Archive for Risk Management

Could Flooding Become A Fundamental Risk in The UK?

For those UK underwriters and loss adjusters watching the scenes of devastation caused by hurricane Irene and particularly flooding in states like Vermont, they will be glad that their insurance company does not have to pick up the bill.

They needn’t have worried though because in the United States Flood Risk is considered fundamental and cannot be covevered under a normal home insurance policy as such…as yet!

In fact all home insurance flood risks are the responsibility of each State to provide under a national scheme. In the United States, uniquely in the developed world, insuring houses against flood damage is the sole province of the federal government.

The National Flood Insurance Program (NFIP), was created in 1968 by Congress and is administered by the Federal Emergency Management Agency, is virtually the only place to get protection against the ever increasing disasters of flood and storm surge.

From an insurance point of view the program is the same as any other private-sector insurance program.

You pay the government a certain amount and when a flood happens, receive coverage for repairs and losses.

As of June 30, the program had nearly 5.6 million policies in force with a total insured value of $1.246 trillion. But from a fiscal standpoint FEMA does not manage the NFIP like a traditional insurer.

Most insurers use a measure of solvency that looks at their capital and reserves and their ability to pay claims. In particular, regulators require insurance companies to keep a statutory reserve of liquid assets to cover potential future losses. FEMA, on the other hand, has said it manages the NFIP to generate enough premiums to cover expenses and losses for an average loss year, rather than keeping capital for the long term.

In other words it does not keep enough reserves! And guess what? It’s run out of money!

Apparantely former agency officials admit it charges rates that dramatically underprice the risks faced. That is all well and good in a normal year and when business is good, but when a worse-than-average loss year happens, the consequences are disastrous.

Folowing the disatrous hurricanes Katrina and Rita in 2005, the NFIP was more or less insolvent, without the capacity to pay the huge volume of claims those hurricanes created. Congress reacted by increasing the NFIP’s borrowing ability from the U.S. Treasury more than 13-fold, to a level of nearly $21 billion. That debt burden is, by all accounts, unsustainable.

While Irene was no Katrina, it comes on top of serious Midwestern flooding that the program has already had to deal with this year. Some people believe NFIP will stretch its debt boundaries and may well end up needing more assistance. “It may be a little bit too soon to tell but it’s certainly not going to be a very good year for the NFIP and we’ve not finished the year yet,” said Robert Hartwig, an economist and the president of the Insurance Information Institute (III).

Hartwig said a private insurance market for flood coverage is absolutely possible, with plenty of insurers and reinsurers willing to get into the business – but only if the NFIP raises its rates and if insurers get assurances from state regulators that they will be able to do the same.

Insurance Blog wonders if given all the recent flood claims in the UK due to climate change and the pressure to build houses on floodplains, whether Flood Insurance will at some point become a fundamental risk in the UK for some homes?

The UK Government would be well advised to consult with construction companies, environmental scientists, climatologists, pressure groups and Insurance companies before we reach the crisis about to hit the US Treasury.

The solution is simple – do not solve the UK housing problem by building on floodplains or areas of geographical risk.

Police Negligence Fails to Mitigate Riot Insurance Losses

Watching live coverage of the riots as they happened across the UK it was quite clear that the Police were totally unprepared to deal with incidents of this type, and more worryingly their laissez-faire approach has cost this Economy tens of millions of pounds in damage that could have been avoided.

Listening to these patronising Chief Constables talking about how they were going to go after these criminals  ‘after the event’ made Insurance blog feel sick.

Countless stories appeared on the TV news of how business people saw the Police stand by and watch doing nothing to prevent their livelyhoods being trashed by mindless kids.

From recent dealings with the Police I am disgsuted that their attitude to everything is that Insurance is there to pick up the bill for their professional negligence.

Well it isn’t!

Insurance Blog urges all UK Insurance companies to refuse to pay for riot damage where the Police stood around idly and watched a bunch of kids run riot.

Under UK Law if the Police are not able to deal with a situation the risk becomes Fundamental and is the responsibility of inept UK coalition Government, and not covered by any insurance policy. The taxpayer will then be footed with the bill for damage that could have been mitigated.

Insurance Blog predicted that the minority conservative Government would cause riots on the streets of Britain and we were right. If the cuts continue there is a lot worse to come!

Don’t rely on the Police saving your home and property and if the trouble gets any worse, they just stand around filming, and I’d read that fineprint of that policy very carefully!

