With Frankenstorm bearing down on the U.S. East Coast, and Halloween approaching, it’s time for the WillisWire team to sit around our screens and share the terrifying tales that keep our clients awake at night. I’ve 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. Take our poll at the bottom and let us know.
(Jump down: Aerospace, Analytics, Brazil, Capital Markets, Captive Insurance, Catastrophe Management, China, Claim & Risk Control, D&O, Employee Benefits, Energy, Environmental Liability, Financial Services, Health Care, Mining, Power, Reinsurance, Terrorism)
Catastrophes: Unexpected Perfect Storms
The scariest risks are the ones that sneak up on people and catch them unprepared. The official weather forecast for the Northeastern U.S. on September 21, 1938, was for cloudy skies and gusty winds. The Category 3 hurricane that struck Long Island that day came as a terrible shock that cost hundreds of lives and the equivalent of billions of dollars at today’s values. With modern technology—weather satellites, Doppler radar, and platforms such as SpatialKey that give access to information in real time—we can be better informed about such fearsome events as this week’s “Frankenstorm” Sandy and better prepare for their effects.
Terrorism – Cyber Terrorism: Potentially Paralyzing
The risk of cyber terrorism directed at U.S. targets (either the private sector or the U.S. Government) continues to evolve into a potentially catastrophic and genuine possibility. Just a few weeks ago, Defense Secretary Leon Panetta called for the U.S. to beef up its cyber defenses. He warned that a cyber attack by a nation state or terrorists on the U.S. could be America’s “cyber Pearl Harbor” and “be just as destructive as the terrorist attack of 9/11.” Earlier this year, FBI Director Robert Mueller said cyber threat will surpass terrorism as the number one threat facing the U.S. The evolution and advancement of this particular risk has an inherent tie to the amount by which we rely upon and utilize electronic means, such as the internet, to conduct operations and execute normal activities.The risk becomes even more complex given the interconnectivity of our global networks. What is one, if not the top priority, of most terrorist attacks? The answer is to cause as much destruction to the target, and create as much fear, as possible. It is difficult to imagine a scenario that would be more destructive or cause more fear than a cyber-attack crippling the U.S. financial system, railways, power grid or other critical infrastructure.
Claim & Risk Control – Catastrophic Acts of Violence
Acts of senseless, catastrophic violence—shootings causing multiple fatalities and injuries—have occurred in shopping malls, restaurants, fitness centers, movie theaters, places of worship, military bases, grocery stores, summer camps, schools, nursing homes, and places of employment. Going forward, corporate leaders from risk managers all the way up to the “C-suite” level will be called upon to become more diligent in their efforts to ensure the safety and security of their patrons, students, guests, employees and others. As more attention is placed on organizations “Duty of Care” and “Standard of Care” requirements as well as OSHA’s increasing attention to acts of violence within the workplace, a greater degree of responsibility will be expected. Failure to meet these expectations may result in findings of negligence, loss of revenue, significant recovery costs, large financial settlements/judgments, reputational damage, and most importantly…. the loss of life. (Check back next week, when I’ll tell you some things you can do to safeguard your workplace.)
Mining – Strike Contagion: The New Epidemic in the Mining Industry
Is South Africa facing a “meltdown in the mining sector” as posed by Perry Williams of the Australian Financial Review? On 17 August — police shot dead 44 striking miners at one of the Lonmin (the world’s third largest platinum producer) mines in South Africa. Since then, demands for higher pay and improved conditions have spread across the mining, power and transportation industries in South Africa:
- Anglo American Platinum sack 12,000 illegally striking miners, deaths reported
- Kumba Iron Ore halted production at Sishen Mine due to strikes
- Atlatsa Resources (Platinum) hit by strike action
- AngloGold Ashanti forced to close down operations as 24,000 out of 35,000 workforce go on strike
- Over 100,000 miners involved in strikes
- Eskom power supply expected to be impacted by truck drivers’ strike
The National Union of Mineworkers (NUM) is the dominant union and has been for years, but now the Associated Mineworkers & Construction Union (AMCU) is challenging their dominance – this creates a confrontational and aggressive environment which lends itself to intimidation, intransigence and violence. This is not a recipe for success.
At a time of volatile commodity prices, falling demand, and rising costs, this pressure from the workforce is a massive challenge for management and it will have a huge impact on the mining industry in South Africa.
