May 5th, 2009

Casualty Cat Part II: Tracking Integrated, Intricate Risks

Posted at 1:00 AM ET

metropoulos_emil_bioEmil Metropoulos, Senior Vice President

Casualty (re)insurers do not cover standalone risks. A steep drop in stock price, product defect with recall, or other event could lead to class action lawsuits and ultimately large claims. This emergent reality, however, is difficult to address. A carrier would need to identify the many possible starting points of a liability chain reaction and follow their rapidly spreading implications throughout a portfolio. Without powerful modeling technology, this process is time-consuming, impossible to complete, and likely to miss key threats and underlying exposures. Because of the impracticality of integrated liability risk management under these conditions, most casualty (re)insurers segment their efforts to protect their capital, for example, by geography or line of business. This approach leaves gaps, some of them quite wide. An anticipated directors and officers (D&O) claim for a particular insured may arise from an event that also triggers D&O — and possibly errors and omissions (E&O) — claims for other insureds. The losses begin to mount, often in excess of carrier expectations.

Because of the complexity and uncertainty involved in integrated casualty catastrophe risk management, carriers generally have not advanced their risk management practices in this regard. They instead have continued to manage liability risks independently and assume the integrated risks, sometimes unknowingly. The capital needed to support cover for a specific D&O peril, for example, may not account for ancillary D&O effects from an event elsewhere in the portfolio … not to mention the E&O implications. In the event of a casualty catastrophe, it is not enough to model these scenarios separately and aggregate the results. The whole may be greater than the sum of the parts.

Catastrophe risks must be identified, accumulated, and modeled as entireties in order for their implications to be understood and hedged.

  1. Locate areas of vulnerability to catastrophe risk in a portfolio
  2. Identify casualty catastrophe mechanisms and determine how they operate within a portfolio
  3. Model the major disaster scenarios that could trigger substantial casualty losses 
  4. Formulate a risk management plan that addresses the full reach of each scenario identified

Ultimately, identifying and managing casualty catastrophe risk requires a systematic approach. The various connections within a portfolio must be scoured in order to understand the implications of a particular event. A product recall could lead to product liability, D&O, and E&O claims. A plane crash due to equipment malfunction could cause claims for product liability, D&O, and life to be filed. Likewise, an industrial accident causing workers compensation or employers liability losses could lead to general liability, environmental, and D&O claims. The implications of a particular situation can reach far beyond the root cause, even if it stretches the imagination.

Previous installment:

Casualty Cat Part I: Casualty Catastrophe Risk Modeling >>

This is the first in a six-part series. To have the next installment delivered directly to your inbox, register for e-mail updates.


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