Ten days ago, an irresponsible and unthinking young man crashed into me from behind at great speed while I was skiing with my children. The force of the impact broke two things: my right ski and the top of my right arm. There were multiple fractures and (the shoulder being full of many nerves, tendons, muscles) I was advised that I would need surgery to ensure proper healing and that I should entrust this only to an expert specialist surgeon. Fortunately, via my network I was able to identify just such a doctor quickly but it meant that my surgery could not be scheduled until Wednesday last week. I think it is fair to say that I totally underestimated the seriousness of the injury and surgery and somehow thought I’d be patched up and good to go in a day or so. Today is Tuesday and only now am I “back at my desk” feeling pretty good, although without the use of my right hand for typing. So, other than some limited iphone-based twitter and email scanning, a couple calls and starting some “to-do triage” over the last couple days, this totally random accident has cost me nine days “offline” (in the broader getting-things-done sense) and will continue to impact my productivity – in particular my ability to travel and type – for at least the next 4-6 weeks. While I am confident that I’ll be able to adapt somewhat (my left-hand only typing is already 5-10x faster than a couple days ago, although still not close to my usual 60+ wpm and I can now actually get the curser to the right spot in under a minute using a mouse), it would be ridiculous not to acknowledge this as a unwelcome setback.
But why am I explaining this here? And no, it is not to generate an outpouring of sympathy (which however I must acknowledge as very nice as I have been fortunate enough to have been reminded of over the past week.) No, there are effectively two distinct reasons I thought it would be worth telling this story.
The first is from a strictly practical standpoint: to get the word out to all the people I “work with” on a day-to-day basis without needing to write dozens or hundreds of emails (never much fun at the best of times but even less appealing with one-hand…) I suspect not all the people that I’d like to have this information are readers, and clearly for many of you this is probably unnecessary information, but while clearly not perfect, the broadcast mechanism of a blog I felt was the best option available to me. So for those of you waiting for an email or call to be returned, or an appointment to be confirmed, now you know what has happened and I would ask your indulgence and patience. If you have heard nothing back from me in the next few days or so, or if it is more urgent than that, please follow-up with a nudge. Otherwise, give me a couple weeks and I’m sure I can get back on top of things (at least as much as I ever do!)
The second reason is hopefully more interesting to a wider audience and is about addressing one of the risks that seems to me to be less discussed in the vibrant “start-up commons” that many other issues venture entrepreneurs and investors face. This is the risk to founders health from exogenous, unanticipated events.
In particular, I’m interested in risks not readily addressable by traditional key-man life insurance. This of course is a standard requirement when raising outside investment and insofar as it protects investor capital (if not their opportunity cost) from the worst-case result of a catastrophic injury or death of one or more of the founders (ie winding up of company), it probably doesn’t help in the more probable situation of a significant productivity loss due to severe illness or accidental injury. Thinking through our portfolio of early stage companies, I dare say none of them has thought much about this except for one, and if I am honest, this was only because we had to manage just such a risk in the early days of the company (which I’m happy to report was successfully done, helped of course by the individual’s recovery proceeding as expected.) If you are a start-up founder or investor, have you given this much thought? If so what sort of solutions or contingencies have you put in place to mitigate this risk? Are any insurance companies writing policies that pay out (to companies, quickly) in the case of non-critical short term health issues with key personnel? If so is the pricing reasonable?
I’ve obviously had a few days and a good reason to think about this, and just to be clear, have been considering the question in the first instance from the point of view of a founder. (For while we are also investors, my company is in fact a start-up and I am reliant upon it for my livelihood.) And in terms of protecting my family, I have life insurance, but this accident underlined that in the event I were temporarily incapacitated and unable to work, mitigating the financial risk arising is potentially much more problematic, and that this is a problem (most acutely) faced by start-ups and small businesses. Indeed, were I still working for an established (big) company or organization, I have a very nice letter from my doctor stating I cannot work for the next 4 weeks and so I would sit at home collecting my salary and healing. But even more importantly, the business of the company would go on (even if I were Steve Jobs); and while (one would hope that!) some opportunity cost would be incurred, the larger and more established the company or organization, the more marginal it would be. ie The problem (for founders and their investors) isn’t insuring the loss of a month’s salary/revenues/burn per se (which is I’m sure a tractable actuarial problem.) Rather, it is insuring the opportunity loss of a month of foregone productivity or progress. And because the “value” of this lost opportunity is subject to so many internal, external and temporal/situational variables unique to each founder/company pair, I suspect this is probably an uninsurable risk, at least in the sense of financial insurance. Indeed, I think the solution to mitigating this risk if one exists lies more in ‘operational engineering” admitting that in some cases even this will be impossible.
