Kiran Kamath and the Emerging Risks Working Party look at why actuaries, senior manager and CEOs should care about emerging risks
The start of another busy week in my dream job as Chief Risk Officer of Snowdonia Mutual, I thought, as I drove to work. I turned the radio on.
" and in other news, the Chancellor has announced plans to free everyone from the need to buy an annuity with their pension savings ."
Free people from buying annuities, I thought. That can't be right; the reporter must have got that wrong.
I arrive at work and spot the new CEO, Josh.
"Oh, hello Josh, surprised to see you here," I said.
"Haven't you heard about the Budget?" the CEO asked.
"Yes, I did hear something, but the press have just got it wrong."
"No, they haven't. I've just seen the Treasury website and they're scrapping compulsory annuities. So our new £100m investment in a platform to launch the annuity business is about to go up in smoke. How could you let this happen?"
"Me? How on Earth could I have known there would be a surprise in the Budget?"
"There's always a surprise in the Budget! The Pensions Minister and the FCA have been saying annuities are poor value for months now! I want to see your CRO risk report on the business case now."
"Risk report? Yes, yes I'll send it to you but we didn't mention this risk. We covered all the operational risks, but not this sort of remote risk. There just wasn't time. I mean guaranteed returns, great growth prospects, we had to do the deal quickly or someone else would have got in there. It just looked so risk free - I mean everyone needs a pension, right?"
"Well, you're going to have to explain to the Chairman of the Board why you didn't tell him about this risk. How on Earth could you have missed this?
Sounds uncomfortable, doesn't it? And maybe a bit unfair. How can any CRO be expected to predict the unpredictable? Well, history tells us that the unpredictable emerging risks are often the ones that can bring down companies. The story above is fictional of course, but it shows us the key reason a CRO should care about emerging risks - to do your job properly you need to consider everything, not just the risks which you think are most likely to occur.
We can define emerging risks in many different ways. Here are a couple of industry definitions:
Newly developing or changing risks which are difficult to quantify and which may have a major impact on an organisation (Swiss Re);
An issue that is perceived to be potentially significant but which may not be fully understood or allowed for in insurance terms and conditions, pricing, reserving or capital setting (Lloyds of London).
In this article the Profession's Emerging Risks Working Party discusses why you should care about emerging risks.
Emerging risks are big - but they can often be spotted
Emerging risks can cross over industry sectors and cause company failure and bankruptcy. This in turn can impact the whole of society - customers, investors, other industries and governments. By contrast, risks that you know about are rarely fatal as they are managed and mitigated.
The good news is that there are often mechanisms for improving the management of emerging risks. Before accumulating to a catastrophic level, they usually start in a mild form. So, once a company has identified the emerging risks that can threaten the business, it can build the MI that will help detect them early and give them the best chance to respond. Take for example the 2008 Global Financial Crisis: although we tend to focus on the banks that fared the worst, a number of banks were able to spot the impending crisis and took actions such as reducing lending, selling assets or purchasing expensive default insurance.
Past performance is not a guide to the future
As actuaries, our models usually assume that the future will resemble the past - even if we don't realise it! Emerging risks are what can, and eventually will, invalidate this major assumption. If we don't consider emerging risks we can rely too much on our models and draw false comfort on the risks that can emerge in the future.
Over the last 20 years emerging risks have fundamentally changed the world in which we operate - look at the impact of climate change and terrorism. Risks which we previously thought of as being extreme and far fetched are now at the centre of decision making in businesses.
We all know that "what gets measured gets managed". Don't fall into the trap of assuming your business is low risk because everything you're measuring is telling you that it's low risk. The chances are that what you've chosen to measure is based on the risks that materialised in the past. But are you measuring and managing the right aspects of your business to prevent tomorrow's crisis?
A competitive advantage?
Some emerging risks offer great opportunities for those institutions that are able to mitigate those risks and therefore turn a threat into an opportunity for growth.
Take online shopping. Some companies failed to spot the trend early and as a result have gone bust. Others have embraced the new technology via "click & collect" and online delivery. What was once seen as an emerging risk is now a permanent feature of the market, which provides opportunities for companies to access new customers and build brand loyalty.
Our reputation depends on it
Society looks to the insurance industry to be there and stick to its promises in the worst times - flooding, pandemics, market crises etc. In the specific case of life insurance and pensions, our time horizon is over 30 years into the future rather than the next 12 months most other companies are focussed on.
In fact if we go back to basics, one of the main reasons people buy insurance is to allow them not to consider extreme risks, but pay us to worry about them instead. If we are unable to provide them with this peace of mind then we have failed as an industry and could face a backlash from customers and governments.
The importance of emerging risks is recognised by regulators and rating agencies who will want to know whether a company has addressed emerging risks, for example in ORSA processes and recovery & resolution planning. So, caring about emerging risks can boost a company's credit rating, standing with the regulator and ultimately the share price.
Emerging risks are largely outside of the control of any one company and are not afraid of crossing legal and geographic jurisdictions.
This makes it crucial for all interested parties across an industry to work together as it can be hard for any one company to mitigate an emerging risk. It is therefore the responsibility of all of us to care about emerging risks so that companies across an industry can work together for the good of society. For example, after the September 11 terrorist disaster, the airline industry around the world worked together on security measures. This undoubtedly helped avoid another similar attack in the years after.
The Profession's Emerging Risks Working Party can see significant advantages in the formation of a cross-industry body to look at emerging risks, incorporating insurers, pension funds, consultancies, academia, regulators and governments. Hopefully we've shown you why you should care about emerging risks. Over the next few months the Working Party will be investigating approaches for managing emerging risks. We'd be delighted to hear your views on this article and how you think emerging risks can be identified and managed.
Kiran Kamath is the chair of the IFoA's Emerging Risks Working Party
The members of the Working Party who contributed to this article are Marcus Bishop, Peter Telford, Edward Luke, Patrick Thorne and Juliana Dengeri.
Disclaimer: The story in this article, and the views expressed by its characters, are fictional and are not intended to reflect any actual insurance company or individuals.