Understanding and Managing Extreme Event Risk: The Insurance IndustryGero Michel and the Willis Research Network The purpose of insurance is to hedge against the risk of uncertain loss. This is done by pooling funds from many insured entities to pay for the losses that some may incur. Reinsurance and the capital market help diversify risk of insurance and reinsurance companies further and the main purpose of insurance is to minimize capital cost. In order to be insurable, losses need to be accidental, diversifiable, finite, affordable, and calculable - in other words insurance makes only sense if risk is recognized and understood sufficiently such that it can be shared and paid for. Failure of insurance companies due to extreme and deemed unforeseeable losses is allowed for (as insurance would otherwise not be affordable) and governments tend(ed) to step in, if the society faces unexpected large or uninsured losses. Incomplete historical risk knowledge and recent extreme loss events pose a threat to the market - and increasingly to governments as well. In order to allow trading extreme risk, risk assessment has been partly outsourced to a limited number of vendors. These vendors provide statistical and numerical models that help calculating odds and sizes of extreme events for insurance companies. Recent large losses and further financial and regulatory rigor has increased resilience despite the fact that shareholders consider risk loosely understood and future profit unlikely (average stock multiple <1). Willis has teamed up with 50 scientific organizations, data and platform providers, as well as government bodies for the largest Public Private Academic partnership in the financial world. The idea is to increase skill in risk modeling, and make better decisions under uncertainty. The group focuses on global models and interaction of risk, variability and regimes, company performance, as well as on better understanding extreme natural and man-made events. Risk results range from those related to tropical and extratropical storms, convective systems, flood, earthquake, volcanic risk, and tsunami risk to capital allocation, credit risk and risk financing. The presentation describes how the insurance industry copes with major hazard and risk and how it can learn from the science community. |
