Covered for Life

Life catastrophe underwriters are being forced to grapple with the changing dynamics of terrorism and pandemic risk. Analytical capabilities will be key to their success.

Under Solvency II, life catastrophe risks are defined as “threats that stem from extreme or irregular events”, yet events such as 9/11 and the 2009 swine ’flu pandemic illustrate just how unpredictable these mass-fatality incidents can be.

For a number of regions, including much of Europe and the US, terrorism constitutes the key catastrophic peril facing the life market. As Mark Lynch, catastrophe model developer at Impact Forecasting, Aon Benfield’s catastrophe model development team, explained to Bermuda:Re, this has led to particularly high levels of demand within the life cat sector for analysis regarding the potential damage that large-scale terrorist events can cause to a client’s book of business. “As a result, significant emphasis is being placed on understanding potential risk concentrations, operational capacity and the impact of extreme tail events such as chemical or biological attacks,” said Lynch. Due to the infrequent nature of such events, ongoing mortality data has rarely helped with estimating future risks—until now. Estimating capital for extreme risks is a crucial element of managing life insurance portfolios, which can be examined from a group life or whole life perspective, but can prove challenging without data to benchmark future losses. The majority of life cat risks are associated by infectious disease, yet the threat of material terrorism risk to group life portfolios means that terrorism is an issue that life cat players need to grapple with, particularly when there is a clustering of a company’s policies around potential terrorist targets. Franck Pinette, CEO of Guy Carpenter’s European life business, added that when talking about cat exposure, it should be viewed as an important component in the context of group life cover. “In the French market, group life is a key business line as a number of companies are looking for group catastrophe cover for the exposures they have.” This can be from man-made events such as terrorism attacks, through to pandemics and large-scale and destructive natural catastrophe events. As Pinette explained, “There will be significant exposure from a group life perspective where you have countries which are exposed to major natural disasters.” Assisted by brokers and risk modelling firms, insurers are beginning to understand the full scope of emerging catastrophe exposures, particularly terrorism risk. Buying habits have in the past been largely driven by a lack of understanding about terrorism as a peril, but attitudes and capabilities are changing. Lynch said that past attitudes had led to extremely conservative purchasing limits, as well as an overemphasis of the effect of certain scenarios and blanket exclusions in some areas. He explained: “Over time, as greater analytical capacity has been invested in terrorism, we have seen a more nuanced understanding of the risk, which has opened up a number of opportunities for domestic markets and Lloyd’s.” Knowledge is undoubtedly key in developing capabilities and understanding in the life catastrophe space. When confronting terrorism risk, a keen understanding of the motivations, operational capacity and target selection of terrorist groups helps to provide the substantive basis for scientific loss data. This in turn enables re/insurers to make sensible decisions regarding their exposures and coverage. Lynch said that the scientific models for terrorism covering factors such as blast overpressure, reflective pressures and particle dispersal are all highly advanced thanks to the significant investment the military community has made to understand the phenomena. This has all proved useful to the understanding of such exposures, but as Lynch explained: “There is no point knowing the potential losses stemming from a 2 kiloton nuclear device if you cannot correlate that with the likelihood of such an attack taking place.” Nevertheless, Lynch was confident that scientifically-based models can help re/insurers quantify losses stemming from catastrophe events with an increasingly high degree of accuracy, and are a vital tool in enabling companies to fully manage and understand their exposures. Greater granularity of data and understanding will help with natural catastrophe risk as much as terrorism or pandemic events. As Pinette explained, “At Guy Carpenter, we use geo-coding to help clients assess what their maximum cat exposure is, as well as factoring in components such as the time of day that an event might occur, as this will affect the number of people involved. It depends on where the risks are concentrated.” But are companies using this knowledge to help them better understand and plan for life cat risks? Lynch said that the market’s view of terrorism risk has tended to oscillate between extreme caution and blasé disregard. “The truth is somewhere in the middle and modelling helps to bring this to the fore,” he said. Pinette, however, believes that insurers have good reason to be cautious, and said that while simulation is a relatively straightforward and well managed process, there is always a margin of uncertainty in the results which must be factored in. “Sometimes it is better for insureds to buy slightly more capacity to make sure that the potential extremes are covered—especially because at present catastrophe capacity is not overly expensive.” State terrorism pools have acted as a headwind for the sector, reflecting earlier reticence to take on terrorism risk. However, increasing appetite for such coverage may be holding back the development of demand. The renewal of the Terrorism Risk Insurance Act (TRIA) has been watched with interest, with Lynch arguing that its future status will have an immense impact on the direction of the US terrorism property market. “Life sits outside TRIA and is usually excluded from most governmental pools, so there is generally a more comprehensive understanding of terrorism risk in the life market as they have had to take important steps to fully understand the peril,” he said. This should help life cat writers better grapple with such exposures and enable them to make the case for the greater use of private solutions. Pandemic coverage for its part is purchased through stop loss policies, for which the market is much smaller than for terrorism. Pinette said that this may change in Europe as a result of Solvency II, where insurers are currently calibrating internal models in preparation for the legislation’s arrival. “It is likely that due to the stress testing required under the regime, the market will grow and re/insurers will have to dedicate much more capacity to pandemic-type risk,” he said. It is apparent that pandemic and terrorism catastrophe risks pose a significant liability threat to life companies and it is imperative that brokers and risk modellers work closely with their clients in helping to create strengthened insights into these risks, as Pinette knows all too well. “We must keep monitoring developments on these fronts and offering state of the art services, to help clients manage their exposures effectively,” he concluded. By: Guy Carpenter, Bermuda Re