logo image
More Topics

Reset Filters

Helen Yates
September 06, 2019
Severe Convective Storms: A New Peak Peril?

Severe convective storms (SCS) have driven U.S. insured catastrophe losses in recent years with both attritional and major single-event claims now rivaling an average hurricane season. EXPOSURE looks at why SCS losses are rising and asks how (re)insurers should be responding At the time of writing, 2019 was already shaping up to be another active season for U.S. severe convective storms (SCS), with at least eight tornadoes daily over a period of 12 consecutive days in May. It was the most May tornadoes since 2015, with no fewer than seven outbreaks of SCS across central and eastern parts of the U.S. According to data from the National Oceanic and Atmospheric Administration (NOAA), there were 555 preliminary tornado reports, more than double the average of 276 for the month in the period of 1991-2010. According to the current numbers, May 2019 produced the second-highest number of reported tornadoes for any month on record after April 2011, which broke multiple records in relation to SCS and tornado touchdowns. It continues a trend set over the past two decades, which has seen SCS losses increasing significantly and steadily. In 2018, losses amounted to US$18.8 billion, of which US$14.1 billion was insured. This compares to insurance losses of US$15.6 billion for hurricane losses in the same period. While losses from SCS are often the buildup of losses from multiple events, there are examples of single events costing insurers and reinsurers over US$3 billion in claims. This includes the costliest SCS to date, which hit Tuscaloosa, Alabama, in April 2011, involving several tornado touchdowns and causing US$7.9 billion in insured damage. The second-most-costly SCS occurred in May of the same year, striking Joplin, Missouri, and other locations, resulting in insured losses of nearly US$7.6 billion. “The trend in the scientific discussion is that there might be fewer but more-severe events” Juergen Grieser RMS According to RMS models, average losses from SCS now exceed US$15 billion annually and are in the same range as hurricane average annual loss (AAL), which is also backed up by independently published scientific research. “The losses in 2011 and 2012 were real eye-openers,” says Rajkiran Vojjala, vice president of modeling at RMS. “SCS is no longer a peril with events that cost a few hundred million dollars. You could have cat losses of US$10 billion in today’s money if there were events similar to those in April 2011.”  Nearly a third of all average annual reported tornadoes occur in the states of Texas, Oklahoma, Kansas and Nebraska, all states that are within the “Tornado Alley.” This is where cold, dry polar air meets warm, moist air moving up from the Gulf of Mexico, causing strong convective activity. “A typical SCS swath affects many states. So the extent is large, unlike, say, wildfire, which is truly localized to a small particular region,” says Vojjala. Research suggests the annual number of Enhanced Fujita (EF) scale EF2 and stronger tornadoes hitting the U.S. has trended upward over the past 20 years; however, there is some doubt over whether this is a real meteorological trend. One explanation could be that increased observational practices simply mean that such weather phenomena are more likely to be recorded, particularly in less populated regions.  According to Juergen Grieser, senior director of modeling at RMS, there is a debate whether part of the increase in claims relating to SCS could be attributed to climate change. “A warmer climate means a weaker jet stream, which should lead to less organized convection while the energy of convection might increase,” he says. “The trend in the scientific discussion is that there might be fewer but more-severe events.” Claims severity rather than claims frequency is a more significant driver of losses relating to hail events, he adds. “We have an increase in hail losses of about 11 percent per year over the last 15 years, which is quite a lot. But 7.5 percent of that is from an increase in the cost of individual claims,” explains Grieser. “So, while the claims frequency has also increased in this period, the individual claim is more expensive now than it was ever before.”  Claims go ‘Through the Roof’ Another big driver of loss is likely to be aging roofs and the increasing exposure at risk of SCS. The contribution of roof age was explored in a blog last year by Stephen Cusack, director of model development at RMS. He noted that one of the biggest changes in residential exposure to SCS over the past two decades has been the rise in the median age of housing from 30 years in 2001 to 37 years in 2013. A changing insurance industry climate is also a driver for increased losses, thinks Vojjala. “There has been a change in public perception on claiming whereby even cosmetic damage to roofs is now being claimed and contractors are chasing hailstorms to see what damage might have been caused,” he says. “So, there is more awareness and that has led to higher losses. “The insurance products for hail and tornado have grown and so those perils are being insured more, and there are different types of coverage,” he notes. “Most insurers now offer not replacement cost but only the actual value of the roofs to alleviate some of the rising cost of claims. On the flip side, if they do continue offering full replacement coverage and a hurricane hits in some of those areas, you now have better roofs.” How insurance companies approach the peril is changing as a result of rising claims. “Historically, insurance and reinsurance clients have viewed SCS as an attritional loss, but in the last five to 10 years the changing trends have altered that perception,” says Vojjala. “That’s where there is this need for high-resolution modeling, which increasingly our clients have been asking for to improve their exposure management practices. “With SCS also having catastrophic losses, it has stoked interest from the ILS community as well, who are also experimenting with parametric triggers for SCS,” he adds. “We usually see this on the earthquake or hurricane side, but increasingly we are seeing it with SCS as well.” 