A Brief History of Insurance: Part 4 Genoa and the first ever single independent insurance contracts

In this the fourth article on Insurance Blog within this series exploring the origins of insurance we move to Medieval Europe and the invention of separate insurance contracts in 14th Century Genoa…

As you may recall from earlier articles within this series, both the Romans and the Greeks had contributed to the development of insurance, shaping it into the complex financial product that it is now quite considerably. However it was from the ashes of the Roman empire that we see insurance start to fully develop.

As we move through history and reach the medieval period which is universally acknowledged as beginning when the western Roman Empire fell in 471AD, we see the Guilds rise to prominence and amongst their functions is something remarkably akin to that of the early Roman Burial Clubs. However, they also provide rudimentary medical insurance, fire insurance, marine insurance and even personal accident insurance to their members as well as a whole host of other social and economic benefits.

In fact despite the fall of the Empire the insurance practices that have become part of every day life across Europe for Merchants, Noblemen and Serfs alike remain in place. With the importance of insurance now firmly established as a key element within any society with commerce at its heart, the varieties of insurance and the complexity of the products continues to develop throughout the Middle Ages.

Again it was Maritime insurance which proved to be the area which established itself as both the innovative and indeed original category of insurance. This is of course is easily attributable to the fact that at this point in history, the overwhelming driving force in any economy was the merchants of the sea. Boat Insurance developed more rapidly and technically than any other form of insurance at the time out of sheer economic necessity.

After the fall of the Western Roman Empire, a number of successful city-states developed to fill the vacuum created by the failure of Rome. These included Pisa, Milan, Venice and Genoa. Each of these mini- empires have a rich and fascinating history, but for the world of insurance, it was Genoa who would play the major role.

In fact Genoa is able to lay a fairly indisputable claim to be the home of modern insurance.
Genoa- Home of The Insurance Contract
It was here in the fourteenth century that we saw some huge landmark moments appear on the insurance development time-line. It is at this point in history that we start to see commercial insurance begin to establish itself as a product independent of investment. This is evident from both the inception and invention of insurance contracts which were neither included as a guild benefit, nor based on a loan.

The earliest ever recorded insurance policy discovered to date is believed to be between Amiguetto Pinello (the insurer) and Tomaso Grillo (the insured) and is dated the 13th February 1343. The contracts between the two parties are hugely important in that they mark the first steps away from what are now the ancient and archaic traditions of Marine Loans.

Whilst traditional marine loans of ancient Rome and Greece (and even Mesopotamia before them) had provided adequate coverage throughout the ancient and early medieval periods, as the commercial revolution that was rapidly spreading throughout the coastal micro empires of Italy and the Mediterranean grew, these archaic laws no longer succeeded in meeting the requirements of the modern ‘sedentary merchant’.

So the need for insurance to once again evolve led to the birth of the stand alone insurance contract.

A fascinating insight into the politics of the time is hidden away in this original contract. In fact much of the content of this original contract was necessarily fictitious. This fictitious wording was required to cloak the contracts within the phraseology of Roman Law, as at this point in history insurance contracts still had no legal standing Per Se.

In fact the work of these early pioneer insurers was constantly frustrated by existing clerical usury law and the insistence of those in authority that despite the legislation being out dated, it was relentlessly enforced.

It seems that there are more similarities than we could have imagined then!

In the next article within this series we shall look at post-renaissance Europe and perhaps arguably the most important period in the history of insurance ever – the 17th Century. This is where we see insurance arrive at what is now regarded as it’s modern day home – Lloyd’s of London.

How Insurance Shares Risk Across The Population And Aims For Fair Premiums

Insurance Blog often gets unusual requests, more proof that Insurance is not grey and boring, the latest being particularly unusual so we thought we’d rise to the challenge.

A mature student friend of ours was struggling with his first year accountancy exams when asked to write an essay on the following, so he thought he’d approach us for some answers and help writing his assignment.

1.Explain how Insurance shares risk across the population?
2.What is a fair insurance premium?
3.How can adverse selection prevent Insurance being available at a fair premium?
4.What strategies do insurance companies follow to reduce the problem of adverse selection?

So we farmed it out to our technical expert Dave Healey and this is what he came up with.

The Primary Functions Of Insurance As A Service Industry

By Dave Healey

There are three primary functions of Insurance which determine how Insurance companies operate and how the public interacts with these companies.

The first is as a risk transfer mechanism, whereby the individual or business can shift some of the uncertainty of life onto the shoulders of others. In return for a known premium, usually a very small amount compared to the potential loss, the cost of that loss can be transferred to an insurance company. Without Insurance there would be a great deal of uncertainty experienced by both the individual and the enterprise, not only as to how and whether a loss would occur, but also to the extent and size of the potential loss.

