not easily predictable from its component parts. One could, in a sense, refer to these as tipping points, where the rate of change rapidly increases with potentially disastrous consequences. So, one has to look for linkages that may not be obvious.

Thirdly, irreducibility. While the goal of simplification is an admirable one, at some point continuing the attempt becomes counter-productive and potentially misleading, because the model for a risk and its components have become irreducible.

Fourthly, Bayesian updating. This has a formal mathematical model; but, for practical purposes, requires one to take into account new information as it arrives in order to update one’s assessment of the probability of an outcome. Given that the world is largely non-deterministic, this is essential if one is not to become “stuck” in an outdated and potentially fatal model.

There are, as we said, many more, and we aim to return to the topic in a future post. None of this is exactly “rocket science”, and it will be seen that there are overlaps between the four models briefly described. Nevertheless, it is surprising how often individuals fail to analyze and reflect upon why they should or did make a certain decision. At Awbury, we debate constantly how we can make an effective and rational decision based upon the information available to us, being well aware that no single approach can or should be considered the “only way”. “Received wisdom” can easily become a trap.

The Awbury Team

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Kafka and insurance…or, I’ll have a manuscripted poem with my policy…

Readers will, no doubt, be familiar with at least a couple of the works of Franz Kafka- The Trial and The Metamorphosis- but may not realize that he spent much of his short working life in insurance- in particular for the “Worker’s Accident Insurance Institute” of the then Kingdom of Bohemia, from which he retired because of ill-health in 1922. Workers’ Compensation insurance is not exactly a new concept!

We mention this because the world of (re)insurance is often regarded as a soulless, dispiriting space. This is unfortunate, because its existence underpins much of what enables modern societies to function. In essence, the industry has to try to navigate through chaotic systems and manage the risks that flow from them, often with imperfect information. Its existence underpins the ability of economies to create value, because risks of loss are mitigated through the medium of (re)insurance.

Much closer to our Greenwich, CT base, Wallace Stevens, a highly-regarded, Pulitzer Prize-winning 20th Century American poet (“Money is a kind of poetry”), spent his career at The Hartford, even turning down the offer of a professorship at Harvard. Make of that what you will, but clearly Stevens’ poetic abilities were in no way constrained by being a lawyer in the insurance industry. As research, we read perhaps his most famous poem (from the collection “Ideas of Order”) entitled “The Idea of Order at Key West” (https://www.poetryfoundation.org/poems/43431/the-idea-of-order-at-key-west). Even the title creates an interesting juxtaposition, given the poem’s focus on “The ever-hooded, tragic-gestured sea”.

Perhaps equally surprising is the fact that Dashiell Hammett (creator of Sam Spade) was a private investigator for insurance companies- “I don’t mind a reasonable amount of trouble” makes one wonder about his investigation techniques.

The fundamental point of these three facts (which are referred to in Mihir Desai’s’s “The Wisdom of Finance”) is that while, as with much of finance, (re)insurance is somehow perceived as being separate from the real world, with an often poor reputation, in reality its existence helps rebuild shattered businesses and lives by providing protections, and solutions to needs. One has only to consider Shakespeare’s “The Merchant of Venice” to understand the consequences of the lack of a decent Marine policy.

So, next time you feel like complaining about the cost of your insurance protection, bear in mind that, without it, you would not be willing, nor would even be permitted to run a business; and that in the commoditized NatCAT area it is still probably far cheaper than it should be!

Of course, there is an art to understanding and addressing a client’s needs; and at Awbury we believe strongly that being creative in designing and executing on carefully crafted solutions is an essential part of our franchise. We may not be poets (and shall refrain from subjecting you, Dear Reader, to any specially-composed doggerel), but we know that what we do requires imagination and creativity.

And we shall finish with a quotation from Kafka: “Start with what is right, rather than what is acceptable”.

The Awbury Team

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Born to be Wild…(with apologies to Steppenwolf)

This year, it will be 50 years since the Summer of ’68 (Here’s to you, Mrs. Robinson…), when red bandanas were the height of street-fighting fashion, access to a ready supply of cobblestones essential, the cocktail du jour was a Molotov, MAD was not just a comic- and the Viet Cong’s Tet Offensive provided clear evidence that the Viet Nam War was not necessarily going America’s way.

Why should we mention this?

Because, while 1967 was the Summer of Love, soon thereafter, in 1968, the world appeared to be a more dangerous, restless and uncertain place; and yet, in spite of all the fears expressed then for the future, we are still here.

Of course, it had become rather difficult to find much sense of the positive in 2017, given all the governmental oppression being inflicted in too many parts of the world; and it is clear that the “mood” within many unfortunate polities remains dark and full of foreboding; whilst the series of fires, floods hurricanes and earthquakes in the second half of the year simply added to a feeling of malaise.

