Editor's Corner

Editor's Corner
Raymond Leung

Our two leaving directors, Mr. Leon Jackson of CAA Insurance and Mr. Stephen Lui of IDC Financial and our two new directors, Ms. Jing Cheng of SunPros & Associates and Mr. Mark Luo of Canwell Insurance. They said they did not want flowers.

So, to continue with CCIPA’s tradition of cost consciousness and value driven, I want to dedicate this article to them. Though it does not incur any monetary cost, I hope it could deliver some values. The secret of the value of CCIPA membership has yet to be uncovered.

As this article is dedicated to them, of course, the topic is going to center around them.

My first question is ‘what are their commonalities?

It is a common belief that we are all children of Africa. The oldest human-like bones found so far was in Ethiopia, dated back 195,000 years ago.

So far geneticists could not find any human species including modern day human that their DNA could not be traced back to a few hundred Homo sapiens. This small tribe of our ancestors probably travelled out of Africa through the Gate of Grief, crossed the Red Sea and reached the Arabian Peninsula about 85,000 years ago. And from there, they branched out to Europe, Australia, Asia and finally reached North America about 25,000 years ago.

That is not enough. Alright!.

It is a common belief that we have to go back 4.5 billions years ago when many and many amino acid molecules had collided, by random, with each other for millions of years. Till one day, by accident, it reached the perfect balance. That was when the history of our solar system started and here we are.

When we look up at the beautiful night sky with a very high powered telescope, we could see them, the stardust. They were created by supernovae, the self destruction of dying stars, which exploded billions of years ago. Their dusts only arrive in our night sky now. They provide the ingredients from creating a new star, to Empire State Building and to the creation of you and me. We are all children of stardust.

The creation and destruction come from the same source, but in alternate form. We are just lucky because we are at the right time and in the right place. We should celebrate our brisk moment of time in the 14 billion years of the history of the universe.

Fine. I can touch the Milky Way. That is too far away. Let’s go back to Toronto, Ontario, Canada, Earth.

The two leaving directors and the two new directors come from different background. One is from property and casualty only. One is from life only. One is from finance and accounting only. And one is from both property and casualty and life. What are their commonalities and how could we describe them on a micro level.

Well, we could describe the behaviours of property and casualty and life insurances in a financial model.

But before that, let us have some introductions. Both property and casualty and life insurances are mainly assessed by probabilities, the chance of something. If we need to describe the chance of something in an objective and scientific way, we have to rely on the Law of Large Numbers that could depict a pattern of the chances of happening of different scenarios. And, based on empirical data and the Law of Large Numbers, we could then plot a bell curve (normal distribution or Gaussian function), calculate the mean and standard deviation etc. to get the estimated insurance premium, based on the pattern of probability. This is one of more common methods used by actuaries and statisticians.

The mathematical model for Gaussian functions or bell curve is as follows:

where parameter μ is the mean (location of the peak) and σ 2 is the variance (the measure of the width of the distribution). The distribution with μ = 0 and σ 2 = 1 is called the standard normal distribution.

In reality, it might not be standard normal distribution. It would be distorted to certain extent, especially for property and casualty insurance.

Let’s go back 25 to 35 years ago when there was no common use of the internet except that it was restricted to only a very niche group of scientists, as a by-product of the Cold War. What were the most common hazards at that time? Probably you would say fire, water damage, burglary and theft. Let’s compare with the most common hazards of some of the newer companies in the market today, say Google, Facebook, LinkedIn etc. You might agree their most compelling hazards could be cyberattack, service interruption, breach of privacy, loss of data etc due to system design imperfections and improper maintenance, sudden surge of traffic, unbalanced load, improper or unsecured backup, disgruntled employees, ignorance etc.

If we look at the bell curve, the conventional hazards would normally concentrate around the median whilst the new hazards would be located at the end, sometimes at the far, far end of the tail.

