Beware the Private Catastrophe

Having a poor handle on the exposure on their books can result in firms facing disproportionate losses relative to their peers following a catastrophic event, but is easily avoidable, says Shaheen Razzaq, senior director – product management, at RMS.

The explosions at Tianjin port, the floods in Thailand and most recently the Fort McMurray wildfires in Canada. What these major events have in common is the disproportionate impact of losses incurred by certain firms’ portfolios. Take the Thai floods in 2011, an event which, at the time, was largely unmodeled. The floods that inundated several major industrial estates around Bangkok caused an accumulation of losses for some reinsurers, resulting in negative rating action, loss in share price and withdrawals from the market.

Last year’s Tianjin Port explosions in China also resulted in substantial insurance losses, which had an outsized impact on some firms, with significant concentrations of risk at the port or within impacted supply chains. The insured property loss from Asia’s most expensive human-caused catastrophe and the marine industry’s biggest loss since Superstorm Sandy is thought to be as high as US$3.5 billion, with significant “cost creep” as a result of losses from business interruption and contingent business interruption, clean-up and contamination expenses.

“While events such as the Tianjin port explosions, Thai floods and more recent Fort McMurray wildfires may have occurred in so-called industry ‘cold spots,’ the impact of such events can be evaluated using deterministic scenarios to stress test a firm’s book of business.”

Some of the highest costs from Tianjin were suffered by European firms, with some firms experiencing losses reaching US$275 million. The event highlighted the significant accumulation risk to non-modeled, man-made events in large transportation hubs such as ports, where much of the insurable content (cargo) is mobile and changeable and requires a deeper understanding of the exposures.

Speaking about the firm’s experience in an interview with Bloomberg in early 2016, Zurich Insurance Group chairman and acting CEO Tom de Swann noted how due to the accumulation of risk that had not been sufficiently detected, the firm was looking at ways to strengthen its exposure management to avoid such losses in the future.

There is a growing understanding that firms can avoid suffering disproportionate impacts from catastrophic events by taking a more analytical approach to mapping the aggregation risk within their portfolios. According to Validus chairman and CEO Ed Noonan, in statements following Tianjin last year, it is now “unacceptable” for the marine insurance industry not to seek to improve its modeling of risk in complex, ever-changing port environments.

Women carrying sandbags to protect ancient ruins in Ayuttaya, Thailand during the seasonal monsoon flooding.

While events such as the Tianjin port explosions, Thai floods and more recent Fort McMurray wildfires may have occurred in so-called industry “cold spots,” the impact of such events can be evaluated using deterministic scenarios to stress test a firm’s book of business. This can either provide a view of risk where there is a gap in probabilistic model coverage or supplement the view of risk from probabilistic models.

Although much has been written about Nassim Taleb’s highly improbable “black swan” events, in a global and interconnected world firms’ increasingly must contend with the reality of “grey swan” and “white swan” events.

According to risk consultant Geary Sikich in his article, “Are We Seeing the Emergence of More White Swan Events?” the definition of a grey swan is “a highly probable event with three principal characteristics: It is predictable; it carries an impact that can easily cascade…and, after the fact, we shift the focus to errors in judgment or some other human form of causation.” A white swan is a “highly certain event” with “an impact that can easily be estimated” where, once again, after the fact there is a shift to focus on “errors in judgment.”

“Addressing unpredictability requires that we change how Enterprise Risk Management programs operate,” states Sikich. “Forecasts are often based on a “static” moment; frozen in time, so to speak…. Assumptions, on the other hand, depend on situational analysis and the ongoing tweaking via assessment of new information. An assumption can be changed and adjusted as new information becomes available.”

“Best-in-class exposure management analytics is all about challenging assumptions and using disaster scenarios to test how your portfolio would respond if a major event were to occur in a non-modeled peril region.”

It is clear Sikich’s observations on unpredictability are becoming the new normal in the industry. Firms are investing to fully entrench strong exposure management practices across their entire enterprise to protect against private catastrophes. They are also reaping other benefits from this type of investment: Sophisticated exposure management tools are not just designed to help firms better manage their risks and exposures, but also to identify new areas of opportunity. By gaining a deeper understanding of their global portfolio across all regions and perils, firms are able to make more informed strategic decisions when looking to grow their business.

In specific regions for certain perils, firms’ can use exposure-based analytics to contextualize their modeled loss results. This allows them to “what if” on the range of possible deterministic losses so they can stress test their portfolio against historical benchmarks, look for sensitivities and properly set expectations.

Exposure Management Analytics

Best-in-class exposure management analytics is all about challenging assumptions and using disaster scenarios to test how your portfolio would respond if a major event were to occur in a non-modeled peril region. Such analytics can identify the pinch points – potential accumulations both within and across classes of business – that may exist while also offering valuable information on where to grow your business.

Whether it is through M&A or organic growth, having a better grasp of exposure across your portfolio enables strategic decision-making and can add value to a book of business. The ability to analyze exposure across the entire organization and understand how it is likely to impact accumulations and loss potential is a powerful tool for today’s C-suite. Exposure management tools enable firms to understand the risk in their business today but also how changes can impact their portfolio – whether acquiring a book, moving into new territories or divesting a nonperforming book of business.