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Every day we learn something new. A new fact or condition arises that changes our perception of risk and reveals the limitations of our intellectual models.

In February 2003, for example, Zogby International in Utica, New York, reported that by using satellite imaging they “discovered” over 1,000 new islands in Indonesia. This discovery will not radically change the cartographers maritime models. It merely confirms the daily experience of the expert mariners who ply their trade in the Java Sea: Their navigation charts are inaccurate and do not reflect their true risk.

So, too, through various events over the past several years, insurance underwriters have discovered many more catastrophe risks than their financial models had contemplated.

In corporate America directors and officers are discovering that the business maps or models they used throughout most of the late 20th century do not reflect the true extent of their business or personal risk. Some risks the business models deemed statistically improbable. Others were not even contemplated. With the benefit of hindsight they have proven to have both the substance and gravity to destroy decades of profit, ruin shareholders and destroy careers.

“Satellite imagery” of todays business environment can reveal thousands of new risk “islands” upon which any insurance executive could run aground: deflation; medical inflation; interest rate risk; reinvestment risk; accumulation risk; terrorism; regulatory risk; legislative risk; and an increasing array of diverse catastrophic risk.

Life underwriters also have to consider, for example, the increased catastrophic risks posed by the countrys changing demographics.

The demographic trend is for populations to concentrate in areas prone to hurricanes and earthquakes. In the last census Florida, Texas, Georgia and North Carolina all experienced population growth in excess of 20%.

Property and casualty underwriters, in addition to their life counterparts, recognize these population concentrations from Long Island to Florida and worry about the potential loss to life and property in the event of a major hurricane or a tornado.

The deadliest hurricane in U.S. history was the storm that destroyed Galveston, Texas, on Sept. 8, 1900. This storm killed more than 10,000 people. Galveston was a modern and progressive city that believed its geography protected it from the full fury of any hurricane.

The Galveston hurricane is merely an opening chapter in a surprising history of hurricanes that have punished the U.S. coast line.

Hurricanes are not natures only killers. Tornadoes, with almost no warning, can be equally deadly. The most deadly tornado on record was the March 1925 Tri-State tornado. This storm destroyed four towns and 15,000 homes. It killed 695 people. The “2003 World Almanac” lists 66 “notable” tornadoes between 1925 and 2002. A little simple math reveals that 24% of those tornadoes killed over 100 people.

With our “satellite survey” we have touched on the East Coast (hurricanes) and the middle of the country (tornadoes). It is important that we not fail to mention the West Coast and its earthquake potential. Life and workers compensation underwriters push out of their minds the potential impact of a magnitude 8 earthquake hitting San Francisco at 3 p.m. on a work day.

In October 1989 an earthquake measuring 7.1 on the Richter scale hit San Francisco and destroyed or damaged over 100,000 buildings, killing 67 people.

No place in the country is safe from natures savagery. We are also not safe from the downside of our own technological wonders. Technology, in the broad meaning of the word, often requires complicated and potentially dangerous mechanical, chemical or industrial processes that present a real catastrophe threat to the life underwriter.

The 1984 Union Carbide Corporations Bhopal disaster in which methyl isocyanate escaped and killed 7,000 people and injured over 200,000 should concern life underwriters when managing catastrophe exposure. In the United States there are over 60,000 chemical plants and 124 of them, according to the Army Surgeon General, contain enough dangerous materials that if released in an urban area could cause 2.4 million casualties.

The interplay between technology and man also presents another huge risk for the life underwriter. Technological advancements in all areas of human endeavor from transportation to building construction are creating leverage points where seemingly minor mistakes can cause massive loss of life. The trade press, for example, has reported on the Airbus A380 double-decker jetliner which will eventually have the capability of carrying 800 people.

The sheer size of this generation of aircraft should give any life underwriter concern as plane crashes may be caused by the simplest of mistakes. In 1996 the AeroPeru 757 airliner, as an illustration, crashed into the Pacific killing 70 people because the maintenance company washing the plane failed to take off the masking tape on the pilot tubes!

Simple human error can initiate a chain of events that can destroy any technological marvel. It is hard to believe, for example, that rubbish destroyed the French Concorde in 2000. A mere piece of debris on the runway caused the crash and killed 113 people.

