Lloyd’s Analyzes New and Changing Risks

January 7, 2010

The start of a new decade is always a time to take stock in what the past has brought, and what the future may bring. As part of its “360 Risk Insight” series, Lloyd’s of London queried “a cross section of experts to highlight potential risks to look out for in 2010 and beyond.”

Daniel Golding, risk analyst at Lloyd’s insurer Chaucer, “warned of macro-economic risks, such as inflationary pressures and the potential collapse of the carbon credit market. According to Golding, there is a possibility that the value of assets or income will decrease as inflation shrinks the purchasing power of a currency.”

He described the emerging risk as “due to factors such as quantitative easing, increasing government debt, inconsistencies in the CPI index and a peak of oil production. All of this will likely contribute to a significant increase in inflation over the next year.”

He also pointed out that instability in the US or UK economy could lead to a second financial crisis. “Debt to GDP ratio for all levels of US government debt is 87 percent, but inclusive of household and business debt and government-sponsored enterprises the ratio rises to 331 percent. Inclusive of Social Security and Medicare, the ratio rises to 1,000 percent. This is unsustainable and could result in a financial crisis far greater than that experienced to date,” he warned.

On the subject of cutting CO2 emissions, Golding expressed concerns that carbon credits are being packaged into increasingly complex financial products, similar to the “shadow finance” around sub-prime mortgages which triggered the recent economic crash.

“As recession slashes output, companies pile up permits they don’t need and sell them on,” he continued. “The price falls, and anyone who wants to pollute can afford to do so. The result is a system that does nothing at all for climate change but a lot for the bottom lines of mega-polluters.”

Finally, Golding pointed to the lack of social responsibility among some businesses. “There is a growing need for companies to take account of their presence in the community and their effect on it. This includes the downside impact of transacting with nefarious individuals and questionable companies.”

He added: “There is an increasing propensity for organizations to suffer reputational, legal, political and regulatory repercussions from focusing purely on financial success without considering ‘softer’ ethical motivations.”

Dan Trueman, an underwriter at Lloyd’s insurer Kiln, expressed confidence that the insurance market can step up to such challenges: “The key message is that while the world readdresses itself to the changing issues it faces over the next year, many threats present opportunities for the insurance industry to show how creative and flexible it can be in providing solutions. For Lloyd’s, in particular, this innovative approach is, and must remain, a key source of competitive advantage.”

Trueman, a specialist in intellectual property, brand and reputation risk, expects recent controversies to influence business risk priorities in 2010: “Hard on the heels of the adverse media reports about Tiger Woods and the subsequent impact on his sponsors, organizations are once again examining the value of their reputation and the possibility of protecting against a loss of revenue when it is damaged.”

“Such reputational risk events that we are beginning to see include the effect of data privacy breaches, the longer term effect of product recalls, as well as the behavior of key directors and officers of organizations,” he stated.

As pirate attacks off Somalia continue unabated, Lloyd’s remains in the forefront of marine and its increasingly sought after adjunct, kidnap and ransom coverage. According to Guillaume Bonnissent, kidnap and ransom underwriter at Hiscox: “In 2010 it is likely that we will see the expansion of piracy attacks into new waters. Last year saw pirates become more daring in their tactics, demonstrating that they can avoid waters protected by warships and attack vessels more than 1,000 nautical miles from the coast.”

He also noted that there has been a substantial increase in the size of ransoms that have been paid to pirates in the last 12 months, creating more problems for ship owners. “The publicizing of these amounts in the press is likely to fuel copycat attacks, with pirates evolving their techniques in response to measures being taken against them,” he observed.

Natural catastrophes are likely to continue as well, with the possibility that 2010 will experience an active hurricane season. This “raises a warning flag for catastrophe modelers,” Lloyd’s said. George Davis, vice president at AIR Worldwide, believes that insurers must improve the quality of exposure data in 2010, or suffer the consequences.

“Companies rely on catastrophe models to provide reliable estimates of loss, whether for purposes of managing risk over the long term or for understanding their loss potential in real time as an actual event unfolds,” Davis told 360 Risk Insight. “However, the reliability of model output is only as good as the quality of the exposure data used as input. Information on property valuation, location, and building characteristics needs to be readily available and reliable.”

He added: “With the constant threat of increasingly large catastrophe losses driven by an expanding concentration of property value in at-risk areas, the need for companies to reassess exposure data collection practices and put processes in place to enhance data quality is more important than ever.”

Source: Lloyd’s of London – www.lloyds.com

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