Helen Yates
September 06, 2019
Ridgecrest: A Wake-Up Call

Marleen Nyst and Nilesh Shome of RMS explore some of the lessons and implications from the recent sequence of earthquakes in California On the morning of July 4, 2019, the small town of Ridgecrest in California’s Mojave Desert unexpectedly found itself at the center of a major news story after a magnitude 6.4 earthquake occurred close by. This earthquake later transpired to be a foreshock for a magnitude 7.1 earthquake the following day, the strongest earthquake to hit the state for 20 years. These events, part of a series of earthquakes and aftershocks that were felt by millions of people across the state, briefly reignited awareness of the threat posed by earthquakes in California. Fortunately, damage from the Ridgecrest earthquake sequence was relatively limited. With the event not causing a widespread social or economic impact, its passage through the news agenda was relatively swift.  But there are several reasons why an event such as the Ridgecrest earthquake sequence should be a focus of attention both for the insurance industry and the residents and local authorities in California.  “If Ridgecrest had happened in a more densely populated area, this state would be facing a far different economic future than it is today” Glenn Pomeroy California Earthquake Authority “We don’t want to minimize the experiences of those whose homes or property were damaged or who were injured when these two powerful earthquakes struck, because for them these earthquakes will have a lasting impact, and they face some difficult days ahead,” explains Glenn Pomeroy, chief executive of the California Earthquake Authority. “However, if this series of earthquakes had happened in a more densely populated area or an area with thousands of very old, vulnerable homes, such as Los Angeles or the San Francisco Bay Area, this state would be facing a far different economic future than it is today — potentially a massive financial crisis,” Pomeroy says. Although one of the most populous U.S. states, California’s population is mostly concentrated in metropolitan areas. A major earthquake in one of these areas could have repercussions for both the domestic and international economy.  Low Probability, High Impact Earthquake is a low probability, high impact peril. In California, earthquake risk awareness is low, both within the general public and many (re)insurers. The peril has not caused a major insured loss for 25 years, the last being the magnitude 6.7 Northridge earthquake in 1994. California earthquake has the potential to cause large-scale insured and economic damage. A repeat of the Northridge event would likely cost the insurance industry today around US$30 billion, according to the latest version of the RMS® North America Earthquake Models, and Northridge is far from a worst-case scenario. From an insurance perspective, one of the most significant earthquake events on record would be the magnitude 9.0 Tōhoku Earthquake and Tsunami in 2011. For California, the 1906 magnitude 7.8 San Francisco earthquake, when Lloyd’s underwriter Cuthbert Heath famously instructed his San Franciscan agent to “pay all of our policyholders in full, irrespective of the terms of their policies”, remains historically significant. Heath’s actions led to a Lloyd’s payout of around US$50 million at the time and helped cement Lloyd’s reputation in the U.S. market. RMS models suggest a repeat of this event today could cost the insurance industry around US$50 billion. But the economic cost of such an event could be around six times the insurance bill — as much as US$300 billion — even before considering damage to infrastructure and government buildings, due to the surprisingly low penetration of earthquake insurance in the state. Events such as the 1906 earthquake and even Northridge are too far in the past to remain in public consciousness. And the lack of awareness of the peril’s damage potential is demonstrated by the low take-up of earthquake insurance in the state. “Because large, damaging earthquakes don’t happen very frequently, and we never know when they will happen, for many people it’s out of sight, out of mind. They simply think it won’t happen to them,” Pomeroy says. Across California, an average of just 12 percent to 14 percent of homeowners have earthquake insurance. Take-up varies across the state, with some high-risk regions, such as the San Francisco Bay Area, experiencing take-up below the state average. Take-up tends to be slightly higher in Southern California and is around 20 percent in Los Angeles and Orange counties.  Take-up will typically increase in the aftermath of an event as public awareness rises but will rapidly fall as the risk fades from memory. As with any low probability, high impact event, there is a danger the public will not be well prepared when a major event strikes.  The insurance industry can take steps to address this challenge, particularly through working to increase awareness of earthquake risk and actively promoting the importance of having insurance coverage for faster recovery. RMS and its insurance partners have also been working to improve society’s resilience against risks such as earthquake, through initiatives such as the 100 Resilient Cities program. Understanding the Risk While the tools to model and understand earthquake risk are improving all the time, there remain several unknowns which underwriters should be aware of. One of the reasons the Ridgecrest Earthquake came as such a surprise was that the fault on which it occurred was not one that seismologists knew existed.  Several other recent earthquakes — such as the 2014 Napa event, the Landers and Big Bear Earthquakes in 1992, and the Loma Prieta Earthquake in 1989 — took place on previously unknown or thought to be inactive faults or fault strands. As well as not having a full picture of where the faults may lie, scientific understanding of how multifaults can link together to form a larger event is also changing.  Events such as the Kaikoura Earthquake in New Zealand in 2016 and the Baja California Earthquake in Mexico in 2010 have helped inform new scientific thinking that faults can link together causing more damaging, larger magnitude earthquakes. The RMS North America Earthquake Models have also evolved to factor in this thinking and have captured multifault ruptures in the model based on the latest research results. In addition, studying the interaction between the faults that ruptured in the Ridgecrest events will allow RMS to improve the fault connectivity in the models.  A further learning from New Zealand came via the 2011 Christchurch Earthquake, which demonstrated how liquefaction of soil can be a significant loss driver due to soil condition in certain areas. The San Francisco Bay Area, an important national and international economic hub, could suffer a similar impact in the event of a major earthquake. Across the area, there has been significant residential and commercial development on artificial landfill areas over the last 100 years, which are prone to have significant liquefaction damage, similar to what was observed in Christchurch. Location, Location, Location Clearly, the location of the earthquake is critical to the scale of damage and insured and economic impact from an event. Ridgecrest is situated roughly 200 kilometers north of Los Angeles. Had the recent earthquake sequence occurred beneath Los Angeles instead, then it is plausible that the insured cost could have been in excess of US$100 billion.  The Puente Hills Fault, which sits underneath downtown LA, wasn’t discovered until around the turn of the century. A magnitude 6.8 Puente Hills event could cause an insured loss of US$78.6 billion, and a Newport-Inglewood magnitude 7.3 would cost an estimated US$77.1 billion according to RMS modeling. These are just a couple of the examples within its stochastic event set with a similar magnitude to the Ridgecrest events and which could have a significant social, economic and insured loss impact if they took place elsewhere in the state. The RMS model estimates that magnitude 7 earthquakes in California could cause insurance industry losses ranging from US$20,000 to a US$20 billion, but the maximum loss could be over US$100 billion if occurring in high population centers such as Los Angeles. The losses from the Ridgecrest event were on the low side of the range of loss as the event occurred in a less populated area. For the California Earthquake Authority’s portfolio in Los Angeles County, a large loss event of US$10 billion or greater can be expected approximately every 30 years. As with any major catastrophe, several factors can drive up the insured loss bill, including post-event loss amplification and contingent business interruption, given the potential scale of disruption. In Sacramento, there is also a risk of failure of the levee system. Fire following earthquake was a significant cause of damage following the 1906 San Francisco Earthquake and was estimated to account for around 40 percent of the overall loss from that event. It is, however, expected that fire would make a much smaller contribution to future events, given modern construction materials and methods and fire suppressant systems.  Political pressure to settle claims could also drive up the loss total from the event. Lawmakers could put pressure on the CEA and other insurers to settle claims quickly, as has been the case in the aftermath of other catastrophes, such as Hurricane Sandy. The California Earthquake Authority has recommended homes built prior to 1980 be seismically retrofitted to make them less vulnerable to earthquake damage. “We all need to learn the lesson of Ridgecrest: California needs to be better prepared for the next big earthquake because it’s sure to come,” Pomeroy says. “We recommend people consider earthquake insurance to protect themselves financially,” he continues. “The government’s not going to come in and rebuild everybody’s home, and a regular residential insurance policy does not cover earthquake damage. The only way to be covered for earthquake damage is to have an additional earthquake insurance policy in place.  “Close to 90 percent of the state does not have an earthquake insurance policy in place. Let this be the wake-up call that we all need to get prepared.”

