With Halloween upon us, it got us thinking of all the worst-case scenarios that we help our clients prepare for every day. So we asked each of our bloggers to tell us the scariest risk in their area of expertise. Which one makes you tremble most? Take our poll at the bottom and let us know.
(Jump down: Energy, Mining, Terrorism, ERM, Financial Services, Reinsurance, Health Care, Power, Environmental Liability, Employee Benefits, Trade Credit, Middle East, China, Global, D&O, Renewables, Supply Chain, FINEX, Captive Insurance, Real Estate, Aerospace)
Energy: Macondo Mach II
In the energy industry, the unthinkable has perhaps already happened: the $40 billion in losses associated with the Macondo well that blew out last year were utterly unprecedented. Most of that risk was uninsured, so the energy market got off relatively lightly in this case. But as the drive to drill wells similar to Macondo continues, the nightmare scenario for the energy market is the “perfect storm” of another blowout of a similar nature combined with a Gulf of Mexico windstorm on the scale of a Katrina, Rita or Ike. That would almost certainly lead to underwriting losses that would be sufficient to prompt a potential capacity crisis.
When we are young, our parents calm our fears of the dark by turning the light on so we can see that there is indeed no bogeyman under the bed. But what would happen if the light didn’t come on? Scary thought…. Most of the energy required by the power stations around the world comes from coal, and most of the coal is found in areas of the world which are prone to natural catastrophe – flood, storm, cyclone, earthquake. Trying to predict and manage the forces of nature is a more than difficult task as the recent spate of unexpected natural disasters goes to prove. Trying to mitigate and manage the impact of these forces on the coal mining industry is proving to be the challenge of the moment for miners and insurers alike, made even more critical due to the issues surrounding the future of nuclear power after the Japan earthquake. No coal, no power, no electricity, no light – tough when you’re scared of the dark…. Happy Halloween!
Terrorism: ‘Nuf Said
Terrorism remains a fundamental risk management challenge in its unpredictability from the perspective of frequency, mode of attack and target. Terrorists have used planes, mail bombs, anthrax, printer cartridges, shoes and underwear among other techniques to pull off attacks in places as disparate as Oklahoma City, Madrid and Sri Lanka. Companies are tempted to ask, Why would my company be a target when there are so many others in high-profile industries or regions? Ask the residents of Oklahoma City. Or Atlanta. Or an island in Norway. Terrorists have many guises — not just the religious extremist, but the environmentalist protecting migratory bird flight paths, the radical anti-government protestor, or the one opposed to controversial research at a medical facility. Terrorism will not disappear -– it will just adapt as needed to make its powerful message heard
ERM: Italian Default
The threat of escalation of Europe’s sovereign debt crisis continues to make me wake in a cold sweat. The focus has so far been on Greece and the Franco/German attempts to manufacture a solution that protects French banks whilst being just about palatable to the German parliament and populace. But Italy is the key — surely no central fund can be big enough to bail out an Italian default. So much depends on sentiment and credibility. Can the Italian coalition government agree an action plan that satisfies the Berlin/Paris axis and financial market expectations? The leader of the nationalist Northern League has just been quoted saying that he won’t accept German demands to increase the pension age to 67. Resentment about the loss of economic sovereignty has already exploded on the streets of Athens, how long before Lisbon, Madrid, Dublin and Rome follow suit? At best we are in for a few more months of financial turbulence… At worst?
Financial Services: Data Breach
Nothing strikes fear in the hearts of financial managers like the phrase “data breach.” Banks, asset managers, insurance companies and the like, all handle volumes of private financial data. We are bombarded every day with the news of computer hackers and viruses, but breaches can just as easily happen from lost files or mishandled waste. Perhaps, most terrifying is that the cost of a breach keeps increasing. Each state (and privacy laws vary widely from state to state) requires remedial steps taken when a breach occurs. Estimates by the Ponemon Institute now suggest that, on average, a data breach winds up costing a financial institution over $200 per individual affected by the breach. In addition to simple notification, most compliance policies require credit monitoring and other steps be taken. When the cost of regulatory fines, call centers and loss productivity are added in the cost can be, well, frightening. But for a truly horrifying experience, multiply the number of your institution’s customers by $200. This will give you some sense of what’s at stake with your network security. Scared yet?
