Reserving and Capital Setting: Sizing the Problem, Part I: Identifying Emerging Risks

There are three main questions to be tackled in sequence: 1. Which emerging risks potentially expose my company? 2. What means do I have to quantify those risks? 3. How are these risks likely to crystalize? This framework provides an opportunity to categorize risks, identify gaps and decide if, and how, they can be closed. It also offers a way to understand how the financial consequences could become apparent. Identifying Emerging Risks There are many reports and publications including this one that list and describe emerging risks. These can be helpful but are not some sort of panacea in the identification of risks that could be harmful to (re)insurers. Many risks may not be applicable; the list may not be exhaustive and, of course, will never contain the "unknown unknowns." Fortunately, there has been work done on the identification of non-modeled risks in the catastrophe emerging risks. The paper advocates an identification process which considers:

• Exposure-based techniques to analyze current and planned exposures
• Claims-based techniques to leverage knowledge contained within existing data
• Expert judgment to gather the opinions of experts for further analysis.

Clearly it is critical to understand the lines of business written to recognize the risks but it is also vital to comprehend the coverage provided for these classes in detail. This may require a detailed analysis of policy wordings, both current and historic, to consider exclusions and coverage scope. It also necessitates a rigorous examination of areas where contracts are silent on coverage because this could lead to implicit inclusion, or at the very least, contract disputes. Past claims can be of some use. If a risk is indeed already emerging it may be possible to infer trends and make forward-looking projections. Historic data can also be used to identify claims that were unanticipated at the time of writing the business to try to quantify a level of latency associated with different lines of business. It can also be educational to ascertain linkages between lines of business. But, as mentioned before, the past is not necessarily a good guide to the future. Expert judgment has to be used in the case of emerging risks because, by their very nature, data will be sparse. Not many companies will have the resources or indeed find it practical to have a dedicated group of experts locked in a cupboard with the sole purpose of dreaming up emerging risks and their potential consequences. Most will seek views from experienced claims and underwriting personnel using the latest lists of emerging risks contained in publications, as well as any risks they believe are not captured to elicit their perspective on the likely impact to the business.

As with any risk identification process one should always have materiality in mind. The list of potential risks may be long so construction of a ranking system can be helpful through the use of materiality matrices. Those risks whose quantification is highly subjective and for which financial results are highly sensitive, should rank highly and receive a much more in-depth assessment. Link to Part II>> Click here to register to receive e-mail updates>>  Note: 1. Association of British Insurers: Non-Modeled Risk, April 2014.