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Taking A Closer Look

C) Placebo effect — This phenomenon happens when people act in a specific manner based on a belief or assertion, even if not true. In a business context, this phenomenon can be dangerous as it can increase risk-taking behaviour without underlying objective judgement. A real-time example of this is the massive investment in real estate Dubai spurred by the regional booming economy and buy-to-rent potential as a result of a growing demand for property. Heavy government (petro-dollar) investment generated a false sense of permanence supported by double-digit increases in rental prices. Many investors were caught up in the euphoria. The resultant supply glut (which was objectively predicted by Morgan Stanley even prior to the recession) coupled with the global economic slowdown have spelt gloom for many in the region.

D) Perceptual denial — One of the raging arguments in the financial services industry is whether there is still a “war for talent” or whether this was only a factor of the industry’s boom years. The general sentiment on the Risk & Insurance Management Professionals (Linked-In) Network (“War for Talent – When will the first shot be fired?” September 2009) is that there is no war for talent in the industry. One risk professional interprets the estimated 12 million unemployed in the US, compared to the two million jobs available, as there being no war for talent. If one had to step back and objectively analyse this and similar responses in a wider financial services context, one can’t help but feel that perceptual denial creates a mind block to the possibility that, even under current market conditions, there are still (a) emerging insurance markets with a demand for skilled resources and (b) select positions in any market generally requiring particular skill sets that have proved to be virtually “recession-proof”.

E) Bounded awareness — The explanation under selective attention above also lends itself to a case of bounded awareness in interpreting the Lloyd’s year-on-year increase in pre-tax profits to “continued underwriting discipline” while omitting the objective truth that underwriting profits for the year actually declined. Revenue and profits at a macro level in the London market have primarily to do with economics, which in turn influences investor and underwriting behaviour. Soft and hard market cycles (and the factors that cause them) determine short-term profitability which, in turn, influences influx or exit of capital.

To underpin the short-term market success on underwriting prudence may lend itself to opposing greater governance in curbing market excesses that led to the financial crisis. While, admittedly, most of this was spurred by the banking (and not the insurance) sector, some insurers and reinsurers also had a finger in the pie as institutional investors. Lord Levene, chairman of Lloyd’s, is one of the major opponents of the UK and European Union proposals to curb financial sector bonuses (Global Reinsurance, September 18, 2009). The Lloyd’s chairman placing more weighting on economic factors leading to the current strong results would create cognitive dissonance with his opposition to the implementation of performance bonus regulations.

F) Inattentional blindness — The Dubai real estate example also provides a perfect example of inattentional blindness. Objective studies forecasted over-supply and a downturn in property prices in Dubai before (and independently of) the recession even though reality on the ground seemed to suggest otherwise because of the heavy government/quasi-government investment. Of course, one cannot commit the error of hindsight bias and attribute current real estate woes in Dubai to the unheeded property glut forecast. The global economic recession remains the primary cause of loss and also the primary contributor to the drop in real estate demand. But, human behaviour has been a major driver behind it.

Therefore, although the laws of economics, ie implying consumers want more for less and suppliers want less for more generally hold true, their decisions are determined more by how they interpret the environment around them than by the price mechanism. If this was not the case we would experience less hard and soft cycles.

Insurance carriers are willing to supply more in a hard market and insurance buyers generally purchase more insurance (as opposed to, for example, investing in alternative risk financing) when the markets are soft. So far we are in consonance with economic theory.

But what tips the scales initiating a soft market or vice versa? We can cite external factors such as the millennium bug, September 11, and so on, until we go blue in the face, but we know this is not true (and in fact there are cases when this did not happen).

What tips the scales is the interpretation of events bringing about a concerted behaviour (ie making available or withdrawing underwriting capacity or products) with the instigators trying each year to build up the placebo effect at Monte Carlo Rendezvous or in Baden Baden.

James Portelli FCII, FIRM has been active in insurance since 1990 and engaged in the Gulf insurance market for more than 10 years. Views expressed are personal.

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