Reinsurance: Systemic Risk
Are black boxes creating Black Swans? As regulation for the global insurance industry tightens and converges, companies are required to develop and build their own internal economic capital management models around the same underlying assumptions, with catastrophe risk assessed by the same black box vendor models. Are we running the risk that in encouraging all companies to follow similar risk management practices, we are creating an inherent systemic risk which we cannot currently recognize, assess or control, ironically leading to a Black Swan scenario?
Health Care: Obstetrics
There is no more scary risk in health care than obstetrics. Obstetrics is the chief concern of both hospital and physician underwriters due to the potential for large awards. Claim frequency is also an issue for obstetricians. Claims can potentially involve two persons: mother and child. Both are young and can evoke sympathy from juries. The cost of ongoing care for such a young person, especially infants, can be very expensive. While the national medical malpractice environment is greatly improved, the largest awards typically involve events occurring during obstetrical care, especially in the labor and delivery suite. Two weeks ago there occurred one of the largest malpractice verdicts in recent years, a case in Michigan, in which the award was $144 million. Earlier this year a case in Connecticut resulted in a $58 million pay-out. Patient safety in obstetrics is improving with new technology such as patient simulation labs using mannequins and bedside clinical informatics. But despite these technological advances, obstetrics still strikes fear into the hearts of underwriters because of the size and frequency of claims.
Power: Blackout Britain
As aging power plants are closed, the margin of generating capacity in the UK over demand, which used to be over 30% before the industry was privatized in the early 1990s, could fall to as little as 5% by 2018. As a rule of thumb, 20% is generally considered to be an appropriate margin. The investment required to replace this lost capacity with new plants, mainly nuclear and renewables, is thought to be around £200bn, but with no end in sight for the current economic woes, will banks and other investors be ready or able to stump up such a huge amount – especially as the problem of aging power stations is not limited to the UK, and other countries will also be trying to attract investment? And has any nuclear power station ever been built on time and within budget? Now that’s something to keep you awake at night!
Environmental Liability: The Unknown
It’s not the environmental issues that are “known” that keep us up at night…it’s the ones we don’t know about that scare us most. The majority of our clients tell us that they are most concerned about the unknown or unexpected environmental issues that have yet to rear their ugly heads: discovery of new pollution conditions in soil and/or groundwater, growth of toxic mold, Legionnaires’ disease, changes in environmental standards and regulations, contamination that’s unbudgeted for, toxic tort lawsuits and legal defense issues, etc. Fortunately, there are environmental insurance solutions to help transfer the risk and enable you to sleep a little better at night knowing these “monsters in the closet” are not coming out to get you. Happy Halloween!
Employee Benefits: Exploding Health Care Costs
As governments around the world continue to struggle with balancing their budgets, benefits under public health programs are being scaled back and the costs increasingly shifted to employers and individuals in the private sector. As a result, employer-sponsored health programs are growing rapidly and increasingly becoming the most utilized and valued benefit program offered to employees. The financial impact of this trend is becoming significant and quickly gaining the notice of CEO’s and CFO’s who continue to hold down operating costs as they look at an expected slow-growth global economy over the next several years. The rise of health care costs on a global basis is so dramatic that it is becoming one of the biggest financial challenges for multinational companies and organizations. One notable example is the United States, where health care costs currently comprise approximately 18% of GDP. In addition, spending on health care in the OECD countries reached 9.5% of GDP on average in 2009 (according to OECD Health Data 2011) the most recent year available. Finally, recent surveys have shown a 10% average medical trend increase (a combination of utilization and inflation) for health care costs around the world in 2010 and an expected increase to 10.5% in 2011. Think about it — what other cost in a company’s P&L goes up on average 10% a year? At present trends, health care costs around the world could double in just over 7 years. Talk about hard markets! There couldn’t be a better example of the increasing importance and growth of employee benefits around the world. To combat these trends, employers are increasingly implementing global wellness programs as a tool to mitigate health care costs. Although the definition of wellness differs per country, the adoption of “best practice” in each country, along with a comprehensive, well-communicated global strategy can make a significant difference in controlling health costs over the long term. Recent case studies have shown (up to) a 4 to 1 ROI from implementation of a global wellness strategy and program.