Helen Yates
September 06, 2019
Shaking Up Workers' Compensation

Are (re)insurers sufficiently capitalized to withstand a major earthquake in a metropolitan area during peak hours?  The U.S. workers’ compensation insurance market continues to generate underwriting profit. According to Fitch Ratings, 2019 is on track to mark the fifth consecutive year of profits and deliver a statutory combined ratio of 86 percent in 2018. Since 2015, it has achieved an annual average combined ratio of 93 percent. The market’s size has increased considerably since the 2008 financial crisis sparked a flurry of activity in the workers’ compensation arena. Over the last 10 years, written premiums have risen 50 percent from approximately US$40 billion to almost US$60 billion, aided by low unemployment and growth in rate and wages.  Yet market conditions are changing. The pricing environment is deteriorating, prior-year reserve releases are slowing and severity is ticking upwards. And while loss reserves currently top US$150 billion, questions remain over whether these are sufficient to bear the brunt of a major earthquake in a highly populated area. The Big One California represents over 20 percent of the U.S. workers’ compensation market. The Workers’ Compensation Insurance Rating Bureau of California (WCIRB) forecasts a written premium pot of US$15.7 billion for 2019, a slight decline on 2018’s US$17 billion figure.  “So, the workers’ compensation sector’s largest premium is concentrated in the area of the U.S. most exposed to earthquake risk,” explains Nilesh Shome, vice president at RMS. “This problem is unique to the U.S., since in most other countries occupational injury is covered by government insurance schemes instead of the private market. Further, workers’ compensation policies have no limits, so they can be severely impacted by a large earthquake.” Workers’ compensation insurers enjoy relatively healthy balance sheets, with adequate profitability and conservative premium-to-surplus ratios. But, when you assess the industry’s exposure to large earthquakes in more detail, the surplus base starts to look a little smaller. “We are also talking about a marketplace untested in modern times,” he continues. “The 1994 Northridge Earthquake in Los Angeles, for example, while causing major loss, occurred at 4:30 a.m. when most people were still in bed, so had limited impact from a workers’ compensation perspective.” Analyzing the Numbers Working with the WCIRB, RMS modeled earthquake scenarios using Version 17 of the RMS® North America Earthquake Casualty Model, which incorporates the latest science in earthquake hazard and vulnerability research. The portfolio provided by the WCIRB contained exposure information for 11 million full-time-equivalent employees, including occupation details for each. The analysis showed that the average annual estimated insured loss is US$29 million, which corresponds to 0.5 cents per $100 payroll and $2.50 per employee. The 1-in-100-year insurance loss is expected to exceed US$300 million, around 5,000 casualties including 300 fatalities; while at peak work-time hours, the loss could rise to US$1.5 billion. For a 1-in-250-year loss, the figure could top US$1.4 billion and more than 1,000 fatalities, rising to US$5 billion at peak work-time hours.  But looking at the magnitude 7.8 San Francisco Earthquake in 1906 at 5:12 a.m., the figure would be 7,300 injuries, 1,900 fatalities and around US$1 billion in loss. At peak work hours, this would rise to 22,000 casualties, 5,800 fatalities and a US$3 billion loss. To help reduce the impact of major earthquakes, RMS is working with the Berkeley Research Lab and the United States Geological Survey (USGS) to research the benefits of an earthquake early warning system (EEWS) and safety measures such as drop-cover-hold and evacuating buildings after an EEWS alarm. Initial studies indicate that an EEWS alert for the large, faraway earthquakes such as the 1857 magnitude 7.9 Fort Tejon Earthquake near Los Angeles can reduce injuries by 20 percent-50 percent.  Shome concludes: “It is well known in the industry that workers’ compensation loss distribution has a long tail, and at conferences RMS has demonstrated how our modeling best captures this tail. The model considers many low probability, high consequence events by accurately modeling the latest USGS findings.”

