Among the raft of Top 10s that get trotted out every January, only a few address the more sobering topics related to risk—the World Economic Forum’s Global Risks 2012 report, for example, and Allianz’s round-up of business threats.At WillisWire, we wanted to look at the lesser-known, potentially dangerous risks not yet on companies’ radars. Our bloggers came up with 18 emerging risks, some of which have been brewing for a while, some haven’t yet resulted in any claims, others are new twists to well-known risks. These are the sleeping crocodiles to look out for in the midst of the current socio-economic and political upheaval. Which do you think will have the greatest impact in 2012?
(Jump down: Aerospace | Analytics | Captives | D&O | Employee Safety | Energy | Engineering | Environmental Liability | Financial Institutions | Health Care | Life Sciences | Mining | Political Risk | Power & Utilities | Renewable Energy | Supply Chain Interruption | Terrorism | Trade Credit)
One of the most significant emerging energy risks is the growth of the hydraulic fracking process used to extract gas from shale formations. The legal and social issues that accompany the rapid expansion of this method of production, together with the potential environmental impact of these fracking operations, have been extensively highlighted in the media recently.
There certainly remains some debate as to how various risk transfer options available—including General Liability and Umbrella Liability policies, Operators Extra Expense (OEE) policies and Environmental Impairment Liability (EIL) policies—might respond in the event of a loss, particularly where any damage is alleged to be of a gradual nature. Our 2012 Energy Market Review, due to be launched on April 17, will be focusing on this emerging risk in our leading feature.
Environmental Liability: Fracking
As per Robin Somerville’s blog above, hydraulic fracturing, or “fracking” as it’s more commonly referred to, is quickly emerging as one of the more significant risks facing not only the Energy market but the Environmental insurance industry too.
While fracking technology is relatively simple, the potential environmental issues and toxic tort liabilities surrounding it are a bit more complex as it has become a very contentious issue among regulatory agencies, exploration companies, environmental activists, land owners, the insurance industry and many other affected stakeholders.
There is much debate and concern surrounding fracking due to the chemicals utilized—for example acids to dissolve minerals and create cracks and surfactants to make fluids more slippery—and the massive amounts of wastewater generated. Not to mention the fear of radioactive materials and other contaminants potentially finding their way into water supplies.
While General Liability carriers are still providing a certain degree of “sudden & accidental” pollution coverage, the environmental insurance carriers have been a lot more selective in their appetite when underwriting these risk in terms of providing any meaningful “gradual” pollution coverage (particularly in the Marcellus shale formation which has received most of the negative media attention lately).
Mining: Contingent Business Interruption
Are you superstitious? I reckon most people are—walking under ladders, black cats crossing the road, the number 13—it’s all about our fear of the unknown.
Contingent Business Interruption (CBI)/Supply Chain exposure is the greatest unknown in the insurable risk transfer business. It has been an insured extension to most Industrial Special Risks insurance contracts for decades, but the impact of globalization on this extension has only really been felt in the last few years.
Identifying, quantifying and then insuring risk is frankly, at best, an inexact science, and trying to actuarially measure this through modeling techniques has proven to be less than accurate, and this applies to risks we think we know and understand.
The risks to the supply chain may be identifiable, but quantifying your exposure to them is very difficult and indeed complicated. This is especially so in the case of unspecified customers and suppliers—how can an underwriter quantify something which is unspecified and therefore completely unknown? The “inexact science” becomes a “punt” and last time I checked, insurance isn’t in the business of punting.
The difficulty in assessing the degree of risk, and exposure to it:
- Manifested itself in the case of the Apache Energy gas explosion at Varanus Island (Apache Energy was a supplier to a supplier).
- Reared its head in Japan after the tsunami/earthquake.
- Showed its ugly face in the catastrophic flooding in Thailand which caused huge unforeseen supply chain disruption.
These serve to illustrate that the CBI/ Supply Chain risks and exposures of today have emerged to become something of a monster – scary and very destructive. Insurance’s equivalent of a werewolf, or a zombie or a vampire! Regrettably, our CBI “werewolf” is no mythical creature but is very real and getting bigger and scarier… watch this space.
Supply Chain: Issues at Subtier Suppliers
Supply chain interruption cannot be considered as an emerging risk anymore, but it is rapidly evolving in terms of its scope, the level of suppliers affected and what causes it.