D&O – A Director’s Greatest Dread: A Reservation of Rights Letter
D&O liability insurance is low incidence/high impact cover (admittedly less low incidence in the U.S. than elsewhere). When a claim hits, it’s often out of the blue. Major fraud, scandal, computer failure, pollution, death/personal injury, product recall are all examples of high-impact situations that have hit global brands in the recent past. For large listed companies, the risk of securities claims and/or significant regulatory investigations on the back of any of these events is very real. The costs and potential losses involved can have a significant impact on even the most robust of balance sheets. It is bad enough for directors to find themselves caught up in litigation storms of this kind. The true nightmare begins though when they discover that the company on whose board they sit is either unwilling or unable to stand behind them financially. It then reaches its scary peak when the directors receive lengthy reservation of rights letters written on behalf of their D&O insurers expressing doubts and concerns as to the position on policy coverage. In situations where personal liability is of potentially epic proportions, letters of this kind are not as rare as directors might imagine. Those who have lived, rather than dreamt, the nightmare understand the value of focusing on the really important elements of cover long before a claim first hits. The devil always hides in the detail.
Financial Services – Cyber Terrorism: Zuccoti or Iranian
Our financial systems come to a halt because no one can trust the numbers in the computer systems that tell us how healthy financial institutions are, or what trades they have done for the last three months—and the Fed pumping in money has no effect. A nuclear power station melts down after the controls stop operating the safety systems, and the radioactivity results in the evacuation of a 30-mile area including one of the largest U.S. cities—and there is little prospect the area can be repopulated for decades. It may be difficult for a government or terrorist group to get the resources to pull off such attacks, but the Stuxnet and Flame viruses directed at Iranian nuclear facilities could be heading in this direction. There are other scenarios we can envisage: a tech employee under cover in our business, or embedded and timed code in systems purchased from offshore. So far, there is no international organization that brings together like-minded countries to stop such threats, and we are only at the very early stages of creating resources that might help us defend these types of events by coordinating and sharing the resources of private companies. Will such an attack come too soon for us to prevent, or will we Die Hard without Bruce Willis to save us?
Employee Benefits – Health Care Reform
The Patient Protection and Affordable Care Act (PPACA) has presented a scary scenario for organizations who are grappling with the reform’s changes to their plans. Employers are faced with compliance and potential cost increases driven by required plan design and eligibility changes ranging from eliminating limits on coverage, to adding adult children, to the Pay or Play Mandate. Full implementation is now lurking in 2014. Yet, the lack of a clear strategy to navigate current and upcoming PPACA measures is a risk faced by many employers. While the resources have existed to assist with planning, many employers have resisted taking proactive compliance measures and evaluating potential options; instead hoping actual implementation would indeed be as ephemeral as a ghost. Many employers took a wait-and-see approach — hoping the Supreme Court might eliminate the need for major changes, and now even waiting for election results. However, if employers wait until they have certainty, they will likely be caught without the needed weapons to address the changes. Since there will be no silver bullet, it is time for employers to develop, review and enhance their action plan. Without a clear strategy, employers risk shooting blindly in the dark at perceived ghosts while missing the true risk.
Reinsurance – Interest Rate Cliffhanger
Today’s low investment yields are leading to a false sense of security as regards the underlying capital strength of the global reinsurance industry. Ultra-low interest rates have driven up the value of fixed interest investments, which has allowed many reinsurers to derive their recent investment returns more from capital gains than interest payments. So long as interest rates remain at their current level the capital appreciation will remain—though one has to wonder if any further capital appreciation is possible with the current rock-bottom interest rates. What is much more concerning is that when interest rates start to rise, the capital appreciation on the fixed interest investments will collapse, leading to a rapid reduction in the asset base of reinsurers. To make matters worse, there is the strong possibility that an increase in interest rates may coincide with an increase in inflation, impacting the reserving levels of reinsurers with longer-tail liabilities. What is of real concern is that this scenario is well known and clearly seen by many market participants, but no real action is being taken to address this impending cliff edge.
Energy – Inevitability of Major Loss
The scary risks in the energy industry continue to be what they have always been: operating in hostile environments while deploying new, untested technology. But the near miss on the Elgin platform in the North Sea earlier this year—where a gas leakage cause by a rupture of a riser failed to ignite, helped by a favourable wind direction—caused some serious reflections in the upstream market. Had that gas ignited, we might have seen another disaster on the scale of 1988’s Piper Alpha tragedy materialise. Although the market breathed a sigh of relief, there can be no doubt that this industry is bound to suffer another major loss soon, as higher oil prices push the search for hydrocarbons into deeper water and towards more remote locations such as the Arctic and the Timor Sea. Supply chain disruption, FPSO mooring systems, shale gas hydraulic fracturing, new engine technology for mobile drilling units—there is plenty to scare the market as 2013 approaches, even if the 2012 loss record is likely to show an improvement on 2011.
Aerospace – Variety of Risks
The vast majority of people have an inherent fear of the unknown and the first time of dealing with a situation. The aviation industry has had to deal with host of unknowns and first-time incidents from 9/11:
- out of control fuel costs
- economic meltdown
- an ash cloud or two
have all significantly impacted the industry and its operators.