NIGEL ALLEN
September 06, 2019
What a Difference

As the insurance industry’s Dive In Festival continues to gather momentum, EXPOSURE examines the factors influencing the speed at which the diversity and inclusion dial is moving September 2019 marks the fifth Dive In Festival, a global movement in the insurance sector to support the development of inclusive workplace cultures. An industry phenomenon, it has ballooned in size from a London-only initiative in 2015 attracting 1,700 people to an international spectacle spanning 27 countries and reaching over 9,000 people in 2018. That the event should gather such momentum clearly demonstrates a market that is moving forward. There is now an industrywide acknowledgement of the need to better reflect the diversity of the customer base within the industry’s professional ranks. The Starting Point As Pauline Miller, head of talent development and inclusion (D&I) at Lloyd’s, explains, the insurance industry is a market that has, in the past, been slow to change its practitioner profile. “If you look at Lloyd’s, for example, for nearly three hundred years it was a men-only environment, with women only admitted as members in December 1969. “It’s about bringing together the most creative group of people that represent different ways of thinking that have evolved out of the multiple factors that make them different” Pauline Miller Lloyd’s “You also have to recognize that the insurance industry is not as far along the diversity and inclusion journey compared to other sectors,” she continues. “I previously worked in the banking industry, and diversity and inclusion had been an agenda issue in the organization for a number of years. So, we must acknowledge that this is a journey that will require multiple more steps before we really begin breaking down barriers.” However, she is confident the insurance industry can quickly make up ground. “By its very nature, the insurance market lends itself to the spread of the D&I initiative,” Miller believes. “We are a relationship-based business that thrives on direct contact, and our day-to-day activities are based upon collaboration. We must leverage this to help speed up the creation of a more diverse and inclusive environment.” The positive effects of collaboration are already evident in how this is evolving. Initiatives like Dive In, a weeklong focus on diversity and inclusion, within other financial sectors have tended to be confined to individual organizations, with few generating the level of industrywide engagement witnessed within the insurance sector. However, as Danny Fisher, global HR business partner and EMEA HR manager at RMS, points out, for the drive to gain real traction there must be marketwide consensus on the direction it is moving in. “There is always a risk,” he says, “that any complex initiative that begins with such positive intent can become derailed if there is not an understanding of a common vision from the start, and the benefits it will deliver. “There also needs to be better understanding and acknowledgement of the multitude of factors that may have contributed to the uniformity we see across the insurance sector. We have to establish why this has happened and address the flaws in our industry contributing to it.” It can be argued that the insurance industry is still composed of a relatively homogeneous group of people. In terms of gender disparity, ethnic diversity, and people of different sexual orientations, from different cultural or social backgrounds, or with physical or mental impairments, the industry recognizes a need to improve.  Diversity is the range of human differences, including but not limited to race, ethnicity, gender, gender identity, sexual orientation, age, social class, physical ability or attributes, religious or ethical values system, national origin, and political beliefs. “As a market,” Miller agrees, “there is a tendency to hire people similar to the person who is recruiting. Whether that’s someone of the same gender, ethnicity, sexual orientation or from the same university or social background.” “You can end up with a very uniform workforce,” adds Fisher, “where people look the same and have a similar view of the world, which can foster ‘groupthink’ and is prone to bias and questionable conclusions. People approach problems and solutions in the same way, with no one looking at an alternative — an alternative that is often greatly needed. So, a key part of the diversity push is the need to generate greater diversity of thought.” The challenge is also introducing that talent in an inclusive way that promotes the effective development of new solutions to existing and future problems. That broad palette of talent can only be created by attracting and retaining the best and brightest from across the social spectrum within a framework in which that blend of skills, perspectives and opinions can thrive. “Diversity is not simply about the number of women, ethnicities, people with disabilities or people from disadvantaged backgrounds that you hire,” believes Miller. “It’s about bringing together the most creative group of people that represent different ways of thinking that have evolved out of the multiple factors that make them different.” Moving the Dial There is clearly a desire to make this happen and strong evidence that the industry is moving together. Top-level support for D&I initiatives coupled with the rapid growth of industrywide networks representing different demographics are helping firm up the foundations of a more diverse and inclusive marketplace.  But what other developments are needed to move the dial further? “We have to recognize that there is no ‘one-size-fits-all’ to this challenge,” says Miller. “Policies and strategies must be designed to create an environment in which diversity and inclusion can thrive, but fundamentally they must reflect the unique dynamics of your own organization. “We also must ensure we are promoting the benefits of a career in insurance in a more powerful and enticing way and to a broader audience,” she adds. “We operate in a fantastic industry, but we don’t sell it enough. And when we do get that diversity of talent through the door, we have to offer a workplace that sticks, so they don’t simply walk straight back out again.  “For example, someone from a disadvantaged community coming through an intern program may never have worked in an office environment before, and when they look around are they going to see people like themselves that they can relate to? What role models can they connect with? Are we prepared for that?” For Fisher, steps can also be taken to change processes and modernize thinking and habits. “We have to be training managers in interview and evaluation techniques and discipline to keep unconscious bias in check. There has to be consistency with meaningful tests to ensure data-driven hiring decisions. “At RMS, we are fortunate to attract talent from around the world and are able to facilitate bringing them on board to add further variety in solving for complex problems. A successful approach for us, for example, has been accessing talent early, often prior to their professional career.” There is, of course, the risk that the push for greater diversity leads to a quota-based approach.  “Nobody wants this to become a tick-box exercise,” believes Miller, “and equally nobody wants to be hired simply because they represent a particular demographic. But if we are expecting change, we do need measurements in place to show how we are moving the dial forward. That may mean introducing realistic targets within realistic timeframes that are monitored carefully to ensure we are on track. “Ultimately,” she concludes, “what we are all working to do is to create the best environment for the broadest spectrum of people to come into what is a truly amazing marketplace. And when they do, offering a workplace that enables them to thrive and enjoy very successful careers that contribute to the advancement of our industry. That’s what we all have to be working toward.”

