General Insurance Spring Seminar‘Facing up to Risk’

13-14 May 2002

Scarman House, University of Warwick, Coventry

The Worst Event

Richard Winter

K P M G

The Worst Event

Suggest a title for a workshop to Julian Leigh, asking him to find a presenter

Get an email by return saying “That sounds interesting – I look forward to hearing you do it.”

Then discover that the workshop has become one of the main sessions

The easy way to assess the worst possible event

Assume that every policy pays out to it’s maximum exposure

That is all the capital you need to hold just in case Impossible – even if you look at just one class of

business within one company Hold a “reasonable” level of capital At some point, need to introduce judgement into

process

The Worst Event

Prior to 2001 - Biggest UK motor claim ~ £9m Severe injury / very high assumed future earnings Selby – estimated cost £40m - £50m WTC – step change in property claims Toulouse Explosion – estimated insurance bill $2bn,

with properties severely damaged 1km from site of explosion

Aim of Presentation

Consider how to manage extreme catastrophe risk Overlaps with other presentations at this event

Manage extreme risks within product lines and individual risks

Most senior management focus on major risks (what could put us out of business / cause insolvency)

Product manager / Underwriting / Pricing focus risk management at a localised level

How do you manage risk?

How do you manage risk?

Identify

Control

Administer Finance

Identify Risk

This is meant to be what insurers are good at Sinister Risk

From an unusual or unexpected source One claim to maximum cover (and massively beyond)

(WTC) Unexpectedly large consequential loss (Selby) Large number of relatively small claims (Asbestos)

Why were events so unexpected

WTC – nothing would happen that could take both towers out simultaneously

Selby – Road Traffic Accident is going to be on the road – there will not be multiple severe bodily injuries

What would it take to….

Get a claim that exhausts the cover on this policy? What is the maximum damage that the entity we are

insuring could cause? Is there any way that every policyholder could claim

under a policy?

What would it take to….

Get a claim that exhausts the cover on this policy? WTC

What is the maximum damage that the entity we are insuring could cause? Dog Toddler Roast Potato

Is there any way that every policyholder could claim under a policy? Cashback

We have a problem

This is the second talk this morning You had a heavy time last night Its audience participation time

Practical Exercise

You are the insurer of 500,000 private vehicles under current UK legislation

How did the first £100m individual claim happen? How did you lose £15m by 1 in 10 of your

policyholders making a £300 claim.

Identification : Realistic Disaster Scenarios

Lloyds Market Risk Unit USA Windstorm $50bn loss European Storm / Flood $10bn Japanese Earthquake $15bn Marine Collision (Ultra Large Crude Carrier and Cruise

Liner) North Sea – loss of complex Aviation collision (over major US city) Loss to largest single risk including PML failure Space storm destroys 6 in orbit satellites Political Risk

Unrealistic Disaster Scenarios

Expect the unexpected If something bad can happen, it probably will Identify key assumptions in thinking

Since May 1984 there has been no significant flood risk to London because of introduction of Thames Barrier

Unrealistic Disaster Scenarios

Control

Limit exposure Don’t sell as much cover Ensure exposure to region / one risk / one event is

understood Restrict cover

Terrorism exclusions More risk bands Enforcement of policy conditions

Encourage Mitigation Withdraw Cover Government – Insurer of last resort

Control

Needs a long (corporate) memory Not conducive to building market share Easier in a hard market Temptation – follow the market practice

Finance

Ignore it, and hope it doesn’t happen

Finance

Ignore it, and hope it doesn’t happen Valid approach Acceptable company failure rate 1 in 1000 year events do happen

How would you perform relative to the rest of the market? If all insurance companies went insolvent together, would

the Government bail them out No one is being singled out over WTC because all

companies have taken a big hit

Finance

Ignore it and hope it doesn’t happen Payback

The purpose of commercial insurance is to smooth declared profit, not to alter the total amount of profit over time

Reinsurance is similarly to smooth profit for the direct insurer, not to alter the total amount of profit over time

Personal lines insurance is a means of spreading the costs of a natural catastrophe amongst the insured population over time, not a transfer of risk to the insurer

Does Payback work?

If make too explicit, ceases to be a contract of insurance

Assumes barriers to entry and exit In practice, relatively easy to introduce or withdraw capacity

At extreme, assumes purchaser is willing to respond quickly enough to save insurer that gets into trouble

Finance

Ignore it and hope it doesn’t happen Payback Reinsurance

Limits loss to an “acceptable” level Can cover be placed? Assumes reinsurer able to pay up

What about reinsurers aggregation of risk?

Finance

Ignore it and hope it doesn’t happen Payback Reinsurance Diversify

Ideally take on a risk with the opposite financial effect Normally not obvious for an insurance product

Control / Finance – What has happened in practice?

Property – PML has been reassessed (e.g. whole buildings destroyed not just floors)

Terrorism cover withdrawn (or not as easy to obtain) Some companies – reducing exposure Lot of new entrants to market – limits upside for

companies that made heavy losses

Administer

Aggregation of risk Within class of business Across multiple classes

Demonstrate monitoring exposure properly (not just have the capability to do so)

Review continually Only a fool learns by his own mistakes

Key issues

It is important to work out the worst that can happen – both at a “macro” and “micro” level

Appropriate action may be to do nothing – but it should be a conscious (and documented) decision

If you don’t identify a risk you can’t control it Is the concept of payback dead – and if so, are

companies acting in a way consistent with this? How short is the memory of the insurance industry?