The evolving change of business models has posed even greater challenges to risk management and insurance. Take a company for example. Amazon.com started about 15 years ago as a small online book retailer competing against the behemoth Barnes and Nobles and Borders. Now Amazon.com is the largest online book retailer in the world with annual revenue of about $10 billion. It still does not have a store front. It conducts all its business through its web front only. Not only it sells books and many other items on line to consumers in the world, it also competes on the ‘Cloud’, a new battle front, against the behemoth Microsoft and IBM on the corporate side. Its most valuable assets are probably its management, its intellectual property, its mega database contained within its hundreds of thousands of servers. All of these are not covered under our traditional insurance policy.

Let’s look at the compelling hazards of the newer internet companies. They are all of the nature of very low frequency, but very high severity. Where can we find them on the bell curve? They are all ‘hiding’ at the far, far end of the tail.

With our conventional wisdom and practice, our traditional insurance products and assessment techniques could not account for them, just like catastrophic losses, earthquake, weather related disasters etc. Some use Cat bond to manage these kinds of risks, like Disney. This also creates a popular investment opportunity for institutional investors especially insurance companies. Not only it could provide insurance companies with a steady income flow, in face of the fluctuations of underwriting results, it could also boast their Return on Investment (ROI). Some use captives to manage and finance these kinds of risks, like Wal-mart, which after probing the issues for more than 15 years; they finally set up their first captive in Vermont about three years ago.

What are these techniques or products? Should we use similar kinds of techniques or products to manage and finance those intangible hazards challenging the newer companies today?

With the extensive uses of Computer-aided design (CAD), Computer-aided manufacturing (CAM), Artificial Intelligence (AI), expert system, robots and the change of software design from ‘waterfall’ to ‘modular’, a product life cycle has greatly shortened. Like a new vehicle design has shortened from an average of 7 to 8 years to 2 to 3 years or even less. Would this increase the complexities on risk management and the design of tailored insurance for these companies, in terms of depth and dimensions? Would there be any effect on the life cycle of a company?

What is the debate on the ‘The World is Flat ‘by Thomas Friedman vs ‘The World is not Flat’ by Ronald Aronica? Would that affect our direction of risk management and insurance like global supply chain? Even further, would that affect the strata of societies and social structure? I feel a deep pain in my head.

Is the differentiation between business and insurance risks, insurable and uninsurable risks, financial and insurance products getting blurred?

Many models have been made based on all kinds of algorithms, theories etc trying to account for those kinds of risks at the far, far end of the bell curve. I want to pick one of the more common models, stochastic differential equation, for illustration.

Its formula could be in the form as follows:

The interpretation of the stochastic differential equation is that in a small time interval of length δ, the stochastic process Xt changes its value by an amount that is normally distributed with expectation μ(Xt, t) δ and variance σ(Xt, t)² δ and is independent of the past behavior of the process.

This stochastic differential equation is derived from Brownian motion or Wiener process. In words, you could describe a Brownian motion as dropping an ink in a glass of water and see how it diffuses randomly without any pattern. How do you compare this phenomenon to our life, to our world? Some said our world is always changing. We are in a constant state of flux. I want to quote the 5th century philosopher Heraclitus, “Everything flows and nothing stands still” and “You will never step into the same river twice in your life time”. Is that exactly the underpinning of Calculus? Would it be possible, one day, for us to formulate a human adventure on earth in a mathematical model, in the Calabi-Yau 11-dimensions space of the universe?

Well, in a more insurance-like, non-philosophical term, you could say its chance of happening is independent of the prior incidents, without any pattern. Does this sound like the opposite of the Law of Large Numbers where you could say with certain percentage of confidence that this scenario is going to happen and so we are going to charge this premium? Well, in this case, we could use stochastic differential equation to account for those risks that basically happen without any pattern, by random only.

Let’s look at the famous Black-Scholes model commonly used in the financial market (Myron Scholes is a Canadian and also a Nobel Prize winner):

With the assumptions of the Black–Scholes model, this second order partial differential equation holds for any type of option as long as its price function V (value) is twice differentiable with respect to S (underlying stock price) and once with respect to t (time). This model is also based on Brownian motion.

What is the commonality between insurance and option? What? Insurance is a ‘put ‘option. Amazing !. Do you mean that we could use all the trading strategies on insurance products as on options?

What if we differentiate an insurance model to higher degrees like the credit default swap and then everyone is betting on something no one really knows exactly what it is. Alright. That is too far away. Let’s go back to Toronto, Ontario.

