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The Actuary The magazine of the Institute & Faculty of Actuaries

Meeting report: Facing up to risk

Day 1: terrorism, stochastic claims reserving, and RAMP
Proceedings began with a talk from David Gamble, the executive director of the Association of Insurance and Risk Managers (AIRMIC), entitled ‘There has never been a greater need for risk management’. Over the last few years, the insurance market has hardened following the withdrawal of major companies, the unavailability of appropriate reinsurance, and the greater scrutiny of the creditworthiness of companies. With the events of 11 September 2001 and the inevitable shake-up in the insurance industry that followed, insurers are now taking a more measured approach to risk management. Airlines have been forced to find new solutions to the problem of finding appropriate insurance, because even governments in their new role of ‘insurer of last resort’ are unwilling to bear the full brunt of the risk that they could be taking on. The question of how to allow for terrorism in risk management is a testing one. Insurance companies are now including terrorism exclusions in their policies, as they are unwilling to be exposed to such enormous loss events. It is important for insurers to work with governments to determine a working solution in the event of future terrorist attacks.
Professor Richard Verrall of City University spoke about the methods and merits of stochastic claims reserving. With an ever-changing claims environment and new requirements from the regulators, the use of stochastic claims methods may soon be the norm in everyday actuarial work. Dynamic financial analysis (DFA) has begun to increase in stature in the actuarial profession, and this has been recognised by the profession through the introduction of the stochastic modelling paper (Subject 103). It may not be long before an actuary’s opinion of a ‘best estimate’ will be insufficient for the average regulator. The focus is rapidly turning from point estimates towards measures of variability and the derivation of a distribution of possible outcomes of unpaid liabilities. Insurers are able to interpret a best estimate, but their concern is the risk that actual experience will turn out to be widely different from this. With stochastic methods, insurers can get a better feel for the inherent uncertainty in the types of business in which they operate.
To end the first day, Chris Lewin spoke about RAMP and Stratrisk, the profession’s joint project with the Institution of Civil Engineers. Many projects fail because insufficient attention is paid to risk before they are launched. RAMP is a comprehensive framework for managing risks and quantifying them before a project is launched. Those familiar with the capital appraisal chapter of Subject 301 will appreciate the importance of a measured approach to risk management at every stage of a project, including when the project is finally up and running. It seems too easy for all the focus to be placed upon the easily quantifiable risks at the problem identification stage, with too little attention on the more subtle and changing risks that may emerge throughout the lifetime of a project. We ended the session on a relatively light-hearted note by applying some of RAMP’s brainstorming methods to the risks of running the profession’s exams.

Day 2: financial condition reporting, the World Trade Center, asbestosis, and insolvency
The second day began with John Ryan talking about financial condition reporting, bringing us up to date with developments since the working party reported to a sessional meeting early last year, and outlining the challenges it presents for general insurance actuaries. The aim is to create a framework that allows a company’s financial position to be evaluated in relation to the risks that it faces from both a solvency and a shareholder perspective.
Richard Winter’s presentation on the quantification of a worst possible event was of particular interest in the light of 11 September 2001. In the case of the World Trade Center (WTC), it had not been thought possible for such a large loss to occur in respect of one of the twin towers, let alone that an event might cause the complete destruction of both towers. The identification of unexpected events is not an area unique to the consideration of the WTC loss. However, there is no doubt that this event has taken the whole insurance industry by surprise. Events involving aircraft have often been considered when deriving worst case scenarios. A commercial aircraft accidentally crashing into a building is an idea that many considered possible in the past. However, it was beyond even the most pessimistic of minds to have envisaged that two large aircraft would be deliberately flown into two of the biggest buildings in the world, and that both buildings would be destroyed as a result.
Although the WTC loss has been a huge blow to the insurance industry, it is dwarfed in monetary terms by the problem of asbestos liabilities. Many have been taken aback by the fact that such a large number of small claims has spiralled into the largest single liability to face the industry. It is unlikely that anyone would have perceived that one individual class of exposures could cost the insurance industry as much as $200 billion in claims. There is no easy solution to eliminate the occurrence of ‘unexpected’ events, but it is clear that insurers need to concentrate carefully upon risk identification. Only then can appropriate methods of mitigation be considered.
In the one breakout session of the seminar, Lis Gibson led a discussion on the World Trade Center, detailing the latest thoughts on reserving for these losses and the lessons that can now be learned about exposure management.
In the other session, an important message came out of James Widdows’ presentation on insurance insolvency. There appears to be a persistent inability of companies to learn from past mistakes. This is not helped by the focus that insurers have on the short term. Insurers are always going to be at the mercy of catastrophic events. However, they continue to write large volumes of unprofitable business to increase their market share. The problems of rapid business expansion, lack of appropriate underwriting, and pricing that fails to reflect the underlying risks, over- (or under-) reliance on reinsurance, and the lack of experience are all areas of potential concern. All this before we consider the ‘darker’ side: failures due to fraud, greed, false reporting, under-reserving, and loopholes in regulation that give insurers too much freedom to do as they please. Better appreciation of the risks that insurance companies face can help the industry to reach a stronger position than it has ever been in.

Debates, risks: the end
By lunch on the second day we had spent a full day hearing about risk, so it was surely brave of Andrew Smith to move the motion ‘This house believes that actuaries cannot handle risk properly’ in the afternoon debate. He gave a number of cogent examples of areas in which actuaries still fall behind best practice on risk management, and good reason for us to examine our own approach in this area, but Lis Gibson pointed out the many good things actuaries were doing, and the motion was defeated by a large, but certainly not overwhelming, majority.
Dr Simon Ashby of the FSA rounded off the seminar by investigating the ways that insurance could be used to protect against operational risk the risk of losses arising from management and control failure. Devising insurance solutions to these problems is difficult, and not all operational risks are insurable, but there are some promising approaches being developed.
Focusing the seminar around the theme of risk meant that delegates were able to consider a number of important general insurance issues from a slightly different perspective from the normal. The effective handling of all the issues concerning risk is essential for the long-term survival of the insurance industry but it is not possible to eliminate completely all causes of insurance failure; however, a full appreciation of the important issues will certainly prevent the situation where the failure of one company leads to the systematic collapse of the whole industry. There is clearly plenty of opportunity for the actuarial profession to provide the appropriate support that insurers require by applying current principles, or by developing new ways to meet the industry’s needs. The role of the actuary in general insurance is no longer confined to the traditional tasks of pricing and reserving. It is now growing increasingly important to develop new ideas and approaches to keep in line with an ever-changing insurance environment.
Overall, the seminar was very enjoyable, and particular thanks go to all the speakers and the conference organisers at Staple Inn who helped to make this a worthwhile and enjoyable event for everyone involved.