Aviation technology is not the only system where interaction of technology and man can have deadly consequences and make a mockery of financial modeling. Architecture and material science can be equally catastrophic.

The Jan. 18, 1978, collapse of the Hartford Civics Centers new space frame roof during a snow storm would have killed thousands of the University of Connecticut fans attending a game five hours earlier. For yet another outstanding example of technological failure, the 1981 collapse of skywalks at the Kansas City Hyatt Regency Hotel killed 114 people.

While these deadly catastrophes involved unintentional architectural, material science, engineering or construction mistakes, the intentional acts of terrorists are proving to be worse.

The terrorist attack on Sept. 11, 2001, revealed both the limitations of our collective foresight and the inadequacies of our modeling techniques. The resulting death toll was greater than the loss at Pearl Harbor on Dec. 7, 1941. The resulting conflagrations caused insured losses in excess of $40 billion and immediate economic losses in excess of $151 billion.

Unfortunately, catastrophe models and expert analysis did not forecast the magnitude of this financial and human catastrophe. Models and expert analysis did not understand the magnitude of the correlation risk that involved almost every line of insurance including life insurance. The leveraging effect of mobility risk on the ultimate life insurance loss underscored another weakness of expert analysis and financial modeling.

Life insurers did not estimate their accumulation risks. On the most fundamental level underwriters and financial professionals, relying on a misunderstanding of history and world events, simply failed to account for the life peril of fundamental religious terrorism. The real world, especially for a life underwriter, is a much scarier and more dangerous place than is reflected in our financial models.

In thinking about the World Trade Center it is sobering to realize that there are over 469 other buildings in the country which are over 500 feet tall. Each building represents a unique accumulation risk for the life underwriter.

In looking at our “satellite images” one future risk that we have not touched on is the threat cyber-risks and cyber-terrorism present to the life insurer.

Computers control everything from our national power grid to global positioning satellites, nuclear reactors, transportation, health care, dams and traffic lights.

When these wonderfully complex systems break down or give us wrong information the results can be catastrophic. Planes can crash. Vessels can run aground. Power grids can fail. Hospitals cant operate. And, as happened to the national air defense system twice during the cold war, the system can show an imaginary ballistic missile attack (1979 and 1980). What does this technological dependency and vulnerability mean to the thoughtful life underwriter?

This dependency and vulnerability mean that the thoughtful life underwriter needs to step back and assess those aspects of catastrophic risk that dont lend themselves to historical modeling.

It is a fact of human nature that low frequency or historically improbable high severity events are easy to underestimate. Catastrophic risks that historically may have been deemed remote or are new need to be managed, avoided or transferred by life underwriters, but they should not be ignored. The potential financial impact of these catastrophic losses is far too great.

CEOs, COOs and directors and officers cannot afford to rely exclusively upon financial models that fail to account for technology, system risk, human error, intentional malfeasance or the whims of nature when managing catastrophe risk.

Life underwriters, like the Java Sea mariners, instinctively understand the real-world limitations of financial models, and they protect their companies and their managements by purchasing life catastrophe reinsurance. When one reflects on the range of possible perils that can trigger a life catastrophe it is a bargain at current prices.

Life catastrophe reinsurance, especially for the small and medium size life carrier, is an important tool in an underwriters risk management portfolio. Life catastrophe reinsurance protects us against our shortsightedness and an unreasonable confidence in our expert analysis as well as the supposed infallibility of our historical financial models.

It is a very important hedge against the fact that financial models can only model that which we know and it is the unknown or remote loss that often proves catastrophic.

The life catastrophe product on Sept. 11 protected many insurance companys financial results and, just as importantly, their managements. While it would be comforting to think of Sept. 11 as a unique event, the current demographic, technological and political trends imply that there is a convergence of influences that is increasing our risk of catastrophic loss.

The thoughtful life underwriter will need to continue to utilize reinsurance including catastrophe reinsurance as an integral part of a catastrophe management program. New islands and new risks are being found every day.

Donna Peterson is a senior vice president and Art Bocek is a vice president with PMA Re, Philadelphia. Peterson can be reached at dpeterson@pmare.com and Bocek can be reached at abocek@pmare.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, October 10, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.