And so my (highly tentative) conclusions are that:
founders should probably think about a “Plan B” to manage their personal risk (eg this could be cash savings, support from family, returning to traditional employment, etc.)
investors need to consider the value of portfolio diversification in this context and perhaps, insofar as possible, think about what critical skills may be replaceable on a temporary basis should a founder be incapacitated for a few weeks or months and ideally build a network of people who have or have access to these skill sets; my thinking here is not to suggest that founders are replaceable but that it may in some cases be possible to soften the impact should the unexpected happen.
I would be very interested in the community’s thoughts on this and in particular whether they think it is a risk that can and should be acknowledged and managed in early-stage (and/or later-stage) companies, or if on the contrary they believe this is an intractable risk and so just needs to be “accepted” without wasting any time, energy or money trying to manage it.
So having spent 90 minutes on this post (sooo slow…) I better get down to work, and so while I’ve a dozen posts up my sling, I probably won’t be back here for a week or so as I work my way through a daunting (but mostly exciting) to do list. Oh, and for the next few weeks at least, you can just call me Lefty.
I’ve been avoiding putting together a list of predictions for 2010 (more on that later) but just couldn’t resist suggesting that 2010 could well be a breakout year for weather risk management. All of the conditions necessary have finally started to come together and with the worst of the 2008/2009 hysteria behind us (without passing judgement on the future direction of markets), companies (and hopefully individuals) will start to wake up and respond to the risks and opportunities inherent in weather variability. I wouldn’t be surprised if weather risk was one of the top three risks faced by the vast majority of (non-financial) corporations, perhaps even the most important risk in some cases, and of the same order of magnitude as liquidity, foreign exchange, commodity and interest rate risk – all risk categories for which massive global markets in risk pricing and transfer exist. Weather in this regard remains significantly underdeveloped:
(via Ben Smith, First Enercast Financial) For example the Department of Commerce estimates that more than $1 trillion of U.S. economic activity is exposed to weather. Even if a small fraction of new risk is hedged through derivative contracts, 2010 will be a very good year for these markets.
The massive costs incurred in much of the northern hemisphere over the last few weeks due to heavy snowfalls and cold temperatures are just one more example of how important a factor in economic outcomes weather risk can be. For example, just take the exceptional – and uninsured – costs incurred by local authorities and airport operators across the UK for snow removal, sanding, salting, loss of revenues, etc. Previously, a manager of a company (or government entity) who suffered an exceptional weather-related loss could shrug their shoulders and plausibly say “it was out of my hands.” In a way that would be impossible if for example their organization suffered a massive loss because their buildings or equipment perished in a fire and they were not insured. In that scenario, shareholders or taxpayers would be incandescent with rage at the incompetent risk management of the managers. Not managing weather risks is no different in substance (now that appropriate weather insurance and derivatives are increasingly widely available), only remaining so in perception as awareness lags.
Of course I am biased, having invested in Weatherbill, which is at the vanguard of transforming weather risk markets:
(via J. Scott Mathews, WeatherEX LLC) The weather market was built upside down, which is quite a feat, even for financial engineers. What we mean is that it started on the wholesale level without any retail underpinnings. It started out like a castle in the air…The changes coming in 2010 for the weather derivative market will be keyed “from the bottom up.” Solutions companies such as Guaranteed Weather and Weatherbill who bring management choices to “ground level” risk holders are helping to complete a strong base to keep that castle from crashing on us.
The difference between weather derivatives (Weatherbill.com) (or any other new risk management tool) and say books (Amazon.com) is that risk management tools need to be ‘sold’ – there is a learning curve, however shallow; and while most people instinctively understand and can conceptualize their weather risks, their survival instincts – honed by decades of doing business with rapacious financial services firms – and fear of ‘getting their eyes ripped out’ means that they are understandably cautious when considering using weather risk management instruments for the first time.
This is where Weatherbill’s business model I think is particularly well adapted to the opportunity: on the one hand, they have a very modern (open) approach to pricing: anyone can go to their website and play around in their pricing ‘sandbox’. Try doing that ten years ago when you wanted to price up a complex FX or interest rate option. Basically it was build your own model or keep sending pricing request to your favorite sales person (who would then have to go beg the trader for a price, and in addition to the regular parameters, the client’s identity, the salesperson and the trader’s mood would also be imputed into the price. That is of course if he felt like making one.) On the other hand, (and this is something that has evolved over the past couple years) Weatherbill has aggressively sought out distribution partners – insurance brokers, industry platforms (eg travel sites), etc. – as trusted providers to their respective customer bases, they are ideally positioned to help their customers manage their weather risks by leveraging Weatherbill’s platform. I first wrote about this a few months ago, and since then they have signed up a number of new and significant partners.