Recent events in New Zealand, Japan and Thailand have helped increase awareness of the business interruption implications from the loss of key suppliers, but it’s no longer only the security of your major tier one suppliers that’s an issue… companies need to look further down the food chain to tier two suppliers and beyond.
The survey provided a revealing analysis on the deep-rooted sources of supply chain failure. Respondents from across 62 countries revealed that 85% of organizations recorded at least one supply chain disruption in 2011.
What is really interesting in terms of emerging themes is the type of cause or initial peril that leads to a loss of productivity at both upstream and downstream sites. Whilst adverse weather conditions are recorded as the principle cause, outage of IT or telecommunication systems coupled with cyber attack are beginning to emerge as strong contenders particularly in the financial services, government and IT and comms sectors.
Evidence is showing that this issue can only get worse: senior management teams need to ensure that balanced risk management solutions are in place that will bring together supply chain and business continuity management techniques and will ultimately help reduce future impacts on brand and reputation.
Trade Credit: Political-Economic Turmoil
From ominous rumblings in Iran to a full-blown crisis in the Eurozone, two potentially mega political-economic risks are brewing in the trade credit arena: trade disruption and a lack of availability of credit.
Mass Trade Disruption
Aside from the impact on world oil prices, Iran’s threat to close the Straits of Hormuz, one of the most strategically important choke points for traded seaborne oil, could create significant disruptions to trade in the region.
In addition to normal asset risks that the closing of the Straits would cause, we need to take into consideration the myriad other risks that globalization throws into the business mix. With just-in-time manufacturing and dependence on single suppliers (as outlined in Tom Teixeira’s post above), disruptions to the supply chain due to political events like blocking the Straits of Hormuz can cause unexpected expenses, loss of revenue and contractual penalties, that companies, especially those in the oil industry, need to plan for.
Corporate Defaults Set to Rise
With S&P recently announcing a swathe of downgrades, the European sovereign debt crisis is set to deepen further. Whilst these recent downgrades may have already been factored into credit spreads for banks, it could trigger a contagion amongst others.
European banks—which hold billions of euros worth of Greek, Italian and other sovereign debt–face increasing liquidity issues. In a move to strengthen their balance sheets and prevent a large-scale banking meltdown, banks are being forced to meet tighter capital requirements.
The European Banking Authority has set until the end of June 2012 for European banks to attain core tier-one capital ratios. There are a number of ways banks can increase their capital, such as undertaking a rights issue, withholding dividends, converting debt instruments into equity, reducing risk-weighted assets and so forth. However, the easiest way to reduce assets is to simply deleverage. Whilst regulators are keen to avoid a scale back in lending, the impact–particularly on SMEs—could lead to credit lines being withdrawn or non-renewed resulting in corporate defaults as cash flows dry up.
Financial Institutions: Bradley Manning 2.0
Bradley Manning is the most frightening emerging risk facing financial institutions. Who is Bradley Manning and what makes him so dangerous? Manning is the 24-year-old army private who worked as a low-level technician on the top secret communication system employed by the US government to transmit information around the world, and is accused of leaking more than 250,000 diplomatic cables to Wikileaks.
In an age when data and information are moved electronically, if Manning did leak the cables, it would demonstrated in unambiguous terms that one dissatisfied individual can wreak havoc on a corporation, institution or a government. That knowledge can be dynamite. What has been lacking is a fuse.
Last year’s Occupy Wall Street movement may be that missing fuse. While some in the media may dismiss the Occupy movement as a collection of unemployed malcontents, the truth is that the movement has won supporters from all socio-economic levels. Some of those supporters are employed in positions that could give them the opportunity to cause immeasurable damage to a single institution or financial network.
Frankly I am not afraid of an army private downloading documents on a thumb drive, like Manning is accused of doing. I am not afraid of the foreign extremist trying to hack his way past firewalls. Our systems are prepared for those eventualities. It is the bright programmer with an Ivy League education and an access card working at a technology, bank or credit card companies that should scare us all.
Perhaps nothing on our current radar is more chilling than an intelligent, technically capable individual who believes that the financial system is broken and they can make a significant impact by throwing a wrench in the system. I am afraid of Bradley Manning 2.0.
The other emerging cyber risk is not the lone recluse, but the angry mob. One Manning can wreak havoc. With the US government’s closing of the illegal download site “Megaupload.com” on January 19th we saw what 5,600 coordinated hackers could do.
This was a spur of the moment response. Envision the risk to a financial institution that is specifically targeted by a group such an Anonymous in a coordinated attack. Bradley Manning times thousands.
