October 27th, 2010

Casualty Catastrophe Implications of the Deepwater Horizon Oil Release Disaster

Posted at 5:00 AM ET

metropoulos_emil_gcciEmil Metropoulos, Senior Vice President

There has been no shortage of media coverage and discussion of the Deepwater Horizon oil spill and attendant insurance implications. The media has reported up to 300 lawsuits filed against BP and other defendants involved in the Deepwater Horizon oil release disaster.

The loss from the Deepwater Horizon disaster is a major event for the offshore energy insurance and reinsurance market. Estimates of industry insured losses range from USD1 million to USD3.5 billion.

Liability risk has a tendency to spread: some, rapidly, while other industry links take months or even years to emerge. One event can trigger a chain reaction across industries and lines of business, causing insured losses to accumulate.

A casualty catastrophe is an event in which risk spreads rapidly across industries and borders, transmitting exposure along a variety of common trading relationships. When this occurs, claims have the potential to be filed against companies that seem to have little in common with the root cause.

Yet, the actual risks can be difficult to discern, especially in advance of a catastrophic loss where there is no relevant loss history or conceivable causal relationship to reference. Tracing these relationships is virtually impossible without the support of a rigorous methodology and robust modeling solution.

When considered in the context of the Deepwater Horizons oil spill, the casualty catastrophe threat is not remote. With this type of event, liability extends both forward and backward throughout the entire supply chain. Affected companies’ insurers may be paying claims that were unexpected when the catastrophe first hit.

There are two components to effective risk and capital management in the face of a casualty catastrophe: strategy and modeling. One cannot be effective without the other. Guy Carpenter & Company’s approach to casualty catastrophe risk management consists of five key components:

1. Manage portfolio liability accumulation risk and integrate premium loading
2. Contemplate casualty catastrophe scenarios in capital modeling including portfolio stress testing
3. Generate custom-built scenario specific event sets with distribution of possible losses to your portfolio
4. Formulate underwriting guidelines and optimal clash reinsurance triggers, coverages, terms and conditions
5. Demonstrate to regulators and stakeholders that you are applying sound modeling techniques on casualty catastrophe risks

The strategy presupposes the use of a model that makes it possible to identify and track the proliferation of risk through the web of relationships. A new approach to modeling liability risk management has become essential. The analysis and transfer of individual risks must give way to an integrated portfolio evaluation.

Guy Carpenter has developed a comprehensive process, supported by CasCatTM - the industry’s first casualty catastrophe model - for identifying the potential quantum and spread of exposure to insurance portfolios from a variety of liability catastrophe scenarios. In conjunction with the utilization of the proprietary software of risk modeling specialists Arium, Guy Carpenter has spent the last four years developing the CasCat modeling process.

Guy Carpenter is the first industry risk consultant to provide a modeling framework for a variety of potential casualty disaster scenarios. Although the threats derived are not readily discernible on their own, CasCat makes the domino effect from the root cause seem intuitive. It can efficiently model highly complex interindustry connectivity networks and apply them to the most likely industries, coverages and policies in a casualty portfolio.

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Guy Carpenter & Company, LLC provides this article for general information only. The information contained herein is based on sources we believe reliable, but we do not guarantee its accuracy, and it should be understood to be general insurance/reinsurance information only. Guy Carpenter & Company, LLC makes no representations or warranties, express or implied. The information is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such.

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