Taming Chance

SPREADING CAT RISK GEOGRAPHICALLY

Risk-sharing models may have to account for regional disparities if cat losses continue to be spread disporportionately across geographic territorities, panelists told an audience attending the Ontario Risk and Insurance Management Society (ORIMS)’s professional development day seminar in March.

This is partiucularly true as cat losses continue to mount, speakers noted.

Panelist John Chippindale, the CEO of Integro Canada, observed annual catastrophe-related losses averaged US$3.5 billion between 1970-90, US$20 billion between 1990-2000 and US$35 billion between 2004-05. Natural catastrophe losses totaled US$76 billion in 2005 compared to US$5 billion in man-made losses. Chippindale said losses from the 2005 hurricane season wiped out the industry’s first underwriting profit in 27 years.

“I think this creates a couple of important questions about the principle of insurance,” Chippindale said. “One is: Who should be financial responsible for what? That leads into the second question: What should be the parameters of the spread of risk? In other words, which risks should be put in the same pot? Should all of these be in the same pot now? Should companies that don’t have any cat exposures be impacted the same way they are now? If it weren’t for these losses, we would have had a record profit of US$38 billion. Who should be paying for this?”

Given that cat losses are predicted to escalate progressively in the future, panelists were asked: ‘At what point will insurers simply decline to share losses with particular risk areas?’

The question followed a presentation that predicted an 81% chance the U.S. coast will be hit by a major [Category 3, 4 or 5] storm in 2006, and a 61% chance a major storm will hit Florida the same year. Referencing AIR Worldwide, Jeff Setterington, assistant vice president of sales and marketing at AIG, showed a slide that indicated New York [at US$1.9 trillion] and Florida [at US$1.94 trillion] account for almost US$3 trillion out of the total insured exposure of US$7 trillion along the U.S. coastlines.

“The model [for risk-sharing] is going to have to change,” Setterington said. He referred to the increasing concentration of insured exposure in some areas of the United States. “Whether that becomes a more regionalized model that’s focused on Florida, Georgia, or The Florida Panhandle [the northwest and north central part of Florida], the model will have to change. That graph [indicating U.S. coastline exposure] shows you can’t have $US80 billion in losses in a two-year window and expect to keep going on that basis. The ratings agencies will start kiling us.”

Chippindale added: “There’s a very significant debate going on whether the overall map of insurance should be as affected by single items that are outside their control, and to what extent is that geographic?”

For now, Swiss Re’s senior vice president of marketing Bill Lacourt said: “The industry needs to charge higher prices and tighten conditions for hurricane-exposed risks.”

MANAGING THE CRASH OF AIR FRANCE

In the spirit of talk-show host and comedian David Letterman, Richard Doherty, the risk manager of the Greater Toronto Airport Authority (GTAA), outlined the ‘Top 10’ risks he faces daily.

Doherty listed airplane crashes as his Number 1 risk. Not surprising, considering the onus is on the GTAA to shoulder the safety of up to 90,000 passengers and employees moving from land to air every 20 to 30 seconds on any given day.

“Sometimes you wish for a loss, not a big loss, but a loss you can use to educate people on best practices to reduce risk,” Doherty says.

Most recently, the GTAA experienced and survived the real-world loss of the Air France A340. On Aug. 2, 2005, the Air France plane overshot the runway’s touchdown target by 3,000 ft, forcing the plane to tear through about 800 ft of grass, fence and public roadway before coming to a crashing halt. “Everything about this accident is God-given luck,” Doherty says. “No one was driving on the road at the particular moment …Cars were just a matter of seconds away from colliding (with the A340).”

Although luck helped avert total disaster, Doherty credited the GTAA’s good risk management practices for ultimately saving lives and property, and keeping lawsuits and losses to a minimum. Nonetheless, the loss did pinpoint areas in need of improvement, Doherty observed. Specifically, he referred to communication, which is often strained during times of disaster: “Communication for Air France was … in some cases too good,” Doherty recalls. “Cell phones and radios got overloaded very quickly.”

The media, Doherty recalls, claimed the GTAA was slow to report on the status of passengers. However, while it appeared all passengers were safe within 25 minutes of the crash, Doherty explains: “As an organization, we decided it wasn’t appropriate to release info without having final confirmation of the facts.”

The incident also highlighted inefficiencies in the training program. Prior to A340, Doherty said, potential risks were not properly accounted for, which negatively affected training programs. “We didn’t plan for all the variables,” he said. “We schedule training drills when everyone’s available, but that’s not a guarantee in a real-world event. You’ve got to train for the unexpected, so we’ve incorporated that into our plan…We aren’t doing pre-emptive planning training exercises; instead, they’ll be off-the-cuff.”

One rule set in stone, Doherty said, is getting an adjuster on the scene quickly. Adjusters must view, assess and photograph the incident before safety personnel arrive and begin closing off areas vital to validate insurance claims.

The Air France incident is a testament to sound risk management practice, Doherty said. But real-world risk is not consistent, meaning mistakes are guaranteed. So while Doherty applies “textbook-to-tarmac” fundamentals, he also incorporates risk management devices deemed necessary by real-world events.

AUDITING BROKERS

In the same way companies ask for discipline around contracts, service levels, and penalties for non-performance when outsourcing work to service providers, insurers should be managing and carefully auditing their relationships with brokerages, panelists told the ORIMs meeting.

“The broker’s role is the outsourcing of the insurance placement for the company and therefore [the broker is] like an outsourcer,” Susan Meltzer, assistant vice president, insurance and risk management of Sun Life Financial, said. “Oversight of the broker should be parallel to the oversight of any vendor and indeed any outsourcing activity…Federally-regulated financial institutions are required to have a policy on outsourcing of business functions. And prior to [undertaking regular audits of broker performance], we realized if we are categorizing what a broker does for us as an outsourcing, then we were not in compliance with the very policy that the risk management department had created to manage outsourcing.”

Meltzer said insurers probably don’t need to go through a full RFP process with brokers as they would with vendors. Such a “disruptive” and “non-productive” process, she said, fails to address the root of the relationship between an insurer and a broker. An RFP process might uncover better value propositions for the client or insurer, for example, but it won’t address operations protocols and policies that might hamper the insurer’s relationship with the broker. “It’s my belief that the only reason that a risk manager should do a broker RFP is if the relationship with the broker is broken – and not with the individual, but with the firm.”

Like Meltzer, Teresa Pahl of Hilbs Rogal & Hobbs [HRH] in Chicago, dosen’t believe a full RFP is required when contracting work to a broker. “Just do an audit,” she recalled advising Meltzer one night, when Meltzer told her about her concerns with a company. “Look at how the underwrit er is doing business. Talk with them. Look at how your vendor is doing business, your broker. Look at how your own team is operating, because we all know the team is more than just what the broker is doing. Many times the brokers are working hard to make up for the sins of the client.”

Pahl said a detailed audit should include how loss frequency is developing, how claims are handled, how long it takes to issue a policy, management of collateral, the carrier’s service on the account (not just the broker’s service), the process for the flow of funds, and how brokerages are using their other regional offices.

The audit process should also involve interviews with underwriters, Pahl said, so that underwriters can better communicate to brokers their perceptions of how the claims process should work and how the underwriters organize themselves.