Terrorism: Cyber Terror
As has been evidenced by the recent cyber-attacks which brought down the Tel Aviv Stock Exchange and Israeli national airline El Al, cyber terrorists and can be technologically advanced and capable of executing attacks on diverse targets.
Unlike other conventional modes of terrorist attacks, which can be modeled for potential severity and are for the most part, insurable, the profile of cyber terrorism changes daily and can have a global impact. Cyber terrorism can often evade early detection, hampering loss prevention efforts and the development of effective risk transfer products.
The FBI defines cyber terrorism as “the pre-meditated, politically motivated attack against information, computer systems, computer programs, and data which result in violence against noncombatant targets by sub-national groups or clandestine agents.”
Experts believe and history has shown the most common scenario to be the act of hacking into a network to gain control in order to cause chaos, physical or financial harm. The target of such an attack varies and could include for example: power grids, dams, refineries or transit systems.
The 2010 discovery of the Stuxnet virus, which specifically targeted computers running Siemens software and infiltrated an Iranian nuclear power plant allowing control of the facility remotely, was a particularly chilling reminder of the cyber terrorism threat.
By planting spyware, viruses or other malware, or even by manipulating stock prices, the cyber terrorist could cause direct financial harm to a targeted organization or industry sector and thus must be addressed proactively by corporations.
Aerospace: Space Tourism
The inherently high-risk nature of aviation operations can mean that emerging risks are largely considered and addressed before they happen. Business risks are rarely unique to aviation and ash clouds are now “on the list” alongside introducing new technology for many businesses.
You therefore have to look a little harder at emerging aerospace business sectors. Space tourism represents one such sector with the full astronaut experience starting at USD20m in 2001. Space adventures are now being brought closer to home and at much lower prices nearer USD200k.
There are a number of businesses looking to offer the experience to the rich and famous and there appears to have been no shortage of takers. As this new breed of explorers begin their life-changing voyage into near space, the question is whether insurers will consider it an expensive business jet that just flies a bit higher?
Power & Utilities: Sodium-Sulfur Batteries
Emerging risks in the power sector usually seem to revolve around the introduction of new technologies, or changes in regulation or the complex contractual and trading arrangements seen in many power markets.
An example of the former is the development of sodium-sulfur batteries to store energy on electricity grids. This is particularly useful to support renewable energy generation, which has inherent intermittencies depending mainly on the weather.
These batteries have been developed by the Japanese company NGK Insulators in cooperation with Tokyo Electric Power Company. However, they appear to represent a major fire risk, and there have been three fires in Japan. The most recent was in September last year, prompting NGK to suspend production of the batteries in order to investigate the cause and consider preventive measures. In the meantime it has advised customers not to use their batteries.
Meanwhile in Lerwick on the Shetland Islands, a local man who has been campaigning against the use of one of these batteries at Lerwick Power Station, on the grounds that it would create a dangerous fire risk, appears to have been vindicated.
Health Care: Booming Physician Employment
Hospitals and health care systems of all sizes, from critical access facilities to huge non-profit and for-profit organizations, are struggling to deal with the health care professional liability issues raised by the seeming tidal wave of physicians becoming employed by hospitals.
Physicians and hospitals are now working more closely together than ever before with physician employment as the dominant model. This isn’t a marriage always made in heaven either! Physicians are seeing their incomes shrink as reimbursement declines, so the move is one often made reluctantly. Doctors are autonomous by nature and nurture.
Physician employment raises a host of health care risk management issues:
- Adequacy of self insurance funding for a significant increase in exposures to the facility’s program
- Lack of risk management staff to process physician-related issues
- Lack of experience in dealing with physician risk control and risk financing issues
- Lack of the risk management department’s involvement in physician practice acquisitions or joint ventures
- Dealing with troublesome, expensive and complex tail issues of employed physicians
- Orientation to or adoption of electronic medical records
- Complex defense issues with physicians now employed by hospitals including apportionment of liability, data bank reports, selection of separate or joint defense counsel
These issues related to physician employment present a major challenge to hospitals and health care systems regardless of what the Supreme Court does with cases involving the constitutionality of the Patient Protection and Affordable Care Act.
Renewables: Uncertainty Caused by National Energy Policies
Judging by the enquiries we receive on a regular basis from all over the world there seems to be an emerging trend surrounding the future uncertainty of renewables in many countries’ energy policies.
