Look Back in Anger…

No, we are not evoking nostalgia for the famous John Osborne play, the perils of exotic options, or the mis-spent youth of a generation of “angry young men”, but rather referring to the risks of making a fundamentally wrong call on certain future trends by evoking the past.

Of course, the above statement sounds like a paradox. However, it is not.

Most large financial institutions have a mechanism for identifying and assessing so-called “emerging risks” within their risk management functions; and, periodically, the (re)insurance markets fixate upon a particular one- with “cyber risk” being the front-runner at present. The problem is, of course, that if a risk is truly “new” how does one measure its potential probability and impact?

Standard approaches tend to rely upon datasets of previous experience as the basis for predicting future frequency and severity, leading to the “1-in-100” and “1-in-250” year exposure tables and graphs that pepper (re)insurers’ reporting and are meant to soothe policyholders, investors and regulators that everything is under control and manageable. However, these are really analogous to the Value at Risk (or VaR) calculations that almost destroyed the banking system; so, how does one address a risk for which large, accurate, consistent and long-term datasets do not exist?

“Cyber risk” is used as a term of art, as is “climate change”; but what do they really mean; and how does one measure them? Cyber risk is a “clear and present” danger, whereas climate change (assuming one can get past the politicized rhetoric) is a much longer term one. The former can certainly have serious consequences; but the latter is potentially an existential threat.

Returning to the title of this note, at Awbury we are concerned that the industry will find itself looking back in anger (and chagrin), or at least the survivors will, because it was unable to assess the dangers it faced from these emerging risks, and found it difficult to frame the questions; make appropriate assumptions; and build robust models that would enable it to ensure that it did not over-reach its claims-paying capacity. And there is, in our view, a real risk that, because of the continuing dearth of premia available in traditional “natCAT” product lines, underwriters will be so eager to capture business in new product lines that they will mis-price the risk.

And as for climate change, the subject is one which we keep under constant review, because its complexity and potential impact mean that businesses and risks that would once have been considered predictable may suddenly experience a dramatic shift, largely because of political or societal decisions. This means that it is critical to maintain constant vigilance in order to detect such shifts and factor them into our risk-selection and –pricing.

So, do not ignore those who are often mocked as “Cassandras”. Remember what happened to her. It did not end well.

The Awbury Team

Standard

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.