Finally, we touched down on Pearson. How is the 15-minutes Cosmo tour? Excited? Puzzled? Perplexed?

Having said that, who would care? Let’s go out to sell tons and tons of insurance.

Wait a minute. I have to refine the statement. Let’s go out to sell tons and tons of insurance with no or very low claim. WOW!. You will be the king.

OOP!. Does it require a special skill set and mentality?

THE END.

The above article is for fun only. We try to look at things from another perspective, that sometimes we take it for granted. It is never intended for serious academic or professional use because the arguments and illustrations have been overly simplified to make it more readable and appealing to most readers.

Buildings, machineries and inventories are the most valuable assets a corporation has. How is the modern corporation? Would idea, knowledge and data are the most valuable assets to them. Even for a traditional ‘brick and mortar’ company like Wal-mart, what is its most valuable asset that made it the biggest and most profitable retailer in the world? Is it tangible or intangible? What is its value on the financial statements? This changing horizon has posed big challenges to risk management, insurance and finance. How could we manage and insure an intangible? How could we derive a fair market value on intangible asset etc? Take a modern corporation like Dell for example. What makes Dell stand out from all other major competitors? Is that most valuable asset appreciate or depreciate in value over the years on the financial statements?

Though the article is written fifty thousand miles above and mainly from the eye of a corporation, there are still some truths for small and medium size businesses. Sometimes, we might want to revisit our conventional wisdom in face of the rapid changes in technology, business environment and horizon and ever evolving and revolutionary operating models.

To conclude, I would like to quote the management guru, Peter Drucker. ‘Why couldn’t IBM sell insurance? Why couldn’t insurance companies sell interest rate contracts?’ Lou Gerstner overhauled and turned IBM from the largest hardware company to the largest service company in the world.

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The article only represents my personal opinion. It does not represent the opinion of the Board.

It is written to celebrate the 20th anniversary of CCIPA and to honour the past presidents, directors, volunteers and many other people who have built the foundation of CCIPA in the past 20 years and make it success. Without them, CCIPA would be nothing like today. Thank you.

Let’s be a 5-minutes self-proclaimed dreamer, Stephen Hawking, to guess what could be the world when CCIPA celebrates its 30th or 40th anniversary.

The first insurance office is opened on a bigger planet in the outer space because the time runs slower on that planet than on earth. Those people working in that office could probably slow down their own aging. Insurance is for risk transfer. As there is no readily available market for aging insurance and the risk could not be totally avoided by nature, risk mitigation is probably the only logical alternative left. So moving to the outer space is one of the risk mitigation methods available to delaying aging.

But, though the time is running slower, how is about our body metabolism? We could practice the ‘Chinese’ way of deep meditation to slow down the heart beat to near death, during the time we are not working, in order to reduce the metabolism to a barely minimal. Does it sound like those of H.G. Wells’s writings that we sleep in cocoons? WOW! Mission: Impossible completed.

Well ! Time’s up, dream’s over.

Best wishes and thank you to the many dedicated men and women working, day and night, deep underground in France and Switzerland to make impossible happened and to keep on pushing what the Nobel economist Paul Samuelson called the Production Possibility Frontier outward, for the human race.

Starting from next edition, we are going to talk to the past presidents, founding members, directors etc and ask them to share their stories and experiences during the past 20 years so that we could learn from them. Looking forward to reading their stories.

Last but not least, on behalf of the Board, we would like to express our deep gratitude to Mr. Leon Jackson and Mr. Stephen Lui for their past service as directors and Mr. Anthony Chan as the President of the Board and welcome Ms Jing Cheng and Mr. Mark Luo joining the board and Mr. David Cheng as the 2nd Vice President and Ms. Susan Cheung as our new President.

Members and non-members are cordially invited to send in their articles. The topics do not have to be serious or informative. It could just be a funny encounter with a weird customer. Once accepted, it will be published on our newsletter. Please email to raymond.leung@ampexinsurance.ca with ref: CCIPA-newsletter. Thank you.

Please see Member's Corner for more membership information.

Tel: (647) 726-0288
Fax: (416) 491-9988
E-mail: raymond.leung@ampexinsurance.ca