NIGEL ALLEN
May 20, 2019
Earthquake Risk: New Zealand Insurance Sector Experiences Growing Pains

Speed of change around homeowners insurance is gathering pace as insurers move to differential pricing models New Zealand’s insurance sector is undergoing fundamental change as the impact of the NZ$40 billion (US$27 billion) Canterbury Earthquake and more recent Kaikōura disaster spur efforts to create a more sustainable, risk-reflective marketplace. In 2018, EXPOSURE examined risk-based pricing in the region following Tower Insurance’s decision to adopt such an approach to achieve a “fairer and more equitable way of pricing risk.” Since then, IAG, the country’s largest general insurer, has followed suit, with properties in higher-risk areas forecast to see premium hikes, while it also adopts “a conservative approach” to providing insurance in peril-prone areas. “Insurance, unsurprisingly, is now a mainstream topic across virtually every media channel in New Zealand,” says Michael Drayton, a consultant at RMS. “There has been a huge shift in how homeowners insurance is viewed, and it will take time to adjust to the introduction of risk-based pricing.” Another market-changing development is the move by the country’s Earthquake Commission (EQC) to increase the first layer of buildings’ insurance cover it provides from NZ$100,000 to NZ$150,000 (US$68,000 to US$101,000), while lowering contents cover from NZ$20,000 (US$13,500) to zero. These changes come into force in July 2019. Modeling the average annual loss (AAL) impact of these changes based on the updated RMS New Zealand Earthquake Industry Exposure Database shows the private sector will see a marginal increase in the amount of risk it takes on as the AAL increase from the contents exit outweighs the decrease from the buildings cover hike. These findings have contributed greatly to the debate around the relationship between buildings and contents cover. One major issue the market has been addressing is its ability to accurately estimate sums insured. According to Drayton, recent events have seen three separate spikes around exposure estimates. “The first spike occurred in the aftermath of the Christchurch Earthquake,” he explains, “when there was much debate about commercial building values and limits, and confusion relating to sums insured and replacement values. “The second occurred with the move away from open-ended replacement policies in favor of sums insured for residential properties. “Now that the EQC has removed contents cover, we are seeing another spike as the private market broaches uncertainty around content-related replacement values. “There is very much an education process taking place across New Zealand’s insurance industry,” Drayton concludes. “There are multiple lessons being learned in a very short period of time. Evolution at this pace inevitably results in growing pains, but if it is to achieve a sustainable insurance market it must push on through.”