The aviation industry does everything it can to improve its operations from a safety perspective. Manufacturing, training and operations are now producing the safest period of aircraft operations ever. Statistically you are far more likely to be killed on your way to the airport that on the flight itself. The risk of flying is therefore very low and it is the variety of risks to flying that are perhaps the scariest of all.
China – Gridlock in the Chinese Capital
That the traffic in the capital of the world’s most populous nation is a nightmare is well-known to its inhabitants, and it is often ranked as the worst city in the world for traffic congestion. To confirm its claim to this dubious distinction, it was near Beijing that the world’s longest-ever traffic jam was recorded in 2010, 100 km (62 miles). It lasted for one month. Part of the problem is that Beijing’s 20 million people are still in love with the idea of owning their own vehicle, as well as being reluctant to embrace the rigours of the over-crowded (albeit very cheap) public transport system. Over the last 10 years car ownership has been rising rapidly—and the demand for licence plates is around 1,000,000 per month.
It’s no longer just a matter of inconvenience to the citizens of Beijing, but a real environmental and health risk scenario, which is steadily growing. The iPad China Air Quality app tells me that over the last year, of the 120 Chinese cities listed, Beijing ranks as 6th worst, vying for top (bottom?) position with large industrial cities in the highly-polluted North-West. The health effects of ozone and small particle matter, known as PM2.5, in Beijing’s air and other pollution caused by motor exhaust fumes will take an increasing toll on the city’s inhabitants and its finances in the years to come. The indirect effects of stress, lower work productivity and reduced quality of life should also not be underestimated.
Analytics – Science Threatened
It’s tempting to pick the regulatory confusion caused by continued delays in the Solvency II process in Europe. Many insurers have invested a fortune in staff and systems, but we have no idea yet of a start date or indeed exactly where the goalposts are. There is a real risk that companies will take their foot off the gas and risk missing some of the business advantages that could and should lead from adoption of the sound risk management principles behind Solvency II. One key principle is the concept of insurers developing their own view of risk, something I have been rabbiting on about for years, but whose time has now come. Models, especially catastrophe models, need to be understood and challenged, not blindly used and accepted. Models inform, they do not decide. The computer shouldn’t say no (or yes), humans must call the shots. Firms should use the best scientific and business knowledge available to weigh all the evidence they have before deciding on the assumptions that underpin their decision making. Which makes it all the more concerning that scientific opinion is now coming under serious legal challenge.
In Italy recently, six leading scientists were convicted of manslaughter, given a sentence of six years in jail and ordered to pay compensation of €7.8m. They were accused of giving “incomplete, imprecise and contradictory” information on the dangers locals faced before the 2009 L’Aquila earthquake. The scientists, Italy’s leading experts, were unpaid advisors on the National Commission for the Forecast and Prevention of Major Risks. They now face a lengthy and expensive appeals process. Already other scientists are resigning from government committees in Italy.
But this is not just an Italian problem, the world is getting much more litigious. In the UK for example, libel laws have been used to attempt to silence scientists who express an opinion contrary to the powerful interests.
Science works best by a process of challenge and review. Model assumption development is exactly the same. If scientists and analysts are afraid to express an opinion and/or challenge the status quo, we get poor decision making and a society/industry exposed to systemic risk. This must not be allowed to happen.
Environmental Liability – Undead Cases: Closed Cases Coming Back to Life
What environmental risk can be worse than an “unknown” pollution condition rearing its ugly head? How about one that comes back to life after you thought it was dead forever? Regulators are “reopening” hundreds of cases that had previously received regulatory closure in Massachusetts, California and New York to examine potential issues involving vapor intrusion. The exposures range from third-party lawsuits to remediation expenses. The EPA and state agencies are also starting to reopen sites where no vapor intrusion analysis was considered in earlier remedial decisions. Here’s a risk that could haunt even the bravest of souls! (Look for my post on vapor intrusion next week.)
Power & Utilities – Climate Change Regulation
This summer, sea ice in the Arctic was recorded at its lowest ever level, prompting renewed fears of accelerating climate change. The power generation sector is a significant source of carbon emissions, which governments around the world are trying to reduce through subsidies and incentives for low carbon energy production (such as the carbon tax introduced in Australia this year) and setting targets for energy from renewable sources. However, recent developments have not been promising. Last year the world’s consumption of coal grew by 5.4%, with China up 9.7%, as energy demand increases in developing countries which, for perfectly understandable economic reasons, want to use the cheapest available fuel to power their growth. In the UK, there are fears that a new ‘dash for gas’ could make it impossible to meet the obligation under the 2008 Climate Change Act to reduce the country’s carbon emissions by 80% by 2050. Meanwhile, the Fukushima nuclear meltdown last year, prompted Germany and Switzerland to phase out their nuclear plants (jeopardising, in turn, the revival of nuclear power in the UK, as the German giants RWE and E.On abandoned their planned investment), and recently Japan and France announced plans to move away from nuclear power. Although opinion on nuclear power is divided among environmentalists, some believe that “without nuclear, the battle against global warming is as good as lost”.
