Thinking the unthinkable, calculating the incalculable
By: Lyle Fearnley
In an article published in 2003 on “Catastrophe Risk†in Economy and Society, Phillip Bougen follows the application of insurantial calculation to the unpredictable field of catastrophes and natural disasters. In fact, reinsurance for insurance companies faced with disasters beyond the scale of their actuarial analysis is a long-standing practice, though one whose forms of rationality are little known. As one analyst puts it, these rationalizations are “either a carefully guarded secret to be protected at all costs or . . . the methods [reinsurers] employ defy description or communication to interested parties.†Bougen’s article traces a more recent mutation, which he calls the “securitization†of catastrophe risk, that is, the “transfer of the risk to capital markets.†First of all, there is not necessarily an assurance that this system will work, even though the advantage is the massive amounts of liquid capital available in these markets. More interesting is the different frameworks of risk analysis utilized by insurance companies and trading companies. Bougen describes a process of translation that turns “a risk profile of catastrophe into the standardized risk assessments of more conventional investmentsâ€. Bougen calls medium through which this translation takes place “catastrophe information systemsâ€, referring to a range of modeling techniques and expert analysis offered by a new set of “rating agencies.†It would be interesting to look in detail at these rating agencies and their models. How do these new risk technologies compare with modulations of risk in other domains, for example the use of risk-based statistics in early warning systems like syndromic surveillance?
On a final note, this article is intriguing in part because it is published in 2003, before Hurricane Katrina struck. As can be seen in recent articles describing lawsuits against State Farm for refusal to honor claims, Katrina was a disaster for the insurance industry and no doubt for reinsurers as well. How has catastrophe risk been mutated once again by the Katrina experience? Is anyone following this in the kind of detailed way we would appreciate?
January 27th, 2007 at 10:06 am
…are these “catastrophe information systems” working with historical data, or are they based on real-time opinions and predictions of experts? A key move after September 11, 2001 was a partial shift from risk assessment on the basis of historical data to risk assessment on the basis of a pool of contemporary predictions of experts. These predictions change faster than historical data can. The system is therefore more flexible. Maybe that’s similar to the “rating agencies”? At any rate, this paper below outlines some of the shifts in the insurance industry after September 11. This would all be worth a research project of its own, I guess.
Catastrophe risk, insurance and terrorism
Authors: Ericson, Richard1; Doyle, Aaron
Economy and Society, Volume 33, Number 2, May 2004, pp. 135-173(39)
Abstract:
This article empirically investigates how the terrorist activity of September 11, 2001, was addressed by the insurance industry and government in the United States. It shows that the insurance system worked reasonably well in compensating losses suffered, albeit with various tribulations. It also demonstrates that the insurance industry, along with government as the ultimate risk manager, imaginatively reconfigured markets to continue terrorism insurance coverage in many contexts. The findings challenge many of Ulrich Beck’s contentions about catastrophe risks and insurability. At the same time, they indicate the fragility of the insurance system. Insurers’ perceptions and decisions about uncertainty – with potential for windfall profits as well as catastrophic losses – create crises in insurance availability and promote new forms of inequality and exclusion. Hence, while the insurance industry is a central bulwark against uncertainty, insurers can also play a key role in fostering it.
January 27th, 2007 at 10:09 am
…if I had the time, I would start a research project on Swiss Re and Munich Re, two large re-insurance companies…
January 30th, 2007 at 11:32 am
Interesting intersection with the Nano stuff: Swiss Re is in fact quite interested in careful analysis of the environmental and health risks of nanotechnology; in part because of their experience with GM foods, which caused an equivalent “catastrophic” loss in terms of investments that saw no return as a result of adverse regulation (from the perspective of agri-biotech firms).
Even more interesting perhaps is that one of my collaboraters in the nano world is focused on invistigating the toxicity and exposure risks of nanoparticles and one of the most innovative ways he has figured out to do that is by using the insurance industry’s methods for calculating relative risk…
Robichaud, C.O., Tanzil, D., Weilenmann, U., Wiesner, M.R., “A relative risk analysis of
several manufactured nanomaterials: an insurance industry context,â€
Environmental Science and Technology, 39, 8985-8994, 2005