The second primary function is the establishment of the common pool. The Insured’s premium is received by the Insurer into a fund or pool for that type of risk, and the claims of those suffering losses are paid out this pool. Applying Bernoulli’s ‘Law of Large Numbers’, because of the large number of clients that any particular risk fund or pool will have, Insurance companies can predict with high accuracy the amount of claims or losses that might be suffered over a period of time. The will be some variations in losses over different years and Insurance companies include an element of premium to build up a reserve, to pay for additional losses in bad or catastrophic years. Therefore in principle, subject to the limitations of the type of cover bought, the client should not have to pay additional premiums into the common fund after a loss or claim.

The third primary function of Insurance is to provide fair and equitable premiums. Assuming that a risk transfer mechanism has been set up through a common fund or pool, the contributions paid into the fund should be fair to all parties participating. Each party wishing to insure and paying into the fund will bring with it varying degrees of risk. To avoid adverse selection and provide equitable premiums each risk is broken down into various components and rating factors that can be priced individually on a statistical scale of probability determined by Actuaries. Therefore those who present the greater statistical risk will pay more into the common fund for the same cover, when their individual premiums are calculated.

Insurance companies employ underwriters to reduce the problem of adverse selection and protect the fund. The underwriters will determine parameters of the hazard and value of a risk that is acceptable for the fund, and decline risks that fall outside these parameters. In fixing a fair level of premium they must also take into account the contributions made by others into the common fund and price accordingly.

Underwriters and insurance companies will employ many techniques to deter or price adverse selection out of the risk pool. These typically include exclusions to cover in the form of policy wordings and additional conditional clauses, exempting the risk under certain conditions. They will employ all types of mechanisms and devices to install fear into the population to increase the size of the risk pool and attract the niche or sector of the market that they are aiming for. For example large marketing campaigns aimed at the ‘safe’ sector e.g. women drivers who are statistically less likely to claim. On the Internet, Insurance companies employ automated underwriting that excludes cover to everything that does not fit the desired risk pool parameters.

Ultimately the Government can in certain cases decide the size of the risk pool through leglislation and compulsory insurance as is the case for car insurance where it is illegal to drive without cover and business insurance where it is illegal to trade without liability insurance cover.

Insurance companies can also take further risk transfer from the insurer to a reinsurer (reinsurance) laying of some of their exposure as a mechanism for adverse risk control.

We originally published the Article at:

Well there’s obviously a lot more to write on this subject so if some of you FCII fellows out there who read this blog  wish to contribute, feel free to leave your comments on the questions!

Lloyds prepares for Solar Meltdown!

“Ground Control to Major Tom!”

“Check your policy wording and put your spacesuit on!”

Insurance Business have finally moved into the 21st Century with some truly space age of aquarius exposures to risk to deal with over the next year, according to a new report from Lloyds of London.

These new age risks include Space weather, cyber risk and critical infrastructure attacks that are predicted to cause big problems for consumers, businesses and their insurance companies in 2011.

The Lloyd’s 360 Risk Insight report states that ‘The phenomenon of space weather is one of the most difficult to quantify and yet potentially serious sources of loss and disruption for business.’

“Space weather and its impact on Earth: Implications for business”, says that businesses should be looking at ways to assess and mitigate space weather risks this year because the 11-year solar cycle is expected to peak in 2012/13.”

Turbulent space weather created by solar phenomena such as coronal mass ejections, solar flares, solar wind, solar radiation and magnetic storms could have wide ranging impacts around the globe in climatic responses, many scientists believe.

These phenomena are also predicted to affect aircraft communications, air traffic control and navigational systems which could malfunction or might stop working, satellite and GPS systems could also malfunction, and surprisingly. power grids could collapse.

Scientists know a lot about the possible causes and effects of solar weather from previous cycles. Established infrastructure that we take for granted, such as rail networks, telephone systems, pipelines and electric power grids have all been seriously disrupted by space weather in the past.

But the economic fall-out that could result from the increasingly active solar season is far less certain. That’s because our dependency on wi-fi and internet technology is so much greater than before.

“There is growing concern that the coming solar maximum will expose problems in the many wireless systems that have grown in popularity during the quiet solar conditions that have prevailed over recent years,” the Lloyd’s report warns.

Insurance Blog should have a lot to write about then over the coming year if these concerns are realised.

And then it’s 2012!

Don’t worry about the risks to the Olympic games! The Mayan Calendar stops here……….

And the earth is positioned in alignment with the centre of of the Universe!