We are often asked to see if we can find solutions for potential government-imposed caps on generation output, changes in subsidy payments and alterations to tariffs in one form or another, but it is an area where, generally speaking, the kind of guarantee sought is not given by insurers. Developers are looking for a longer period of certainty to give their investors and backers a greater degree of certainty.
Recent examples of government putting on the brakes include:
- The Spanish government restricted the production hours for solar projects, leaving many projects with an insufficient energy yield to meet their fixed costs.
- The High Court in the UK is hearing a legal challenge on reduction in feed-in tariffs for solar, on the grounds that the rushed plans to slash solar subsidies have pulled the plug on many projects.
- As reported in the Sunday Times, the “Archimedes” screws that are going into the Thames to help power Windsor Castle are just one of many projects in the hydro industries pipeline, but the company behind these turbines has suspended all new projects claiming there is insufficient certainty around the backing of renewable schemes.
The renewables industry is working very hard to bring down costs and create jobs and, over time, it’s more than capable of standing alone, but at this point it cannot change direction quickly, so the immediate reaction to a short-term change in policy is to go into a holding pattern. The renewables industry will thrive on some solid long-term targets, but until policies are firmly committed the emerging uncertainly seems to sit with national energy policies.
Captive Insurance: Transfer Pricing
In this increasingly regulated world, the emerging risks vexing captive owners are not just those insured by the captive but those inherent in its operation. Some of these are already well established with solutions emerging, including the challenges of Solvency II and global program compliance. However, one aspect of this on which Willis is being increasingly approached is transfer pricing on captive lines.
This concern is driven not just out of the regulatory concerns of captive and operating unit jurisdictions, but those of the tax authorities at the location of risks. Here a balance is required between the sensitivities of corporate tax authorities concerned about overstating premiums as tax deductible expenses and insurance premium tax authorities concerned to get the full amount of tax in relation to local insured risks.
Market testing and desk-quoting is not really sufficient to establish the veracity of premiums. You need a robust, arms-length underwriting process and credible underwriting competence available within the management facilities of your captive as your premiums could be challenged as either too high or too low!
Political Risk: Continued Unrest in Egypt & Libya
As the security situation disintegrated in countries where uprisings took place during the Arab Spring, the mass “rush for the door” by multinational companies provided little opportunity to plan what to do with their assets on the ground.
The current turmoil in Egypt and growing tension in Libya between political factions creates a difficult dilemma—when is it safe to return and how can companies look to protect machinery, equipment or other belongings which are left behind?
In the case of some businesses, the value of these assets may be many millions of pounds sterling. Although staff are of course the number one priority, it is worth asking what provision there is within a crisis management plan for sending staff back into country, and before then what happens to the things that are left behind?
Analytics: Over-Reliance on Models
It is hard to take your eyes off the still-unfolding European financial crisis, but we need to keep looking for other sources of risk. Although again delayed in 2011 and perhaps still subject to further transition and political posturing, Solvency II is getting closer and closer. The aims of this regime and similar regulation are laudable: better, more transparent risk identification, risk management and risk mitigation. My worry remains the use and unintentional abuse of standard models, tools and methodologies.
European regulators will not approve specific catastrophe models, which is good as this would be an invitation to systemic risk if ever there were one. But in reality some models will emerge as de facto market standards and certain modeling approaches will come into fashion and become the expectation.
It is vital that firms, encouraged by regulators, consistently challenge the assumptions of their models and test the accepted status quo. For an individual firm, and an individual in that firm, it is hard to argue against being one of the pack—as they used to say, no one ever got fired for buying IBM. But collectively the risks to the market of such an unquestioning approach are huge.
Recognizing this, Willis has invested heavily over recent years in building relationships with the best of the world’s science base to test the implicit assumptions in natural catastrophe models. 2012 will see the launch of the Willis Research Network Economic Capital Forum. The forum will provide a focus for both best practice and assumption/modeling challenge for economic capital modeling. In this uncertain world, never has this been more important.
D&O: International Cooperation of Regulators
The top risks identified in our recent survey of risk and coverage issues for directors were:
- Regulatory and other investigations and enquiries
- Criminal and regulatory fines and penalties
- Anti-corruption Legislation (including the UK Bribery Act)
- Employment practices claims (harassment, age and sex discrimination)
- Risk of being sued abroad
What do you get if you put 4 out of 5 of these risks (all but employment practices claims) together, stir vigorously and add a pinch of regulatory zeal? The answer is a perfect storm of cross-border cooperation between regulators and extra territorial reach of new anti-corruption legislation.
