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The risk business can tell us a lot about catastrophes. Why don’t others listen?

13 September, 2011

A child surrounded by US flags at Ground Zero. Photo by new.yahoo.com

Millions of people across the world have kept abreast of the latest developments in the United States on the 10th anniversary of the World Trade Centre terrorist attack.

With the official opening of a dedicated memorial site at Ground Zero on 11 September 2011, many associated issues have once again come to the fore for discussion and debate. Not least of these are the massive implications for insurers and reinsurers in the face of such colossal disasters.

An interesting online article related to the disaster featured in Bloomberg Business Week. The article highlights numerous insurance-related issues, including Realistic Disaster Scenarios, the “God clause”, the important role played by reinsurers, and other elements that come into play when considering every potential risk that might occur.

An excerpt from the article is featured below:

At 9.03am on September 11, 2001, Britt Newhouse stood in the lobby on the 52nd floor of the south tower of the World Trade Centre. After United Airlines Flight 175 banked above the harbour behind him, it was pointed at the 50th floor. If not trimmed correctly, an airplane will rise as it accelerates, and the man who had killed and replaced the airplane’s pilot added power until he hit the south tower 24 floors above Newhouse. He doesn’t remember the sound of the impact.

A US soldier salutes the US flag at the World Trade Centre memorial site. Photo by wrch.radio.com

At the time, Newhouse ran Guy Carpenter’s Americas operation. Guy Carpenter brokers reinsurance treaties that protect insurers when a catastrophe – a hurricane or an earthquake – causes losses on a large number of policies. Reinsurance, in essence, is insurance for insurers.

Consumers tend not to know what reinsurance is because it never touches them directly. Reinsurers, massively capitalised and often named after the places where they were founded – Cologne Re, Hannover Re, Munich Re, Swiss Re – make their living thinking about events that almost never happen but are devastating when they do. But even reinsurers can be surprised. And the insurers who make up their market put them on the hook for everything, for all the risks that stretch the limits of imagination.

This is what the industry casually refers to as the “God clause”: reinsurers are ultimately responsible for every new thing God can “come up with”. As losses grew this decade, year by year reinsurers have been working to figure out what they can do to make the God clause smaller, to reduce their exposure. They have billions of dollars at stake. They are very good at thinking about the world to come.

Lloyd’s, the London-based company that invented the modern profession of insurance, publishes a yearly list of what it calls Realistic Disaster Scenarios. The list imagines such events as two consecutive Atlantic seaboard windstorms or an earthquake at the New Madrid fault in the Mississippi Valley, either of which could strain or break an insurer’s balance sheet. By 2001, Lloyd’s had already envisioned two airliners colliding over a city, launching claims on hull insurance for the planes, property insurance and workman’s comp on the ground, and life insurance everywhere. But even Lloyd’s lacked the imagination to anticipate September 11.

“People find it hard to believe in a risk unless they can see it in their mind,” says Trevor Maynard, head of exposure management for Lloyd’s. “When you try to describe a risk like this – some terrorists are going to teach themselves how to fly a plane, and will fly into property, the buildings will be weakened – by the time you get to your third point, people’s eyes are glazing over.”

Floors 49 through 54 of the south tower housed Guy Carpenter’s home office and its 750 employees. To any of Newhouse’s clients – insurers – professional employees in an office tower would have presented an attractive bet in terms of risk and reward. There are few slips and falls in white-collar work and not much dangerous equipment lying around. Newhouse indulges in mild profanity and, thinking like a broker, often lapses without warning into the voice of his customers as they think about risk. “If I insure 40 of these firms in two towers across 200 floors, probably the worst is that eight of them, maybe six of them, could be involved in the same loss,” he says. “Because the fire department can get there … usually a fire never spreads, historically, beyond six floors.”

The insurance industry describes these kinds of risks as “high frequency”: the more often a kind of accident occurs, the easier it is to guess its chance of happening and the easier it is to price insurance coverage. For slips, lawsuits, and fires, historical trends predict future probability. “What they hadn’t imagined,” says Newhouse, picking his words carefully, “was an intentional act of human causative agency.”

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