November 9th, 2009

Near-Term Capital Management: Hidden Opportunity

Posted at 1:00 AM ET

harnick_michelle_141pxMichelle Harnick, Managing Director

We’ve had a fairly quiet catastrophe year, making it easy for risk managers to slip into a false sense of comfort. But, the situation could have been much different, especially if Hurricane Bill had taken a slightly altered course. A single storm can affect the insurance industry profoundly, especially if it makes landfall where there is a high accumulation of risk. When the unexpected begins to take shape, the range of options available to risk bearers shrinks rapidly, and even the most thorough of plans can be thwarted. Any measure that can help carriers protect their capital as a storm is bearing down on its insureds can have an impact all the way to market capitalization.

Doubtless, effective planning is irreplaceable. There is no substitute for understanding the risks in a portfolio and the various outcomes associated with different events and levels of insured loss. Discipline and caution, though important, are insufficient to prevent the unexpected. For example, hurricane forecasts don’t account for severity, which means that predictions of a benign year overlook the possibility of one storm causing a mega-catastrophe. When the wind does start to blow, therefore, an insurer could be caught unprepared.

Livecat cover, of course, provides some measure of protection. As a storm approaches, carriers can use this short-term risk-transfer tool to lay off risk and protect their balance sheets. The challenge that remains is timing. National Hurricane Center (NHC) forecasts are limited to five days, giving risk managers little time to make decisions, thus threatening the threat to their capital. Extending the notice would result in increased flexibility … and improved risk and capital management.

GC LiveCatTM, developed in coordination with WSI Corporation, equips insurers to handle near-term hurricane risks more effectively. WSI provides 10-day forecasts - double those available from the NHC — extending the range of choices at insurers’ disposal. GC LiveCat also delivers probabilities of landfall by gate and conditional exceedance probability curves that are updated every 12 hours to offer risk managers an ongoing view of imminent risks in the Atlantic basin. The result is risk management in as close to real time as possible. The decision to buy livecat cover (or not) is based on a more robust set of information, ensuring that every dollar applied to managing near-term risks generates as much value as possible.

The actions that a company takes when a hurricane is headed toward a highly exposed area affects more than a particular portfolio: market capitalization can be at stake. Losses are magnified in shareholder value, as the effects of earnings losses (e.g., from unexpected insured losses) are multiplied in the company’s value. A shock to earnings could push an insurer’s share price lower … and preventing that loss would consequently protect shareholder wealth. Every capital decision impacts shareholders, and managing imminent risks more effectively can give a carrier an edge in the marketplace.

With GCLiveCat, insurers can take additional steps to strengthen their balance sheets against the effects of wind peril-causing loss. Rather than make capital management decisions using questionable information with little lead time, carriers can move forward confidently, taking action to preserve their capital, minimize losses and protect market capitalization. In the insurance industry, the ability to manage capital prudently in the face of any risks is what defines the market’s leaders. Every edge counts — from a broad view of the portfolio, to the specific actions taken when a hurricane is pushing toward the coast.

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