Brazil – Cargo Transport in Brazil: A White-Knuckle Ride
The statistics in the Brazilian cargo transport market are really scary. Many companies need to transport products within Brazil, whether import or export, but the risks are high for vehicles on Brazil’s roads, increasing the insurance and the goods carried value.There were over R$ 675 million in claims last year including national and international transport. According to the São Paulo state Public Safety Department, the number of burglaries/thefts in the state in the first quarter of this year increased 7% compared to the same period in 2011. In 2011, in São Paulo state alone, there were 6,598 cases of cargo theft with a loss of R$ 295.85 million in declared values. In 2010, 12,850 incidents were recorded nationally, resulting in R$ 880 million in losses.
Other scary facts:
- Only 172,897 km (10%) of the 1.7 million km of roads in Brazil are paved
- The cost of cargo tracking technologies and property care preservation is very high
- Despite the technological advances in risk management, recklessness and unprepared drivers increase the number of accidents on even well supervised roads
- New Brazilian legislation establishes stops of 30 minutes rest for every four hours of work, and 11 hours rest for every 24 hours’ work, however, Brazilian highways are not appropriate or secure places for these stops to be made.
Health Care – Escalating Verdicts and Settlements in Pediatric Litigation
The scariest and most volatile health care professional liability cases to defend involve severely injured children. Some of the largest verdicts and settlements in the U.S. over the last few years have occurred in non-obstetric pediatric cases. In many instances they exceed $5 million.The emotional impact on a jury assessing the case of a severely injured child in a medical malpractice trial is almost always a huge hurdle to overcome. This is just one primary factor resulting in multi-million dollar verdicts and settlements. It is always difficult to assess just compensation for severely injured patients and families in negligence cases and especially for injured children.
Another primary factor in the high costs of these cases is improved medical care for severely injured children thus resulting in more expensive care over more years. Life care plans for children are very costly. Large verdicts in pediatric cases can result even in states with caps on pain and suffering like Wisconsin and others. In states without non-economic damage caps like New Jersey, New York, Pennsylvania, Illinois, and Florida, verdicts and settlements can exceed $10 million.
The economy is a factor as well in the increase in claim costs for cases involving children. With low interest rates, the use of annuities is less desirable. A structured settlement is not as cost-effective or as palatable to plaintiff’s attorneys in pediatric cases.
Plaintiff’s attorneys can resort to aggressive tactics, using online and other advertising strategies to find cases involving severely injured children particularly for neonatal injuries and such conditions as: meningitis, kernicterus (jaundice), retinopathy of prematurity, and volvulus/malrotation of the bowel. Plaintiff’s attorneys have also become quite creative in finding ways that will drive up the cost of life care plans for injured children.
The national medical malpractice environment is very stable but pediatric cases are downright scary.
Capital Markets – Waiting for the Perfect Time as an Excuse for the Status Quo
Voltaire’s “Dit que le mieux est l’ennemi du bien”* is a cliché well understood by most executives in reinsurance, finance, and asset management. They do not generally let market timing influence ordinary course decisions towards the status quo (e.g., do we buy less or more quota share relative to excess of loss reinsurance this year). Yet we see some of those very same executives biased towards picking the perfect time to make more transformational decisions. Where compelling economics exist (e.g,. adding a hurricane cat bond to a reinsurance program for some insurers, making a value adding strategic acquisition for others), further waiting may improve the economics. On the other hand the company loses the economic benefit during any delay and in addition the economics may deteriorate rather than improve . . . either is a scary prospect.
*Roughly translates to “the perfect is the enemy of the good”.
Captive Insurance – The Nightmare You Won’t Wake up From: Solvency II Pillar III
Halloween is the time when monsters emerge and nightmares become reality—and a first glance at the Solvency II Pillar III Quarterly and Annual templates will certainly quicken the heartbeat and bring on the night shivers! However like all nightmares once one wakes up and looks at these forms in more detail, reality sets in. An analysis of the forms will show that a significant part of the information requested should already be readily available for captives and is probably already being supplied to regulators through the Annual Business Forms. However, discussions with your fund manager will be necessary to ensure the required look through on investment funds is satisfied. The trick really will be to ensure that all data is maintained as centrally as possible and on the proper platform to guarantee the most efficient extraction. The treat will be a restful night without any tricks next Halloween!
Scary, sure, but no reason to hide under the bed. We’ll follow up on each of these risks with more context, insight, and guidance to help you defang the fear.
Meanwhile, tell us which of these you worry about most in your business.
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