Trade Credit: Price Hikes
With the West facing the prospect of a double-dip recession, growth will depend to a large extent on the ability of banks to lend. In its current guise, the new Basel Accord will greatly impact banks’ funding costs, hiking up the cost of trade credit and undermining cross-border business – potentially resulting in a new liquidity crisis. The score is currently: Basel III; Exporters Nil.
Middle East: A Crude Awakening
One of the surest truisms well known to those who work in or with the Middle East is that nothing really is as it appears. We have lived through 2011 with the promise of an Arab Spring only to be disappointed by dictators who refuse to leave their lucrative posts, shamelessly squashing popular revolt and following up with delayed elections and the threat of “what if we don’t like the outcome of the popular vote?” And we still have another two months to go before the year is out! While we, in the West, continue to try and impose our version of democracy on these various states, the deep-running regional fault lines still present a significant threat to the oil and gas reserves upon which we depend. If a perfect storm were to develop, the notion of oil at $200 or even $300 a barrel would surely put pay to any global hopes for a recovery in the near, medium or even long term future. Let’s hope this remains nothing more than a bad dream!
China: Pandemic Pandemonium
A recent issue of the New Scientist magazine informs us that the H5N1 avian flu virus is now just five mutations away from being capable of human-to-human transmission. Southern China and neighboring countries, where large numbers of poultry are raised in close proximity to people, are the most likely crucibles for such mutations to occur. Being a particularly unpleasant virus with a 60% human mortality rate, the risks to a country like China are severe, with densely populated metropolises such as Guangzhou and Shanghai and a relatively young population towards whom the virus is most deadly. The world has been lucky so far that H5N1 has not evolved. Will our luck hold? Time, perhaps, to swap the Halloween masks for surgical masks, dust off the pandemic business continuity plans and hope that the Grim Reaper doesn’t come calling….
Global: The Death of Innovation
The scariest thing facing our industry is…ourselves! Insurance is too often criticized, many would say fairly, for failing to truly innovate. The world changes every day and no more so than in the last decade, yet the insurance industry barely reacts or changes at all. Collectively we must learn to both demonstrate the real value of what our industry does, but more importantly develop innovative solutions that meet the rapidly evolving needs of our customers. This doesn’t mean innovating around the edges of our existing product suite but generating entirely new concepts and solutions. Failing to do so will mean the slow but gradual erosion of global premium volumes as clients in the developed world find other ways to manage their risks, and clients in the emerging markets fail to even adopt and accept insurance as a viable tool for their business. A chilling thought for underwriters and brokers alike!
What should be keeping board members awake at the moment is the fear of finding themselves suddenly shorn of the protection usually afforded to them by the corporate veil. Insolvency is a game changer even in a benign liability regime like the UK’s. According to the Insolvency Service, in the 12 months ending Q2 2011, approximately 1 in every 139 companies went into liquidation. When a company becomes insolvent, control shifts through the liquidator to the creditors, but the scariest part is that the legal fiction of the company continues to exist after corporate “death” and is still quite capable of suing the directors thus overcoming all the usual defenses such of duty of care etc. Talk about life after death!
Renewables: New Frontiers
Renewable entrepreneurs are fearless and passionate about their projects but we have a “scary” register of risks that occasionally gets their knees knocking. The concept is simple: find a spot where Mother Nature likes to get rough: strong winds, big waves or fast tides — the choice is yours. Then invent, design, conceive and build a device to harness the power – the bigger and more powerful the better without spending an amount similar to the euro zone bail out fund. Once this stage is complete, wrap up the deal in multiple contract interfaces, find a heavy lift vessel and crew to install said kit, then pre-book a summer period of perfect installation weather: blue sky, calm seas and temperate wind. For the price of a couple of world class center forwards you can then dangle export cables and substations over the sides of vessels and repeat many times until your megawatts satisfaction is reached. Add to that your 10 digits of capex in the P&L, some of it your equity and some debt, a dash of working capital to keep it maintained, a power guarantee, some warranties, some government incentives, a grid connection or two (I hope), a risk register and an insurance policy, then hang on tight and never let go!