Helen Yates
May 20, 2019
The Future of Risk Management

(Re)insuring new and emerging risks requires data and, ideally, a historical loss record upon which to manage an exposure. But what does the future of risk management look like when so many of these exposures are intangible or unexpected?  Sudden and dramatic breakdowns become more likely in a highly interconnected and increasingly polarized world, warns the “Global Risks Report 2019” from the World Economic Forum (WEF). “Firms should focus as much on risk response as on risk mitigation,” advises John Drzik, president of global risk and digital at Marsh, one of the report sponsors. “There’s an inevitability to having a certain number of shock events, and firms should focus on how to respond to fast-moving events with a high degree of uncertainty.” Macrotrends such as climate change, urbanization and digitization are all combining in a way that makes major claims more impactful when things go wrong. But are all low-probability/high-consequence events truly beyond our ability to identify and manage? Dr. Gordon Woo, catastrophist at RMS, believes that in an age of big data and advanced analytics, information is available that can help corporates, insurers and reinsurers to understand the plethora of new and emerging risks they face. “The sources of emerging risk insight are out there,” says Woo. “The challenge is understanding the significance of the information available and ensuring it is used to inform decision-makers.” However, it is not always possible to gain access to the insight needed. “Some of the near-miss data regarding new software and designs may be available online,” says Woo. “For example, with the Boeing 737 Max 8, there were postings by pilots where control problems were discussed prior to the Lion Air disaster of October 2018. Equally, intelligence information on terrorist plots may be available from online terrorist chatter. But typically, it is much harder for individuals to access this information, other than security agencies. “Peter Drucker [consultant and author] was right when he said: ‘If you can’t measure it, you can’t improve it,’” he adds. “And this is the issue for (re)insurers when it comes to emerging risks. There is currently not a lot of standardization between risk compliance systems and the way the information is gathered, and corporations are still very reluctant to give information away to insurers.” The Intangibles Protection Gap While traditional physical risks, such as fire and flood, are well understood, well modeled and widely insured, new and emerging risks facing businesses and communities are increasingly intangible and risk transfer solutions are less widely available. While there is an important upside to many technological innovations, for example, there are also downsides that are not yet fully understood or even recognized, thinks Robert Muir-Wood, chief research officer of science and technology at RMS. “Last year’s Typhoon Jebi caused coastal flooding in the Kansai region of Japan,” he says. “There were a lot of cars on the quayside close to where the storm made landfall and many of these just caught on fire. It burnt out a large number of cars that were heading for export. “The reason for the fires was the improved capability of batteries in cars,” he explains. “And when these batteries are immersed in water they burst into flames. So, with this technology you’ve created a whole new peril. There is currently not a lot of standardization between risk compliance systems and the way the information is gathered Gordon Woo RMS “As new technology emerges, new risks emerge,” he concludes. “And it’s not as though the old risks go away. They sort of morph and they always will. Clearly the more that software becomes a critical part of how things function, then there is more of an opportunity for things to go wrong.” From nonphysical-damage business interruption and reputational harm to the theft of intellectual property and a cyber data breach, the ability for underwriters to get a handle on these risks and potential losses is one of the industry’s biggest modern-day challenges. The dearth of products and services for esoteric commercial risks is known as the “intangibles protection gap,” explains Muir-Wood. “There is this question within the whole span of risk management of organizations — of which an increasing amount is intangible — whether they will be able to buy insurance for those elements of their risk that they feel they do not have control over.” While the (re)insurance industry is responding with new products and services geared toward emerging risks, such as cyber, there are some organizational perils, such as reputational risk, that are best addressed by instilling the right risk management culture and setting the tone from the top within organizations, thinks Wayne Ratcliffe, head of risk management at SCOR. “Enterprise risk management is about taking a holistic view of the company and having multidisciplinary teams brainstorming together,” he says. “It’s a tendency of human nature to work in silos in which everyone has their own domain to protect and to work on, but working across an organization is the only way to carry out proper risk management. “There are many causes and consequences of reputational risk, for instance,” he continues. “When I think of past examples where things have gone horribly wrong — and there are so many of them, from Deepwater Horizon to Enron — in certain cases there were questionable ethics and a failure in risk management culture. Companies have to set the tone at the top and then ensure it has spread across the whole organization. This requires constant checking and vigilance.” The best way of checking that risk management procedures are being adhered to is by being really close to the ground, thinks Ratcliffe. “We’re moving too far into a world of emails and communication by Skype. What people need to be doing is talking to each other in person and cross-checking facts. Human contact is essential to understanding the risk.” Spotting the Next “Black Swan” What of future black swans? As per Donald Rumsfeld’s “unknown unknowns,” so called black swan events are typically those that come from left field. They take everyone by surprise (although are often explained away in hindsight) and have an impact that cascades through economic, political and social systems in ways that were previously unimagined, with severe and widespread consequences. “As (re)insurers we can look at past data, but you have to be aware of the trends and forces at play,” thinks Ratcliffe. “You have to be aware of the source of the risk. In ‘The Big Short’ by Michael Lewis, the only person who really understood the impending subprime collapse was the one who went house-to-house asking people if they were having trouble paying their mortgages, which they were. New technologies are creating more opportunities but they’re also making society more vulnerable to sophisticated cyberattacks Wayne Ratcliffe SCOR “Sometimes you need to go out of the bounds of data analytics into a more intuition-based way of picking up signals where there is no data,” he continues. “You need imagination and to come up with scenarios that can happen based on a group of experts talking together and debating how exposures can connect and interconnect. “It’s a little dangerous to base everything on big data measurement and statistics, and at SCOR we talk about the ‘art and science of risk,’” he continues. “And science is more than statistics. We often need hard science behind what we are measuring. A single-point estimate of the measure is not sufficient. We also need confidence intervals corresponding to a range of probabilities.” In its “Global Risks Report 2019,” the WEF examines a series of “what-if” future shocks and asks if its scenarios, while not predictions, are at least “a reminder of the need to think creatively about risk and to expect the unexpected?” The WEF believes future shocks could come about as a result of advances in technology, the depletion of global resources and other major macrotrends clashing in new and extreme ways. “The world is becoming hyperconnected,” says Ratcliffe. “People are becoming more dependent on social media, which is even shaping political decisions, and organizations are increasingly connected via technology and the internet of things. New technologies are creating more opportunities but they’re also making society more vulnerable to sophisticated cyberattacks. We have to think about the systemic nature of it all.” As governments are pressured to manage the effects of climate change, for instance, will the use of weather manipulation tools — such as cloud seeding to induce or suppress rainfall — result in geopolitical conflict? Could biometrics and AI that recognize and respond to emotions be used to further polarize and/or control society? And will quantum computing render digital cryptography obsolete, leaving sensitive data exposed? The risk of cyberattack was the No. 1 risk identified by business leaders in virtually all advanced economies in the WEF’s “Global Risks Report 2019,” with concern about both data breach and direct attacks on company infrastructure causing business interruption. The report found that cyberattacks continue to pose a risk to critical infrastructure, noting the attack in July 2018 that compromised many U.S. power suppliers. In the attack, state-backed Russian hackers gained remote access to utility- company control rooms in order to carry out reconnaissance. However, in a more extreme scenario the attackers were in a position to trigger widespread blackouts across the U.S., according to the Department of Homeland Security. Woo points to a cyberattack that impacted Norsk Hydro, the company that was responsible for a massive bauxite spill at an aluminum plant in Brazil last year, with a targeted strain of ransomware known as “LockerGoga.” With an apparent motivation to wreak revenge for the environmental damage caused, hackers gained access to the company’s IT infrastructure, including the control systems at its aluminum smelting plants. He thinks a similar type of attack by state-sponsored actors could cause significantly greater disruption if the attackers’ motivation was simply to cause damage to industrial control systems. Woo thinks cyber risk has significant potential to cause a major global shock due to the interconnected nature of global IT systems. “WannaCry was probably the closest we’ve come to a cyber 911,” he explains. “If the malware had been released earlier, say January 2017 before the vulnerability was patched, losses would have been a magnitude higher as the malware would have spread like measles as there was no herd immunity. The release of a really dangerous cyber weapon with the right timing could be extremely powerful.”

