A.M. Best Report: ‘Grey Swan’ Risks Can Affect Balance Sheets, Ratings

December 17, 2014

A new special report from A.M. Best discusses the need for non-life and life insurers to address threats called “grey swans,” the low-probability, high-severity events that have the potential to impair balance sheets and lower financial strength ratings.

“Although some risks do not surface in management teams’ day-to-day processes, they cannot be ignored, despite their remote probability,” and need to be part of an insurer’s active risk management, said the report issued on December 8, entitled “The ‘Grey’ Swans: A.M. Best’s Ratings Approach to the Top 10 Threats.”

“The threats discussed in this report are potentially much more damaging to an insurance company than soft pricing or heightened competition. As such, management teams must handle the daily challenges that affect performance and balance sheet strength, while guarding against these game-changing scenarios.”

Almost every insurer, in any market, will be exposed to a combination of these risks, A.M. Best said in the report, in which the agency discusses how its analysts assess insurers’ management of these complex challenges.

“A.M. Best’s financial strength ratings reflect an insurer’s performance and capital adequacy over the long term,” according to the report. “The highest rated insurers are able to illustrate how their risk management practices guard against these tail events and enable the insurer to continue to meet its financial obligations – even under a severe stress scenario.”

A.M. Best lists the top 10 grey swan risks, which are divided into two categories: those that deliver a “knock-out punch that can impair a balance sheet in a relatively short time,” and those that can “inflict a slow, painful death.”

A.M. Best said the top knock-out punches are:

  • Mega catastrophic event
  • Financial system shock
  • Risk management shortfall
  • Hyperinflation
  • Model error

The top risks that provide a slow painful death are:

  • Regulation
  • Alternative capital
  • Emerging underwriting risk
  • Interest rate spike
  • Loss of talent/loss of entrepreneurial spirit

“While each is very significant in its own right, some of these threats could also represent opportunities for the industry,” said Stefan Holzberger, managing director, analytics. “For example, in the case of the mega-catastrophic event, insurers can provide governments, industry and individuals with options for risk transfer, thereby reducing the wide gap between economic and insured loss.”

The December 8 report on grey swans can be accessed via A.M. Best’s Insurance News and Analysis site: http://www3.ambest.com/bestweek/purchase.asp?record_code=231777.

This report is an A.M. Best follow-up to an earlier report the agency issued in June 2014 titled “The ‘Grey’ Swans: Top 10 Threats to European Insurers’ Financial Strength.”

Source: A.M. Best

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