I love skiing and my family take a season pass at Les Trois Vallees. Obviously weather risk is central to running or enjoying a ski resort. While there are many different types of risk you could look at in the context of a ski resort, in the interests of simplicity (ease of understanding/customer acceptance) and maximum pain relief, there are two risks that I would have loved to have had an embedded hedge for in our season ticket (and I suspect the same would go for someone buying a week-long pass for their holiday, in fact they would probably be even more sensitive/appreciative.)
Not enough snow to ski risk: ie not that the snow is great or this or that…the basic risk that the pistes are closed. For most modern ski resorts this is actually a function of temperature and not precipitation, as they use snow-making machine to lay down a base. Temperature risk is much easier to measure and price (than snowfall) and has much lower geographic variability ie you don’t need a weather station on every piste on the mountain.
Rain risk: ie the only time it is absolutely unpleasant to ski is when it is raining. Also, rain typically doesn’t help the existing snowpack, making skiing after rain often unpleasant as well.
Using Weatherbill to hedge their risk, Les Trois Vallees could offer a ski-pass that reimbursed me for every rainy day and for every day say less than 80% of their runs were open due to lack of snow. In an age of increasing climate uncertainty (or perception thereof) I am 100% certain this would help them market (and sell more) season tickets. And for week-long tickets, it would be a great marketing tool for advance sales (with significantly positive cashflow benefits), and great for improving the user experience. Imagine a vacationer whose week in the Alps is ruined by 5 days of torrential rain…getting their money back on the lift tickets (irrespective of whether or not they braved the elements) would go a very long way to having them consider giving it another try next year.
Of course this is but one example, I’m sure all of you can think of hundreds more. In fact it might be harder to think of services or businesses that are completely immune to the weather. So really, what are you waiting for? Start hedging!
I first wrote here about Ken Banks and FrontlineSMS a little over a year ago, after having seen him speak at Supernova in San Francisco where he made a tremendous impression. I remember immediately being excited by the obvious possibility of leveraging the Frontline:SMS platform to provide financial services, not only in developing countries but also in more mature markets. I put ‘try to set up meeting with Ken to discuss’ on my to do list, but it never quite made it to the top as the myriad challenges of setting up our business (and moving house) in the midst of generalized global financial calamity conspired to keep it from becoming an urgent priority. Of course (and thank goodness) the world does not wait for me and an enterprising young man, Ben Lyons, spotted the same opportunity and (much) more importantly has moved to action, teaming up with Ken and FrontlineSMS to create FrontlineSMS:credit:
FrontlineSMS:Credit aims to make every formal financial service available to the entrepreneurial poor in 160 characters or less. By meshing the functionality of FrontlineSMS with local mobile payment systems, implementing institutions will be able to provide a full range of customizable services, from savings and credit to insurance and payroll.
Launching FrontlineSMS:credit a few weeks ago, Ben wrote:
Our mission is simple: leverage the mobile space to extend access to affordable financial services to rural, disconnected and impoverished communities. To achieve this end, we are constructing a series of free and open source financial modules that will allow FrontlineSMS to communicate with mobile payment systems in real time, turning FrontlineSMS in to a microfinance management information system, a payroll center for small & medium enterprises (SMEs), a collection and distribution center for micro-insurance premiums and payouts, and a detailed center for individual credit histories and scores.
Now if this isn’t a massive opportunity, well I don’t know what is. At the risk of sounding churlish, it’s an order of magnitude more substantial and important (socially, financially, economically…) than half the me-too start-ups chasing funding and customers amongst the western digerati. Take another look at Ben’s mission statement:
… leverage the mobile space to extend access to affordable financial services to rural, disconnected and impoverished communities.
I suspect the first time you read that you thought “in Africa”, or perhaps India, or developing countries more generally. But these same under-served communities (alas) exist in every country in the world, and one could even make a case for saying that for those living in a developed economy, the relative disadvantage of not having access to basic financial services is even more damaging. It seems inevitable that the approach taken by FrontlineSMS:credit will become the primary channel through which universal access to basic financial services is delivered in any country or economy. Which leaves the politicians of many European states very little time to figure out what the hell to do with all the postal employees currently cashing cheques and taking payments for utility bills, who will soon need to find more productive work. And I’m not sure how complacent I would be as a shareholder in an incumbent retail banking operation (the top executives I doubt will lose much sleep as the timeline for this kind of transition is probably 10-15 years or so, much longer than their expected tenure…) as this bottom up, platform approach to delivering financial services has the very real potential of blowing a giant hole right in the middle of their business and revenue model.
