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Insuring the unknown

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London Ath 26 Dec 31Dec 2012 022Thu 06 June 2013 – From solar flares to solar planes, the insurance market must constantly assess and take on new risks – even in the absence of historical data.(source: Lloyd’s of London)

Early 2013 has already seen the world’s first no-fuel solar plane take off on a “Mission Across America”, scientists in the US and Europe move a step closer to creating ‘dark matter’, and Lloyd’s broker Aon Benfield warn the energy industry to brace for extreme solar storms. As technology advances and risk evolves, the insurance market is continually required to innovate.

But how does an insurer decide which emerging or new risks to take on? Moreover, how does it attempt to quantify a potentially catastrophic or complex risk in the absence of historical loss data?

The Lloyd’s market is attempting just that by tackling the risk of extreme solar storm activity in 2013. With solar flares and geomagnetic activity forecast to peak this year in accordance with the sun’s 11-year cycle, Aon Benfield Analytics warned that this poses a threat to vital infrastructure including electrical power grids, telecommunications networks and satellites.

According to Neil Smith, manager of emerging risks and research at loyd’s, there are no bespoke products in the market covering solar storm risk, but Lloyd’s is engaging specialists in the US in an attempt to model the frequency and severity of solar storm risk on Earth.

“In the future types of cover may be developed but the challenge is the size of the risk and getting suitable data to be able to quantify it, ” says Smith. “The challenge for underwriters of any new risk is being able to quantify and price the risk. This typically requires loss data, but for new risks that doesn’t really exist.”

Oliver Dlugosch, head of global markets at Swiss Re Corporate Solutions tells lloyd’s.com: “The first question [when taking on a new risk] is whether it is insurable. Then we ask whether as a company we have a risk appetite for it, then whether we can quantify it. This is sometimes very challenging without any large amount of data.”

Swiss Re is the sole insurer of the Solar Impulse project – a one-of-a-kind, solar-powered plane that is earmarked to make a round-the-world attempt in 2015. “Insurance usually likes to calculate risks based on statistical data with history and exposure – but none of this information is available in the case of Solar Impulse, ” Says Dlugosch.

CNBC22052012 083Risk Analysis

Last year, AIG assembled a science team led by a Chief Science Officer specifically to focus on predictive risk analysis. According to Emmanuel Brule, AIG’s president of commercial risk, EMEA, in the absence of solid historical data, an underwriter needs to find the best proxy available.

“A challenge we face as an industry is that the past is not a good enough predictor of the future. We are trying to correlate more and more data and models from various industries to try to find proxies from a correlation of factors, ” he explains.

In the case of Solar Impulse, Swiss Re is combining analysis of technical and ‘soft’ factors unique to the Solar Impulse project (such as the people involved as well as the plane’s technical specifications) with relevant loss numbers from the conventional aviation space to help quantify the risk.

“You must first be sure to understand the risk from an industry perspective, ” says Brule, who believes the best way to truly get to grips with an emerging or unique risk is to get close to the customer.

“What types of measures has the customer put in place to mitigate the risk? Is there any systemic risk across the industry? You must be comfortable that you understand what you know and what you don’t know, and try to assess what the impact of what you don’t know could be, ” he adds.

TRIP OVER FROM ELV TO 17062012 086Dealing with uncertainity

One of the biggest problems for the underwriter in dealing with a unique, one-off risk is that there is little opportunity for diversification alongside similar risks, making pricing that single risk very difficult. And sometimes a new risk is simply too large for an underwriter to tackle alone.

This is why Lloyd’s is seeking industry collaboration to tackle the potentially catastrophic solar storm risk. “If there was a huge solar storm which knocked out power grids across countries the risk might not be insurable because it is too big. Even sharing the risk with other insurers may not be enough to cover a very severe event, ” explains Smith.

“As well as engaging with governments and energy companies we are also working with other insurers to look at potential solutions. By working with others to share the risk and by understanding it better, we might be able to begin to develop the capability to offer cover to our customers.”

Ultimately, taking on a new risk that affords protection to our customers in new areas of risk will also be beneficial to re(insurers) – provided the financial risk is quantifiable.

“We are a specialist market dealing with unique and hard-to-place risks so we are used to dealing with emerging and often complex and that’s what our clients expect of Lloyd’s, ” says Smith. “We are in the business of dealing with uncertainty. Once you acquire enough data to become comfortable, there is an opportunity to grow the business. However, it is also important to understand such risks as best we can before we develop solutions.”

As AIG’s Brule says: “The world is changing, and so is the customer. Innovation is a very good sign of how close you are to the business of the insured.”

 

 

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