General Insurance Spring Seminar ‘Facing up to Risk’

1. abcd General Insurance Spring Seminar‘Facing up to Risk’ 13-14 May 2002 Scarman House, University of Warwick, Coventry

2. abcd The Worst Event Richard Winter K P M G

3. 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 Worst Event

4. 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 easy way to assess the worst possible event

5. 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 The Worst Event

6. 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 Aim of Presentation

7. How do you manage risk?

8. How do you manage risk? Control Identify Administer Finance

9. 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) Identify Risk

10. 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 Why were events so unexpected

11. 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….

12. 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 What would it take to….

13. This is the second talk this morning You had a heavy time last night Its audience participation time We have a problem

14. 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. Practical Exercise

15. 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 Identification : Realistic Disaster Scenarios

16. 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

17. Unrealistic Disaster Scenarios

18. 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

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

20. Ignore it, and hope it doesn’t happen Finance

21. 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

22. 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 Finance

23. 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 Does Payback work?

24. 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

25. 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 Finance

26. 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 Control / Finance – What has happened in practice?

27. 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 Administer

28. 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? Key issues