So, in the face of all this gloom, we thought we would point out a few items that may give one some hope for Humanity at the start of a new year, if only in the short (non-geological time) term. We hasten to add that the Awbury Team has not suddenly begun self-medicating with hallucinogenics. Rather, we always try to take a measured view of risks in terms of both their probability and severity, even if we cannot quite bring ourselves to subscribe to “world without end”.

– The US and the EU economies are growing robustly in real terms, with no immediate signs of a recession
– Real interest rates remain at close to historically low levels, yet in most major economies inflation remains relatively in check
– While still quite volatile, the price of crude oil has settled into a range that most producers and purchasers can tolerate
– At the same time, the shift towards less carbon intensive fuels gathers pace
– The (re)insurance markets have demonstrated their robustness in face of a significant deterioration in NatCAT loss experience
– The Brexit negotiations have not yet gone off the rails, and there are signs that some sort of rational negotiation will finally take place
– The majority of the planet has begun to take the threats posed by global-warming seriously
– Developments in analytics, machine learning and AI continue to generate potential new paradigms and opportunities
– The number of people globally moving out of abject poverty continues to rise
– Star Wars: the last Jedi shows that all is not lost…
– Winter may be coming (in the Northern Hemisphere), but it will end

And while at Awbury we are never complacent, we continue to have a robust pipeline of business across our franchises, which we aim to execute upon and continue to build with the support of all our valued clients and partners.

With best wishes to you, Dear Reader, for good fortune in 2018.

The Awbury Team

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It seemed like a good idea at the time…

At Awbury, our business model is built on the concept of adding value in providing solutions to the credit, economic and financial issues which our clients bring to us- a very different approach from the flow-based, commoditized, cost-plus one which still tends to prevail in much of the (re)insurance industry (let alone elsewhere.)

Scale may be a wonderful thing, but only as long as it creates sustainable value. This is why it seems odd to us that large-scale M&A activity designed to create scale rarely seems to manage to improve Combined Ratios; with the attrition of cost bases and reserve releases only serving to beat back the impact of softening pricing and the disruption coming from “InsureTech”, as the industry struggles with excess capital (even after Q3/17) and the unwillingness of many participants to “walk away” from pricing that is below the so-called “technical reserve” level. Although the events of Q3/17 have raised hopes that pricing trends in the affected NatCAT markets will turn upwards, the evidence remains mixed as the renewal season approaches its end.

The corporate world in general is littered with spectacular examples of value-destruction (leaving aside the truism that the majority of mergers or acquisitions fail to deliver on their supposed benefits)- AOL/Time Warner and Rio Tinto/Alcan come to mind. Both were considered “good ideas” in their time, but turned out to be spectacularly bad in terms of creating value. It will be interesting to see how the AT&T/Time Warner and Disney/Fox transactions turn out. And consider that Shell has accepted the fact that its purchase of US “tight oil” assets near the height of the last oil-price peak was a very poor decision, and now seeks to unload them in some way that at least saves face.

So, why do such events occur with monotonous regularity, when patience and discipline in building one’s existing business would be more likely to preserve and create value?

There can be no single answer to this, but it seems reasonable to assume that senior executives and Boards are susceptible to the blandishments of bankers and other “advisers” who have an interest (and need) to generate business in order to earn fees (and keep their jobs.) Of course, this is something of a caricature. However, there seem to be few investment banks which have the ability to resist providing a “valuation letter” that magically demonstrates that the price for “Xco” bid target is fair and reasonable.

In reality, the success of a transaction depends upon many factors, both tangible and intangible. And some demonstrably work (witness Ace and Chubb), while others do not (Travelers and Citibank).

We suspect that one of the issues that leads to frequent failure and value destruction is “groupthink”; as, once an “idea” gains traction, more and more of those involved are sucked into the belief (because that is what it is) that “buying Xco” is a very good idea, and that the naysayers are the ones who are irrational. All complex organizations develop a culture over time, which is a major indicator of their long-term viability and success, because, unless it is fit for purpose, open and adaptable, it is likely to lead to poor decision-making and an unwillingness to change a decision in the light of further information. In such circumstances, those who challenge the orthodoxy are likely to find themselves ignored, or worse.

At Awbury, our approach has been, and will continue be, to grow organically (avoiding delusions of grandeur) and to provide carefully constructed, bespoke, confidential and value-added products and solutions to our range of clients. Our ideas should not merely “appear” to be good ones; the products and structures we create must demonstrably be valuable, with the actual outcomes being the objective evidence.

The Awbury Team

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