The reinsurance business and emerging risks
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Digital economy and the invasion of big data are revolutionizing emerging risk knowledge and analysis behind which traditional models are left lagging.
Furthermore, the accelerated climate change and the rising longevity of populations have triggered heavy sociological and economic evolutions while creating new needs in the process.
The little information available regarding these new dangers, along with these new high potential exposures to loss compel insurers to reconsider their business. Nowadays, the insurance business is no longer confined to just indemnifying customers, but it has also evolved to involve customers in risk analysis and risk sharing between customer, insurer and reinsurer, working on risk prevention.
Difficulty of reinsurers in identifying emerging risks
Insurance and reinsurance companies are facing major difficulties in their approach to emerging risks. The first difficulty is to identify those risks which are not easy to identify because they arise and evolve at the pace of social and technological contexts which are rapidly accelerating.
Even when they are identified, insurers are finding new risks hard to contain them properly. The guarantees associated with them and the funds allocated to address them are often subject to trial and error procedures.
Everything about risks is hard to identify:
- their exact nature,
- the shape under which they appear,
- their duration,
- their intensity,
- the category of risk to which they belong, etc.
Insurers and reinsurers faced with quantification of emerging risks
Insurance and reinsurance companies face a real problem in quantifying emerging risks.
The September 11, 2001 attacks in the United States of America took short all insurers who, in their worst case scenarios, could not see a loss of that magnitude affecting so many insurance businesses coming.
Only then did the insurance business come to realize its exposure to extreme risks.
Globalization, itself, has created new extreme risks such as the disruption of supply chain. This new emerging risk along with the growing concentration of wealth and human activities may generate outstanding claims as was the case for Tianjin (China) in August 2015.
In fact, emerging risks showcase some features that place them on the borders of non-insurability. With the advent of cybercrimes, some risks may be even regarded as systemic.
Reinsurance as a tool for resilience of emerging risk
In the insurance industry, resilience makes it possible to ensure the continuity of the business after a major event. It is about the capacity to turn around quickly from a catastrophe of exceptional scale. In 2011, the Japanese economy exhibited a high degree of resilience following the explosion of the Fukushima nuclear reactor and the tsunami that ensued.
To this first notion of resilience, it is important to add a second concept which is cyber resilience. Insurers dread the latter because of the risk of chaos that it may trigger. The “2000 bug” was, back then, an example of cyber-risk with a systemic nature which could have brought many countries to a standstill.
Vulnerability and risk mitigation
Vulnerability and mitigation are two close concepts that derive from the principle of protection and reduction of risks.
For many years, insurers and reinsurers have invested in risk prevention.
The first measures to be introduced in this regard a few decades ago touched the areas of road safety and fire prevention. Ever since, insurers have invested in all classes of business whereby, in concert with customers, they introduced measures to mitigate vulnerability of risks.
In terms of natural catastrophes, the insurance business has generally been involved with the States and local governments in order to reduce vulnerability of risks. The purpose is to reduce the likelihood of occurrence of a catastrophe risk or to reduce its intensity.
Mitigation consists in reducing or annihilating damage caused by the occurrence of a claim.
Reinsurance stands as a tool for risk mitigation. It makes it possible to reduce the vulnerability of insurers when faced with major risks.
Reinsurance transfer of longevity risk
Insurers are relying on mathematical and prospective life models to proceed with the modeling of longevity risk.
This risk had both life and non life insurers scratching their heads. Its management which extends over long years turned out to be quite a struggle. That is the reason why insurers transfer it to reinsurers who, themselves, mutualize it with a larger population of risks, often placing it in financial markets. Alternative reinsurance is more and more solicited to absorb this kind of risk.
The needs for reinsurance capacity of emerging risks
In order to underwrite emerging risks without clear limits and with high loss potential, insurers often need the capacity provided by reinsurers. The Bermudan market which emerged after the World Trade Center claim in 2001, brings some solution to those capacity needs for the coverage of new risks, that is, low frequency but high intensity risks such as hurricanes, earthquakes, terrorism, etc.
The London market stands as a traditional investment market for such risks, particularly for risks of war, attacks, riots and civil commotion, etc.
The recent arrival of new capital drained by alternative reinsurance is worth noting. Alternative reinsurance accounts for 18% of global reinsurance capacity in 2014.
Role of the State in the coverage of emerging risks
Whether of traditional or alternative nature, reinsurance cannot, alone, come up with all the solutions to meet the coverage needs of insurers with regard to emerging risks.
The State plays a major role in the resolution of problems. It is the only party that has power to legislate and impose the regulatory framework: Compulsory underwriting of risks of catastrophic nature, cybercrimes, terrorism, climate change, etc.
A public-private partnership remains the most realistic solution to achieve an effective coverage of new risks and to satisfy customers, insurers, reinsurers and the entire community alike.
