October 20th, 2009

Casualty Clash and Casualty Catastrophe Risks, Part II: Age of Casualty Catastrophe Risks

Posted at 1:00 AM ET

metropoulos_emil_bioEmil Metropoulos, Senior Vice President

The global financial crisis that has unleashed havoc on credit and equity markets is the most recent casualty catastrophe (with both systemic and classic clash characteristics), and it may be the largest in recent memory … but it certainly isn’t the first. In fact, there have been many, and their frequency has increased over the past two decades, allowing financial markets little reprieve from one disaster to the next.

The stock market crash of Oct. 19, 1987, kicked off the modern casualty catastrophe age. The Dow Jones Industrial Average lost 22 percent of its value, earning the event the appellation “Black Monday.” Since then, we have endured the initial public offering (IPO) laddering and equity analyst scandals associated with the “dot-com bubble,” as well as accounting irregularities at Enron, Tyco, WorldCom, Adelphia and others. The loss of shareholders’ wealth with each of these events was profound, but none has been as severe as the one that currently has the world’s financial markets in its grasp.

What began with uncertainty in the subprime mortgage market has spread to broader credit and equity markets around the world. The total damage is expected to far exceed USD1 trillion and will affect businesses of every kind. The insurance industry has sustained a considerable loss of surplus (approximately 20 percent in the aggregate), and there have been some major casualties. The banking sector has fared much worse, with an aggregate loss of capital in excess of 30 percent — even with capital from the Troubled Assets Relief Program (TARP).

The situation could still worsen for casualty writers. In addition to losses from the impairment of investment assets, shareholder class action lawsuits may lead to large D&O and E&O claims, which would hit the liability side of the balance sheet and pinch casualty carrier capital. Outsized claims could cause earnings to drop, triggering a response from equity analysts and investors that would push the insurers’ share prices lower. Insufficient earnings tend to magnify losses of market capitalization, making the situation even worse.

Traditional portfolio management and risk transfer practices are insufficient to protect carrier balance sheets (and shareholders) from casualty clash and catastrophe risks. Professional and product liability coverage tends to focus on specific circumstances rather than the rapid transmission of liability through a portfolio. Even with careful risk-by-risk hedging, gaping holes are left unattended. Insurers’ capital and shareholders’ wealth continue to be imperiled.

Originally published in Reinsurance Encounters

Part I: Clashing and Catastrophic Casualty Events >>

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