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What all top layer junkies should know

Dear friend,

It’s great how long flights give you the chance to catch up on a bit of reading.

For instance, I picked up an amazing book in the airport lounge on the way out to Dubai last week for the World Insurance Forum.

It’s called The Black Swan and is by a former bond trader turned philosopher called Nassim Nicholas Taleb.

It’s all about the way our simple human brains just aren’t equipped for the challenges that high impact, low probability events can have on the world and our performance in it.

Never has a tome been more relevant to the psychology of underwriting in general or the psychology of underwriting reinsurance in particular.

Why are we condemned to repeat the mistakes of the past? Why do we find ourselves constantly taking on large risks that we are not sufficiently paid to assume?

This book explains everything.

It’s mostly our own psyche’s fault — it seems our brains are always looking to rationalise things after the event and turn them into neat easily understandable stories.

It makes life easier for us but makes us live in a self confirming delusion like fat, contented turkeys who are suddenly surprised one day to be given the chop and slung in the oven by the farmer who has been so kindly feeding them for the past year.

Based on the visible evidence, what turkey could have guessed what was coming next? Right up to the point of death the farmer had been really nice and friendly!

It’s the things you don’t know that will get you.

Here’s a little experiment Mr Taleb uses:

Read this simple series of numbers;

2, 4, 6

Now, you have to guess what the rule is linking the sequence of numbers – to help, you get to formulate 5 new three-number series and I will give you a simple yes or no answer as to whether they too follow the rule.

Of course in experiments most people just formulate similar series where the numbers rise by 2 each time, like 8, 10, 12 or 6, 8, 10.

And of course these suppositions are correct. So by the fifth try most people are pretty confident of their theory for the number rule (that the number series goes up in increments of two).

Then they are surprised that the rule is dead simple — numbers in ascending order!

So 1, 589, 1,000,000,000 also fits

As does 1,000,000,000, 20 billion, 5 trillion!

Ouch – I’d hate to be on the top layer of that unlucky series of numbers!

How easy it is to be wrong — especially if you ask yourself the wrong questions when analysing a risk.

And what’s so silly is that after the event it’s easy to see where you went wrong — (and then you start rationalising why you missed it and fall straight into another trap).

We seem to happiest finding simple patterns in past events and projecting them into the future, and this leaves us highly vulnerable to unexpected (and often highly improbable) extreme outcomes.

Sound familiar?

Get down to the bookstore — this is a work of tortured genius that all underwriters should be forced to read, especially top layer junkies

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