Helen Yates
May 20, 2019
Living in a World of Constant Catastrophes

(Re)insurance companies are waking up to the reality that we are in a riskier world and the prospect of ‘constant catastrophes’ has arrived, with climate change a significant driver In his hotly anticipated annual letter to shareholders in February 2019, Warren Buffett, the CEO of Berkshire Hathaway and acclaimed “Oracle of Omaha,” warned about the prospect of “The Big One” — a major hurricane, earthquake or cyberattack that he predicted would “dwarf Hurricanes Katrina and Michael.” He warned that “when such a mega-catastrophe strikes, we will get our share of the losses and they will be big — very big.” The use of new technology, data and analytics will help us prepare for unpredicted ‘black swan’ events and minimize the catastrophic losses Mohsen Rahnama RMS The question insurance and reinsurance companies need to ask themselves is whether they are prepared for the potential of an intense U.S. landfalling hurricane, a Tōhoku-size earthquake event and a major cyber incident if these types of combined losses hit their portfolio each and every year, says Mohsen Rahnama, chief risk modeling officer at RMS. “We are living in a world of constant catastrophes,” he says. “The risk is changing, and carriers need to make an educated decision about managing the risk. “So how are (re)insurers going to respond to that? The broader perspective should be on managing and diversifying the risk in order to balance your portfolio and survive major claims each year,” he continues. “Technology, data and models can help balance a complex global portfolio across all perils while also finding the areas of opportunity.” A Barrage of Weather Extremes How often, for instance, should insurers and reinsurers expect an extreme weather loss year like 2017 or 2018? The combined insurance losses from natural disasters in 2017 and 2018 according to Swiss Re sigma were US$219 billion, which is the highest-ever total over a two-year period. Hurricanes Harvey, Irma and Maria delivered the costliest hurricane loss for one hurricane season in 2017. Contributing to the total annual insurance loss in 2018 was a combination of natural hazard extremes, including Hurricanes Michael and Florence, Typhoons Jebi, Trami and Mangkhut, as well as heatwaves, droughts, wildfires, floods and convective storms. While it is no surprise that weather extremes like hurricanes and floods occur every year, (re)insurers must remain diligent about how such risks are changing with respect to their unique portfolios. Looking at the trend in U.S. insured losses from 1980–2018, the data clearly shows losses are increasing every year, with climate-related losses being the primary drivers of loss, especially in the last four decades (even allowing for the fact that the completeness of the loss data over the years has improved). Measuring Climate Change With many non-life insurers and reinsurers feeling bombarded by the aggregate losses hitting their portfolios each year, insurance and reinsurance companies have started looking more closely at the impact that climate change is having on their books of business, as the costs associated with weather-related disasters increase. The ability to quantify the impact of climate change risk has improved considerably, both at a macro level and through attribution research, which considers the impact of climate change on the likelihood of individual events. The application of this research will help (re)insurers reserve appropriately and gain more insight as they build diversified books of business. Take Hurricane Harvey as an example. Two independent attribution studies agree that the anthropogenic warming of Earth’s atmosphere made a substantial difference to the storm’s record-breaking rainfall, which inundated Houston, Texas, in August 2017, leading to unprecedented flooding. In a warmer climate, such storms may hold more water volume and move more slowly, both of which lead to heavier rainfall accumulations over land. Attribution studies can also be used to predict the impact of climate change on the return-period of such an event, explains Pete Dailey, vice president of model development at RMS. “You can look at a catastrophic event, like Hurricane Harvey, and estimate its likelihood of recurring from either a hazard or loss point of view. For example, we might estimate that an event like Harvey would recur on average say once every 250 years, but in today’s climate, given the influence of climate change on tropical precipitation and slower moving storms, its likelihood has increased to say a 1-in-100-year event,” he explains. We can observe an incremental rise in sea level annually — it’s something that is happening right in front of our eyes Pete Dailey RMS “This would mean the annual probability of a storm like Harvey recurring has increased more than twofold from 0.4 percent to 1 percent, which to an insurer can have a dramatic effect on their risk management strategy.” Climate change studies can help carriers understand its impact on the frequency and severity of various perils and throw light on correlations between perils and/or regions, explains Dailey. “For a global (re)insurance company with a book of business spanning diverse perils and regions, they want to get a handle on the overall effect of climate change, but they must also pay close attention to the potential impact on correlated events. “For instance, consider the well-known correlation between the hurricane season in the North Atlantic and North Pacific,” he continues. “Active Atlantic seasons are associated with quieter Pacific seasons and vice versa. So, as climate change affects an individual peril, is it also having an impact on activity levels for another peril? Maybe in the same direction or in the opposite direction?” Understanding these “teleconnections” is just as important to an insurer as the more direct relationship of climate to hurricane activity in general, thinks Dailey. “Even though it’s hard to attribute the impact of climate change to a particular location, if we look at the impact on a large book of business, that’s actually easier to do in a scientifically credible way,” he adds. “We can quantify that and put uncertainty around that quantification, thus allowing our clients to develop a robust and objective view of those factors as a part of a holistic risk management approach.” Of course, the influence of climate change is easier to understand and measure for some perils than others. “For example, we can observe an incremental rise in sea level annually — it’s something that is happening right in front of our eyes,” says