Quietly catastrophic


Quietly catastrophic

From asbestos to the financial crisis, Deepwater Horizon to Chinese drywall, casualty catastrophes are invisible—until they aren’t. How can the reinsurance market prepare for the next major event?

Its name is derived from the ancient Greek for ‘unquenchable’— it was used to strengthen 4,500-year-old earthenware pots and house the ashes of ancient kings. What the industrial revolution would usher in as a mainstream ‘miracle’ insulator, Pliny the Younger recognised as deeply dangerous before the end of the first century AD. To date, it is responsible for the longest and most expensive mass tort in US history, involving more than 8,400 defendants and 730,000 claimants.

The total cost of asbestos litigation in the US alone is estimated at $250 billion.

“There are two things that we see looking back at casualty catastrophe trends,” said Joshua Everdell, managing director at Guy Carpenter. “One is that systemic losses have occurred from a compound that people didn’t fully understand when they were using it—such as asbestos. The challenge there is trying to figure out what the next compound like that could be.

“The second is that a casualty catastrophe is caused by a massive industrial accident event, such as Deepwater Horizon,” Everdell said. “The common element in those is that there are always a number of parties involved—the supply chain is long. When you have an event like that it can cut across more of your book than you might think.”

William Garland, managing director at Guy Carpenter, added: “It’s hard because many of these events are unforeseen. If you think about financial institutions, who would have thought that Bernie Madoff’s Ponzi scheme would have an impact on so many financial institutions from around the world?”

Mark Higgins, executive director, North American Division, JLT Towers Re, added, “Asbestos, mould, silicon and others weren’t even contemplated prior to the devastation they caused. Due to the long-tail nature of casualty business the potential for significant, systemic or catastrophic exposure is at times difficult to detect.”

Crystal ball required

As the fallout from Deepwater Horizon and the financial crisis ebb to their slow conclusions, the casualty market finds itself in a position of strength. That isn’t to say, of course, that chinks in the armour don’t exist.

Tim McAuliffe, president of Ironshore Specialty Casualty, said: “It’s difficult to predict what the next asbestos might be or, frankly, if there will ever be another asbestos-type exposure. The good news from my perspective is that even through the softer cycle we’ve just come out of when pricing moved downwards, terms and conditions tended to improve.”

In the past, McAuliffe said, soft cycles led to deterioration in terms and conditions. Insurers began offering multi-year deals and adding odd coverages to umbrella and excess policies. It was a move to remain competitive, but ended up combusting. “That didn’t happen within this past soft cycle,” McAuliffe said. “People have learned their lesson.”

Nick Pascall, senior vice president of casualty at Hiscox Re, said, “The reinsurance industry reacted quickly to the losses resulting from the financial crisis of 2008 on the D&O and E&O lines by imposing stricter terms and conditions and reducing their appetite, especially on financial lines business. However, as losses generally settle for less than initially feared this tightening has already loosened.”

He continued, “Broadly speaking, reinsurance results remain positive across most lines of business. However, margins are shrinking. There is an oversupply of capacity which has manifested itself as a signings war as opposed to a price war—so far.”

According to Pascall the gradual erosion of the pricing and reserving discipline of the business, often done in the name of competiveness and to increase margins, “is the scenario we have most cause to fear at this stage in the market cycle”.

“Underwriting discipline is very important,” said Richard Jameson, executive director of North American reinsurance at JLT Towers Re. “To simply pursue volume when the margin isn’t there will merely exacerbate the speed of the next hard market.”

Model improvements

While the market is certainly in a strong position—provided it can maintain crucial underwriting discipline—most of those involved agree that a casualty catastrophe is inevitable. But disagreement persists over whether it is—or ever will be—possible to model and predict it.

Bob Revill, CFO of Praedicat, certainly thinks so. His company, which calls itself the world’s first liability catastrophe modelling company, is betting on it.

By mining scientific journals with patent pending technology, then utilising an analytical approach that incorporates applied legal reasoning and economics, Praedicat hopes to identify compounds with dangerous potential—before the million-dollar lawsuits crop up.

“Every mass litigation that we investigated was preceded by peer-reviewed science by some number of years. We realised that a hypothesis that some product, chemical, substance or exposure can result in bodily injury first emerges years before general acceptance within the scientific community, before public awareness and before the first litigation,” said Revill.

“In the liability space there is a fundamental problem with the actuarial approach,” he continued. “After any mass litigation the world changes—companies go out of business and products are removed from the market.”

Some aren’t so sure that casualty risk can be so easily cornered.

“It’s very difficult to pinpoint these risks in advance, but everyone is doing their best to manage their aggregate limits so that, should one of these events occur, its impact will be better managed,” Garland said.

Everdell added, “The modelling approaches at the moment can give you a directional sense of your exposure. There are many different pieces you need to model to get a full picture. There are many elements to manage, and that’s why it’s so difficult to get right.”

“The industry will always have exposure to systemic loss,” Garland said. “That’s just the nature of why insurance is purchased. Each time a major event happens people look forward to what could happen next.”

“The loss may come from something the industry hadn’t even thought of,” Everdell noted.

Be prepared

In a world where a casualty catastrophe is inevitable, preparation is the priority. McAuliffe believes that the industry is in a good place.

He said, “It’s a healthy market in terms of the amount of capacity available and the health of the insurers taking part. The market could absorb a catastrophic loss. There’s always going to be the opportunity for a catastrophic risk to occur, but the industry itself is prepared and has the right mitigating factors in place.

“Insureds themselves have become more cognisant of the risks and can try to control them within their own manufacturing process and within their own quality assessment as products go out of the door. There could always be a surprise, but for the most part there is more awareness and a better ability to control risk.”

Reinsurance is a valuable tool, according to Higgins. He explained, “Reinsurers are better positioned to deal with severity and catastrophe exposures and offer an invaluable knowledge base to partner with clients to identify and support their business approach.

“Reinsurers chasing business they don’t fully understand or are underpricing will lead to the problems of the past. Understanding your clients and their exposures allows reinsurers to create a long-term approach.”

Pascall agrees: “Client communication is paramount. Regular updates as well as onsite meetings and audits are essential. Reinsurers must remain ever-watchful.

“There will be another casualty catastrophe,” Higgins concluded. “As history has shown, it will be those insurers and reinsurers who understand their clients’ exposures and needs that stand the best chance of emerging in a strong position.”    

Casualty, Guy Carpenter, JLT Towers Re, Ironshore, asbestos

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