To further whet your appetite here is an excellent 10 minute introduction to FrontlineSMS:credit by Ben at Africa Gathering in London a couple weeks ago:
This year we wanted to go one step further to give you extra peace of mind. We will give passengers who book flights, car hire and hotels direct* with Flybe in January 2009 free of charge travel cancellation cover in the event of redundancy prior to travel. Offer excludes the self employed and those who have had less than 2 years continuous employment and who do not qualify for statutory redundancy pay as per Statutory Redundancy legislation.
It seemed potentially interesting as yet another example of risk management tools being given to consumers. So I thought it would be interesting to look at the fine print…
Ignoring the irony that the policy backing up this offer is underwritten by AIG UK Limited…I was pretty disappointed (but not surprised) by what I found. Firstly, you are only paid if you cancel your trip. This is totally lame. If you lose your job, you’ll likely be more inclined to take the holiday/family visit/etc. you have booked. Further I’m not sure everyone will realize they only get reimbursed if they cancel, (even though to be fair to flybe they make it clear that it is cancellation coverage…)
On the other hand, I guess if it were true redundancy insurance, you might have a serious adverse selection problem (and AIG would charge more?) even though the terms state that “at the time of booking your trip, you had no reason to believe that you would be made redundant” (does that exclude then everyone who works for a bank? or for AIG UK?)
Anyhow while this particular offer is more gimmick than substance (as opposed to the iTravel Let it Snow promotion underwritten by Weatherbill for example), I think it is indicative of a growing trend to providing consumers with granular risk management tools.
I have to admit to being somewhat disappointed and a little puzzled when I read that Norwich Union was suspending their experiment in ‘pay-per-mile’ car insurance in the UK (via BBC):
Britain’s biggest insurer has suspended a flagship car insurance scheme less than two years after its roll out. Norwich Union’s “pay as you drive” policy used satellite technology to track every journey via a black box installed in customers’ cars. It resulted in cheaper premiums for people who avoided driving at high risk times like rush hour and late at night.
The company said too few customers had joined, and blamed a slow take-up rate of the technology amongst car makers.
It seems only around 10,000 people had taken up this product. I have to admit that our family hasn’t, although I’m convinced it is an excellent product and the ‘right’ way to buy car insurance for many (most?) people. So why didn’t it succeed? I thought about this a bit and boiled it down to two (inter-related) factors:
Inertia. Like many services, especially financial services, most people (myself included) have tremendous inertia. That said with the rise of comparison shopping sites like moneysupermarket.com, confused.com, etc. this is changing. I wonder also if the current economic climate will accelerate this trend as family budgets feel the squeeze of higher inflation and weak balance sheets.
Ignorance. Not stupidity but the proper definition of ignorance: prospective customers either don’t know about the availabilty of this novel product or if they do are put off by a ‘learning curve’ to understand how it would relate to their driving experience.
I wonder (I don’t have time to research this) how Norwich Union marketed this product: ie how helpful / transparent were they in terms of making it easy for their customers to compare the ‘pay-per-mile’ product with their ‘fixed-rate’ offering. Was this an example of the corporate antibodies winning? What did the middle/senior managers responsible for ‘traditional’ insurance think of this innovation? Fear? How would it affect their margins? (Their power?) Short term? Long term? I have no insight into the particular dynamics of Norwich Union, but I suspect this might be an excellent example of how disruptive innovation cannot survive the caustic environment of large organizations. If I were in charge at Norwich Union, I would have set up a new independent company to offer this product, taken a minority stake – bringing in an entrepreneurial management team and a handful of outside investors (like us) – to build this product. If/when it worked, then I might buy the company in a few years time. (Of course I would say this – its at the heart of our business proposition – but equally obviously we believe passionately in the validity of this model; what kind of entrepreneurs would we be if we didn’t? )
Perceptive readers may have spotted an apparent incongruency in my enthusiasm for the ‘pay-as-you-go’ model in car insurance. After all usually I am seen on these pages touting an ‘all-you-can-eat/flat rate’ business model for many companies who’s stock in trade is ‘pay-per-transaction’. So am I just being a contrarian just for the sake of being provocative? Well, no. The thing is, it (the correct business model) depends on the context and the ‘linearity’ of the underlying service to the cost of providing it. And just to be clear, in many many businesses the best model is to offer both pricing paradigms and let the customer decide what is more appropriate to their circumstances. So what do I mean by linearity? (perhaps not a good description) I mean that the cost of providing the service is highly proportional to the amount it is used. Car insurance fits this – the more you drive (and the more you drive in congested cities or at certain times of day), the more statistically likely it is you will have an insurable loss and so it ‘costs more’ to provide this insurance. If you are running a communications network for example (or a health club, or a stock exchange…) your costs are largely fixed and so one more call, or customer, or trade is essentially free. (Up to the capacity of the existing infrastructure of course.) And so ‘broadband’ / fixed rate plans are usually the best way to go in the long term.