Dailey. “So, sea-level rise is very tangible in that we can observe the change year over year. And we can also quantify how the rise of sea levels is accelerating over time and then combine that with our hurricane model, measuring the impact of sea-level rise on the risk of coastal storm surge, for instance.” Each peril has a unique risk signature with respect to climate change, explains Dailey. “When it comes to a peril like severe convective storms — tornadoes and hail storms for instance — they are so localized that it’s difficult to attribute climate change to the future likelihood of such an event. But for wildfire risk, there’s high correlation with climate change because the fuel for wildfires is dry vegetation, which in turn is highly influenced by the precipitation cycle.” Satellite data from 1993 through to the present shows there is an upward trend in the rate of sea-level rise, for instance, with the current rate of change averaging about 3.2 millimeters per year. Sea-level rise, combined with increasing exposures at risk near the coastline, means that storm surge losses are likely to increase as sea levels rise more quickly. “In 2010, we estimated the amount of exposure within 1 meter above the sea level, which was US$1 trillion, including power plants, ports, airports and so forth,” says Rahnama. “Ten years later, the exact same exposure was US$2 trillion. This dramatic exposure change reflects the fact that every centimeter of sea-level rise is subjected to a US$2 billion loss due to coastal flooding and storm surge as a result of even small hurricanes. “And it’s not only the climate that is changing,” he adds. “It’s the fact that so much building is taking place along the high-risk coastline. As a result of that, we have created a built-up environment that is actually exposed to much of the risk.” Rahnama highlighted that because of an increase in the frequency and severity of events, it is essential to implement prevention measures by promoting mitigation credits to minimize the risk.  He says: “How can the market respond to the significant losses year after year. It is essential to think holistically to manage and transfer the risk to the insurance chain from primary to reinsurance, capital market, ILS, etc.,” he continues. “The art of risk management, lessons learned from past events and use of new technology, data and analytics will help to prepare for responding to unpredicted ‘black swan’ type of events and being able to survive and minimize the catastrophic losses.” Strategically, risk carriers need to understand the influence of climate change whether they are global reinsurers or local primary insurers, particularly as they seek to grow their business and plan for the future. Mergers and acquisitions and/or organic growth into new regions and perils will require an understanding of the risks they are taking on and how these perils might evolve in the future. There is potential for catastrophe models to be used on both sides of the balance sheet as the influence of climate change grows. Dailey points out that many insurance and reinsurance companies invest heavily in real estate assets. “You still need to account for the risk of climate change on the portfolio, whether you’re insuring properties or whether you actually own them, there’s no real difference.” In fact, asset managers are more inclined to a longer-term view of risk when real estate is part of a long-term investment strategy. Here, climate change is becoming a critical part of that strategy. “What we have found is that often the team that handles asset management within a (re)insurance company is an entirely different team to the one that handles catastrophe modeling,” he continues. “But the same modeling tools that we develop at RMS can be applied to both of these problems of managing risk at the enterprise level. “In some cases, a primary insurer may have a one-to-three-year plan, while a major reinsurer may have a five-to-10-year view because they’re looking at a longer risk horizon,” he adds. “Every time I go to speak to a client — whether it be about our U.S. Inland Flood HD Model or our North America Hurricane Models — the question of climate change inevitably comes up. So, it’s become apparent this is no longer an academic question, it’s actually playing into critical business decisions on a daily basis.” Preparing for a Low-carbon Economy Regulation also has an important role in pushing both (re)insurers and large corporates to map and report on the likely impact of climate change on their business, as well as explain what steps they have taken to become more resilient. In the U.K., the Prudential Regulation Authority (PRA) and Bank of England have set out their expectations regarding firms’ approaches to managing the financial risks from climate change.  Meanwhile, a survey carried out by the PRA found that 70 percent of U.K. banks recognize the risk climate change poses to their business. Among their concerns are the immediate physical risks to their business models — such as the exposure to mortgages on properties at risk of flood and exposure to countries likely to be impacted by increasing weather extremes. Many have also started to assess how the transition to a low-carbon economy will impact their business models and, in many cases, their investment and growth strategy. “Financial policymakers will not drive the transition to a low-carbon economy, but we will expect our regulated firms to anticipate and manage the risks associated with that transition,” said Bank of England Governor Mark Carney, in a statement.   The transition to a low-carbon economy is a reality that (re)insurance industry players will need to prepare for, with the impact already being felt in some markets. In Australia, for instance, there is pressure on financial institutions to withdraw their support from major coal projects. In the aftermath of the Townsville floods in February 2019 and widespread drought across Queensland, there have been renewed calls to boycott plans for Australia’s largest thermal coal mine. To date, 10 of the world’s largest (re)insurers have stated they will not provide property or construction cover for the US$15.5 billion Carmichael mine and rail project. And in its “Mining Risk Review 2018,” broker Willis Towers Watson warned that finding insurance for coal “is likely to become increasingly challenging — especially if North American insurers begin to follow the European lead.” 

close button
Video Title

Thank You

You’ll be contacted by an RMS specialist shortly.

RMS.com uses cookies to improve your experience and analyze site usage. Read Cookie Policy or click I understand.

close