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Concern over potential wave of casualty catastrophes

Insurers and risk managers failing to properly prepare for impact

Insurers and risk managers are scrambling to prepare for a potential wave of casualty catastrophes that could create losses of a size not seen since those from asbestos and environmental settlements decades ago, experts contend.

“There are potential casualty catastrophe losses everywhere you look,” said Elizabeth Dwyer, Rhode Island’s superintendent of insurance. Opioids, weed killers, electronic cigarettes, financial securities and climate change are all areas that are ripe for litigation, she added.

Ms Dwyer, who was among the panellists discussing casualty catastrophe risks at the national meeting of the National Association of Insurance Commissioners in Columbus, Ohio, said “there’s a gap in risk management practices, and exposure management tools being used by insurers”, to address the ballooning risk.

The size of the casualty exposure is driven largely by social inflation, which has resulted in big losses, the panellists agreed.

Episodes of social inflation have driven up casualty claims in the past but it is particularly worrisome now, said Robert Reville, CEO of liability risk analytics firm Praedicat. “We think there are good reasons to think that this episode could be worse from an insurer solvency and risk standpoint. And we may be on the verge of a new era of larger and more frequent casualty catastrophes.”

Many insurers have for too long taken a “whack-a-mole” approach to managing casualty catastrophe exposures, according to Mr Reville. After suffering heavy asbestos losses, they decided that when claims began to appear for what could be new types of emerging litigation, they would exclude the exposure in future policies. That led to exclusions for losses related to electromagnetic fields, pharmaceutical exposures and others, he said.

“Something pops up, you whack it down,” he said of insurers’ reactions to emerging risks. “But there’s no forward-looking approach to try and think about how to manage aggregations or identify emerging risks before the first signs of litigation. As a result, arguably, you don’t have real preparation for the next emerging risk.”

Justin Schrader, chief financial examiner at the Nebraska Department of Insurance, said insurers commonly try to protect their balance sheets through exclusions, limiting exposures or leaving lines of business. Regulators in his state look closely at insurers’ reserving practices, expecting that they are using modelling tools and lessons from the asbestos and environmental liability crises to set aside adequate capital.

As a result of the exclusion-based approach, there has since 1973 been a “significant decline in the portion of US liability that is actually covered by insurance”, said Mr Reville. Imposing higher retentions, offering limits that don’t keep pace with inflation, expanding exclusions and other ways to limit exposure and avoid risk “is not proactive exposure management”, he stressed, adding: “This is risk avoidance.”

While this approach may have worked from 2000 to 2015, Mr Reville noted, social inflation has created “an elevated casualty catastrophe risk.” Contributing heavily to social inflation is litigation funding, he pointed out, whereby investors hope to profit from large settlements. “Investing in mass litigation versus single claims is a scalable, profitable way to invest.”

Even with the rising threat of casualty catastrophes, there are measures insurers and risk managers can take to lessen exposures, Mr Reville said. “We don’t have to be despondent and continue to think we need to rely on the whack-a-mole approach the industry has used for the last 20 years. The development in technologies over the last 20 years such as machine learning, natural language processing, AI, etc, have made it possible in a scalable way to identify emerging risks and quantify the exposures.”

Modellers are able to “look through the world of commerce”, said Melissa Boudreau, senior VP and head of modelling at Praedicat, adding: “Identify where emerging risks are, quantify them so we can categorise them into the appropriate category and then translate that into information that can be used to act [on managing the risk].”

The new technologies are creating opportunities for more proactive exposure management, Mr Reville said. “Insurers are already beginning to adopt those approaches of aggregation management and early identification, rather than simply waiting for claims to come in and to simply exclude the risk.”

In some cases, technology plays a part in emerging casualty exposures, according to Robin Wilkinson, senior VP and managing director of casualty analytics at catastrophe modeller AIR Worldwide. Algorithmic bias, telemedicine, cryptocurrency and internet failures are areas she highlighted as likely to be “part of our future”.

“We’re also working on a range of other risks,” Ms Wilkinson said, such as liabilities related to climate change, obesity, football concussions, nanotechnology and per- and polyfluoroalkyl substances.

A letter to chief risk officers sent last year from the Bank of England’s Prudential Regulatory Authority (PRA) has heightened awareness around emerging casualty risks and the need to prepare for them, the panellists noted. The PRA said it found that “exposure management frameworks for non-property classes of business are less mature than for property classes” and that “the state of manmade-catastrophe risk assessment remains significantly behind that for natural catastrophes”.

“The PRA letter brought a lot more urgency” to making sure exposures are properly managed, said David Brooks, chief risk officer – Americas, for AXA XL. Apart from its own modelling work, the insurer is looking closely at tools that are available to model and manage the risk, he said.

“We’re continuing to beef up our capabilities in terms of grabbing data by industry,” by using modelling tools to help determine how a potential risk might enter “the chain of commerce”, Mr Brooks explained. “We definitely track our industries and we do manage how much capacity we put into certain industries.”

AXA XL shares its findings with the businesses it insures “and if we think we’re a little hot” on a casualty risk exposure, “we’ll talk to the businesses and they’ll tone it down”, said Mr Brooks.

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