New or evolving risks are usually not backed with extensive
historical data for estimating their future impact. These can be
termed emerging risks. They are difficult to manage due to limited
data and unfamiliarity with their nature, and they can impact all
industries and entities. The length of time before emerging risks
occur can be quite long -- 10 years or more -- which can lead to
unintended consequences if the risks are not acted upon sooner.
Managing these newer or emerging risks can be a tightrope walk
for insurance companies. When a risk manager recognizes a risk much
earlier than competitors, the insurance company acts upon it by
pricing the risk into a product, thus increasing its premium.
If clients do not consider the probability of the risk high
enough to pay the premium, the company can experience reduced
sales. If the risk does not occur for a long time, this can even
cause the firm to be forced out of that market entirely,
irrespective of the correctness of the risk manager's
However, if the risk manager assesses the risk correctly, and if
the risk plays out quickly, the firm can be considered far-sighted
and can gain a leadership position in the industry.
Unpredictability lies at the heart of identifying risks, with
the end result always being elusive. Companies that ignore a risk
may enjoy many years of outsized results, as opposed to those that
plan for it, before finally succumbing to the downside of the
Those who recognized the bubble building in the subprime
mortgage market initially had trouble finding ways to trade on
their knowledge. Even after derivative instruments had been
developed, the bubble continued to grow. Some investors had to
close on these positions before they paid off.
In 2003, following the SARS (severe acute respiratory syndrome)
pandemic, many in the life insurance industry recognized that the
risk of infectious disease such as influenza was only minimally
priced into their products. Knowing that higher mortality
assumptions would price their products out of the market, they
discussed the risk at various actuarial and risk management
conferences in an attempt to engage the industry. By the time a
minor influenza pandemic arose in 2009, steps were in place to
consider this risk when calculating capital requirements and
assessing a company's own risk. Reinsurers also adjusted their
claims assumptions to accept this risk.
Assessing and Prioritizing
Assessment and prioritization of emerging risks depends on a
number of factors, including global events recent trends.
Fourth Survey of Emerging Risks (sponsored by the Joint Risk
Management Section, a collaborative effort of the Society of
Actuaries, Casualty Actuarial Society, and the Canadian Institute
of Actuaries), covered a variety of issues related to emerging
risks. From a list of 23 risks compiled by the World Economic
Forum, these respondents, who were mostly from the insurance
industry, were asked to identify their top five emerging risks and
their overall No. 1 risk, and to answer a series of other risk
The survey categorized risks as economic, environmental,
geopolitical, societal and technological. The initial survey was
completed early in 2008 as the financial crisis was getting under
way. Economic risks have historically scored highest in this
survey. These include concerns about spikes in the price of oil, a
Chinese economic hard landing and demographic shifts.
Geopolitical risks have consistently been strong in the survey
results, representative of the "human anchoring" bias. This bias
reflects a tendency to let recent events dominate thinking about
future events. For example, in the fall 2008 survey, most of the
responses were received before the Mumbai terrorism attacks, so
very few had listed terrorism as one of their top five emerging
risks. In responses afterwards, all participants listed terrorism
in their top five, and for some it was the No. 1 emerging risk.
Understanding this bias helps risk managers manage risks in the
context of recent events.
The reverse of this bias can be observed as we get farther from
the economic crisis of 2008. Risk managers in late 2010 were able
to think about non-financial risks to a greater degree than was
seen in earlier surveys.
In the survey conducted in 2010, a number of recent events
influenced the results. Earthquakes impacted Haiti, Chile and New
Zealand, while Iceland experienced a volcano eruption that impacted
air travel for weeks. The oil spill in the Gulf of Mexico
highlighted the fragility of oil supply. Other natural disasters
occurred, the European debt crisis widened and tensions erupted on
the Korean peninsula.
In the 2010 survey, the top five results continued to come
primarily from the economic category. Allowing for multiple
responses, fall in value of the U.S. dollar came in first, with
49%. It was followed by: international terrorism (43%),
Chinese economic hard landing (41%), oil price shock (40%) and
failed and failing states (38%).
The voting for overall No. 1 emerging risk had Chinese economic
hard landing on top, at 14%, ahead of fall in value of the dollar
(11%), blow-up in asset prices (10%), breakdown of critical
information infrastructure (9%) and oil-price shock (9%).
Key risk indicators (KRIs) can be a measure of risk exposures.
When data on KRIs is collected after an event, they are called
lagging indicators, reflective of historical measures. These
include items from the income statement and balance sheet, along
with metrics like sales levels and counterparty exposures. Trending
macroeconomic data can provide KRIs, as can revenue and liabilities
specific to a firm.
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