Black Swans for Thanksgiving

I, for one, am glad its Thanksgiving next week. First, I love the feast! Family and friends (well, er, no friends this year) gather for dinner and conversation – no gifts, no chocolates, no decorations. Just like me: boring but predictable. Second, like everybody I could use a break from the craziness that is 2020, and Thanksgiving does allow one the opportunity to take a reality “time out” at least for a day.

But as my mind drifted to turkey, another bird edged its way into my brain. The proverbial black swan that is at the top of mind for many of us in the insurance community. An article yesterday in the London Times by Alex Wright highlights how many in our world are working to create insurance solutions for things that historically have been labeled uninsurable, like the pandemic.

As Alex outlined in his article, traditionally, companies have mitigated against risk by taking out an insurance policy. Underwriters would spend hours poring over reams of historical data to determine the likelihood of the risk occurring before giving a quote.  But black swans don’t fit this mode well, as by definition they defy historical data – at least in the linear manner we usually think of.

The burgeoning world of artificial intelligence (AI) and machine-learning is looking to change that. The key benefit of AI in insurance is that it can quickly process large data sets and identify significant trends that mere mortals are unable to do.

Dr. Marcus Schmalbach created the VUCA (volatility, uncertainty, complexity and ambiguity) World Risk Index, a parametric index that uses machine-learning to gather data from a range of trusted and verifiable sources, many of which aren’t considered in traditional underwriting. That data is then rigorously analyzed alongside information the technology has gathered from previous experiences to look for patterns and links between events and determine the likelihood of a major event occurring. Among the areas his group has successfully modelled is business interruption loss in the event of a pandemic based on the data they crunched.

Climate change, natural disasters, political and trade conflicts, all could be better priced in the insurance world with new AI applications. AI can also reduce paperwork and the time taken to receive a quote or claim. Using parametrics, AI can also establish if an event has happened, thereby triggering payouts and avoiding any disputes.  Captives are well poised to take advantage of such innovation.

While nobody can predict the future with 100% accuracy, AI will allow insurers to detect anomalies that will help anticipate future events, like pandemics, and maybe better prepare us for the black swans. Perhaps roast black swan instead of turkey….

Thanks, as always, for your continued support in these trying times. I look forward to hearing from you!

Rich Smith
VCIA President

Friday the 13th – It’s Your Lucky Day

All of us in the captive industry, and throughout the broader risk management industry, are very rational thinkers who rely on science to determine the course of action we take in life, right?  A recent report published on November 10, 2020 in Captive International reminded me of how human behavior, with all its biases and superstitions, is a very difficult element in any kind of modelling.

The report, titled Viruses, Contagion and Tail-risk: Modeling Cyber Risk In The Age Of Pandemics, aims to better understand what modelers looking at pandemics and cyber risk can learn from each other.  The report highlights the lack of data from both types of viruses in trying to determine useful models for risk management. However, what caught my eye was this statement: “Although pandemics originate from pathogens, it is the individual and societal reactions to them that are hardest to model…”

I have always been fascinated by behavior economics as it tries to tackle our human foibles in a way that can be interpreted by economists to better understand how our world works. Even very intelligent, seemingly rational individuals are swayed by their internal biases. Science and economics are getting much better at “adjusting” for these very human traits and captive insurance will no doubt benefit as the industry sharpens risk modelling in everything from workers comp to liability. But just in case, hold on to that lucky talisman for now.

On another note, I want to wish Kevin Heffernan of Artex bon voyage as he announced he will be retiring in March 2021. Kevin has been with Artex for many years in a number of leadership roles and for the past 14 months has led captive operations across the US as executive vice president. Kevin was the first finance chair for VCIA at the start of my tenure over ten years ago and he did an excellent job of guiding the committee as well as providing me solid  advice on a wide range of topics Thank you, Kevin, and good luck!

Thanks, as always, for your continued support in these trying times. I look forward to hearing from you!

Rich Smith
VCIA President

It’s an Election…. Now What Happens?

In case you may have missed it, we had a national election this week where the United States picked who will be our President for the next four years… well, almost. As of this filing, the winner has not been declared and there is talk of court cases and recounts. Such is the way of our world these days.

I have been asked several times (OK, once) how I think the captive industry might be impacted under a Biden administration if he were to win. The short answer, from my perspective, is probably not much. Certainly, there are macro issues that may change if Biden were to tack toward a more open border economy than Trump as seems likely. And he is probably going to tighten some of the regulations that Trump loosened in his four years. Perhaps those policies offset each other, but all the same, I don’t think it will have a huge impact on our industry. And I don’t see much of a change in the IRS’s attitude against 831(b)s!

The hardening of the traditional (re)insurance marketplace that ostensibly started last year looks like it will keep steaming ahead into the upcoming year. That will most likely have a greater impact on our industry than policy shifts under a new administration. Certainly, policies impacting the economy, world affairs, and the continuing pandemic will have an effect, but captives are very good about adapting to new risks and economic environments.

One policy change that might provide a little boost to captive formations is if Biden raises the corporate income tax that was lowered under Trump. The lowering of the corporate income tax decreased the federal tax benefit to captive owners, as the accelerated deduction for losses incurred but not recorded will be worth less at a 21 percent tax rate than at the previous rate.  I will be curious to see if a raise to the corporate income tax (if it happens) will have a perceptible effect in our current market.

So, my advice to you all is to strike “impact to captives” off the list of things you are worried about regardless of who ultimately wins. However, if you want to hear more about what may be coming our way in terms of policies, laws and regulations that will impact the captive industry, join VCIA’s annual members-only Captive State of the Union with Dave Provost, myself and other luminaries as we discuss the outlook as part of VCIA’s Annual General Meeting on November 18th. Click here for full information and how to register.

Thanks, as always, for your continued support in these trying times. I look forward to hearing from you!

Rich Smith
VCIA President