I’d be happy to bet on this space going forward. Norwich Union’s experience is clearly interesting, but I believe their lack of success was due to timing and (probably) execution. A setback. An opportunity?
Well not exactly but pretty damn close: replace 23 red with frequency and intensity of storms hitting population centers in Florida and it is spot on. Only with 23 Red, at least the probability is easy to price.
Of course, ‘gambling’ is illegal in the Sunshine State and if any resident wanted to offer or take odds on the likelyhood of a hurricane hitting their home town, of course they would be breaking the law. The irony of the state taking a giant punt with their taxpayer’s dollars is of course almost certainly lost on the state government…
One of the most significant business and economic opportunities that will arise out of the changing techno-economic paradigm over the coming ten to twenty years is the rethinking and transformation of the business of insurance. The rise and rise of the risk quark will inevitably reshape the landscape of risk transfer and mitigation. But it won’t be easy. Indeed their will be many backward steps along the way as the trinity of inertia, vested interests, and outdated regulatory frameworks conspire to perpetuate the current model despite it’s increasingly obvious failings.
How else to explain the recent de facto nationalization of property insurance in the State of Florida? (from The Economist:)
…insurance companies are shedding customers as fast as they can…
…The slack is being picked up by a fast-growing state-run company, Citizens Property Insurance. Citizens is acting as the insurer of last resort, underwritten by the Florida Hurrican Catastrophe Fund, a pool financed by the state. In January the state decided it could resolve the crisis by expanding Citizens and making it more competitive with private companies. It is now by far the state’s largest home-insurance provider, with 1.3m clients.
…And by allowing Citizens to grow so big, in the eyes of many agents, the state is exposing itself to tremendous financial risk in the event of a large-scale disaster. Unlike private companies, which can seek reinsurance on the global market where risk is less concentrated, the state would have to go to its own taxpayers if a huge storm struck.
Now whether or not the state should bear the risk of weather-related property damage is in my opinion a political debate. What I find appalling is not that a democratically elected government decides (or not) to underwrite this risk, but that they do so in a completely reckless, opaque and market-distorting way. By not allowing the market to work – by pricing risk appropriately based on the market-determined probabilities of certain outcomes – the result is that the economy cannot optimally allocate resources and that the true cost of any subsidy is at once much higher (than it would otherwise be) and completely opaque. Furthermore it is unaccounted for: I doubt that the Florida government accounts reflect the enormous contigent liability they have committed their citizens to.
Just as physicists and chemists have conservation of mass and energy, so to are risk quarks ‘conserved’. Risk transfer and optimization is highly useful and increases overall wealth and utility in an economic system. But risks – like mass and energy – must be conserved. Call it the 1st Law of Financial Dynamics. (Park’s Law? anyone? anyone? … ) One of the fundamental problems of the current risk management paradigm, is that it encourages – often with regulatory and governmental connivance – the dissimulation of ‘inconvenient’ high energy risk quarks.
What do I mean by ‘inconvenient’ risk quarks? These are the elements of risk in any system that when ‘removed’, allow all (or at least all incumbent) constituencies to have only positive outcomes. My contention is that risk is conserved so these elements are never truly removed, but only hidden from view. Worse, frequently the financial physics of segregating and obscuring these elements most often leads to an expensive and suboptimal distribution of risk throughout the system. Indeed -whilst I don’t know whether he would agree with any of my analysis – I believe that Warren Buffet’s view of (financial) derivatives as weapons of mass destruction, is credible only in the context of their (derivatives) bastardized deployment within a system that does not want or allow them to exist unfettered or transparently. The existing industry and governmental complex is applying the rules of classical finance to a new quantum world. With alarming consequences.
And don’t even get me started on sub-prime… (Remember always that gambling is illegal in the US. Well…only as long as it is done in a transparent and robust fashion. Embed it, hidden, within the existing fabric of business and of course it’s ok. Messy yes. But not threatening to the existing socio-institutional paradigm.)