Supply Chain: Mission-Critical Supplier Going Bust
Supply chain disruption is new Nightmare on Lime Street. Some ex-colleagues of mine in the aerospace/defense and pharmaceutical sectors still seem ignorant as to what this actually means and how it could affect them. Their order books are full, their products are leaving their sites on time, to quality and within budget, and buffer stocks seem to be in place. Then one day they hear about a small supplier going bust. The usual reaction is “Oh, it’s only a small supplier, why should we be affected?” Well, it could just happen that the supplier in question provided a unique component or product that was used right across their product portfolio. Buffer stocks were kept to a minimum due to the Just in Time strategy that had been adopted and suddenly all production across all sites grinds to a halt!
Financial Services: Companies in the Dark About Risk
It can be said that insurance is “a solution trying to find a problem.” In the financial services industry there are many, many problems, of course, which continue to dominate newspaper headlines. These problems are defined as “risks” in corporate speak. What is frightening is the number of organizations that still do not have a clear understanding of which risks are mitigated through the insurance they already purchase. On one side of the equation, risk is huge potential cost plus tied-up capital -– on the other side there is insurance, which should, in part, balance the equation -– as a risk mitigant (for a given, often lower, cost than capital). So if you want to avoid surprises this Halloween, understand the risks your organization is running, establish the extent to which they are being managed and in the event that all else fails, make sure you know when insurance will be your backstop.
Captive Insurance: Solvency II
Scary stuff this Solvency II! Especially if you’ve got a captive in the EU or trading into it. But hold on, let’s not get carried away. Our research shows that most EU captive strategies remain viable albeit in some cases with some re-engineering into cell structures and/or amendments to business plans. Sure, required capital levels have increased, but in many cases captives already have sufficient resources to meet this. The spectres of increased risk management and governance requirements for EU captives are, with good management support, thoroughly manageable and in many cases do not go significantly beyond existing best practice. Indeed many captive boards and owners are appreciating the increased insight they are getting. And scary stories about huge increases in fronting fees have to date proved unfounded as commercial fronters reassure clients of their continued willingness to front programmers to their captives, even where these are domiciled outside the EU and in non-equivalent jurisdictions. It’s funny how even the scariest costume is less scary with the lights on!
Real Estate: Weapons of Mass Disruption
Real Estate owners come to us to help them mitigate both recurring and new nightmares. For those of us interested in risk identification, quantification, and mitigation, these nightmares include age-old issues related to mass torts, pandemics, environmental catastrophes, natural catastrophes and man-made issues such as employee dishonesty and other criminal acts. New nightmares have emerged in the recent past which could include weapons of mass destruction, such as global terrorism, and the use of weapons of mass disruption including issues relating to cyber risk. While we can not make nightmares go away we can help our clients identify, quantify and mitigate them and help them recover from the consequences of both natural and man-made disasters.
Aerospace: Fuel Price
The trouble with a Halloween blog about air transport is that it isn’t or shouldn’t be scary. It is statistically one of the safest things you can do. The industry continues, despite all the recent economic challenges, to maintain and improve its safety standards. New technology, mergers in mature markets and growth in emerging economies are only enhancing the risk profile of the industry. Sure the industry has its own set of horrors, not least the fuel price, but the flying is not scary at all. Having said that I have never flown on a broomstick!
Luckily it’s not all doom and gloom this All Hallow’s Eve — insurance solutions exist for most of the risk-related things that go bump in the night, and it’s up to you, the buyers of risk, to tell us what’s freaking you out the most so that we can work together as an industry to innovate and find new and better solutions.