The most recent example of this is the UK Bribery Act. The act is under the auspices of the Serious Fraud Office (SFO), which, anxious to make a case to the UK Government for its continued existence, will wish to find early promising targets for its new-found powers. There is not likely to be any shortage of candidates.
As my recent blog made clear, the risks here for directors are not restricted to direct prosecution for corruption. In casting their nets more widely, the UK and US authorities (under the Foreign Corrupt Practices Act) are able to avail themselves of more effective cooperation agreements with other international regulators than ever before.
In Asia for example, regulators such as the Securities Commission in Malaysia, the Monetary Authority of Singapore and the Securities and Futures Commission in Hong Kong, vie with each other to demonstrate their determination for zero tolerance to financial crime. Also the recent Siemens prosecution announced in Argentina, coming as it does after the company’s well publicized earlier problems in this area, shows that lightning can strike more than once for a large global company.
Engineering: ‘Hold Harmless’ Legal Contracts
In the oil and gas industry, engineering contractors place a high degree of reliance on the legal contracts they have in place to protect them from financial ruin should a major disaster or accident occur. It appears that these legal contracts might not be worth the paper they are written on.
The aftermath of the Macondo well incident in the Gulf of Mexico in 2010 is showing that even supposedly watertight “hold harmless” agreements for gross negligence are being challenged in the US courts with two cases involving BP starting next month:
- One brought by Transocean (the owner of the drilling rig that sank) against BP.
- The other by BP for billions of dollars against Halliburton (who made the cement cap that failed on the well).
This emerging legal risk is a major shock to an industry that relies on specialist contractors with modest balance sheets (in comparison to the oil giants). With legal contracts under major challenge, specialist contractors and service companies in the oil and gas industry might be looking to the insurance industry to make up the shortfall—by providing even greater financial protection for negligence claims.
Life Sciences: ‘No Fault’ Compensation for Clinical Trial Patients
In the United States we are accustomed to clinical trial liability policies that follow the concept of tort liability. For policy coverage to be triggered, the injured trial subject or his/her representative must make an expressed demand for damages or file a law suit.
I am noticing a trend in many foreign jurisdictions where regulators are requiring clinical trial participants to be compensated by the trial sponsor for injuries they sustain during participation in a trial.
In many cases, this patient compensation does not require a determination of fault. The stated reason for these regulations is to fulfill the government’s role to protect its citizens, but one could also surmise that this “no fault” requirement keeps patient injury treatment expenses out of the countries’ socialized medicine system.
As you can imagine, the regulations vary greatly by country and even within countries. New regulations are being proposed frequently, making it difficult for sponsors to stay current and assure compliance. All of this creates additional expense and administrative burden on the clinical trial sponsor.
Employee Safety: Obesity Epidemic
The Centers for Disease Control estimates that 2/3 of the US population is considered overweight or obese. Poor lifestyle decisions not only effect the employee’s health at home, but can also have significant implications on work activities. Many of the disorders related to obesity such as high blood pressure, diabetes, heart disease and sleep apnea have a significantly effected several key industries. Obesity and the related conditions can also significantly effect the rate that an employee recovers from injuries compared to an employee with a normal Body Mass Index (BMI).
One of the industries especially impacted by the increase in obesity is transportation. Sleep apnea can significantly effect the quality of sleep that a driver receives and could leave the driver feeling drowsy and slow to respond even after being off duty. While sleep apnea can be treated, many cases go undiagnosed or untreated, leaving the driver and public at large in danger. The largely sedentary work of drivers could be a significant contributing factor to obesity and has proven to be a challenge for many employers.
The healthcare industry has also been significantly impacted by the increase of obesity in the population. Many healthcare providers have noticed that the patients they treat continue to grow in weight each year. The physical exertion required to lift or transfer an obese patient can often times lead to back, shoulder and neck injuries. These injuries can lead to significant workers compensation costs, reduced work ability and reduced quality of life at home for the injured healthcare worker. While many healthcare organizations have implemented improved lifting techniques or mechanical means to assist in patient lifts, treating the obese patient continues to be a major concern for employee safety.
All this doom and gloom is enough to make one think that maybe the Mayans were right about the end of the world happening in 2012! But before you rush out and start stockpiling food and building bomb shelters, remember that the insurance industry is working overtime to develop innovative solutions to these risks that will safeguard companies against most eventualities – some products are already available. It might also be worth pointing out the Y2K bug that didn’t bite, but at least we were prepared!