Physical Environment for Risk and Insurance

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Physical Environment for Risk and Insurance

• Identification
• Measurement
• Financing

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Types of Risk

• Fundamental risk exposure to loss that may
  affect many people or property interests at the
  same time
• Particular risk exposure to loss that is usually
  limited to a single entity or small group

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Characteristics of fundamental risks

• Broad Impact
• hurricane, flood etc. affect a number of people
• Catastrophic Potential
• natural catastrophe
• technical catastrophe (human origin)
• Localized
• cost of losses might not be shared among people
  from other regions

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Important fundamental risks

• Earthquakes
• caused by moving tectonic plates
• plate boundaries (called faults) are at a greater
  risk
• coastal regions typically have faults
• Pacific Rim is very prone
• Ring of Fire Alaska, Japan, China, Philippines,
  Indonesia

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Worst case scenario (b)
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Storms

• Beaufort Scale
• 0 Calm 0-1(mph)
• 8 Gale 39-46
• 10 Storm 55-63
• 12 Hurricane 73
• Other types Tornado has a funnel with wind speed
  of 200 miles or more

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Other risks

• Floods
• Environmental risks
• Nuclear risks
• Chernobyl death toll will be 100,000
• Global warming
• Since 1800, global temperature has risen by at
  least 0.5C
• Produced mainly by excessive CO2

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Factors defining loss potential

• Key factors
• distribution of people and property
• Concentration of people and property create the
  critical mass necessary for a catastrophic loss
• Nature of peril and frequency/severity
• Susceptibility of property to damage

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Distribution of people property

• Concentration
• Scale economies produce large concentration
• 747 carries many people cheaply
• giant oil tankers make transport cheaper
• large ocean oil platform make extraction of oil
  feasible
• Economic reasons for concentration

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Reasons for concentration

• Personal reasons
• coastal climate is better
• usually warmer and sunnier
• Cultural reasons
• strong family ties
• absence of social security by government

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Trends

• Frequency of catastrophes on the rise for both
  man-made and natural
• Property damage severity is also on the rise
• Why?
• Possible culprits global warming, more
  development, less care for risk

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Management of physical environment risk

• Risk assessment
• modeling need to understand geology,
  meteorology, structural engineering etc.
• Loss mitigation
• land use restriction (Acapulco problem)
• building codes
• retrofitting existing property
• disaster planning

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Risk financing

• Retention
• Insurance
• reinsurance
• private risk pools Marsh McLennan has created
  ACE Ltd. And XL Insurance Ltd. To create risk
  pools not available in the traditional markets
• Government risk pools

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Modern approaches

• CatRe options
• an insurer or reinsurer exposed to catastrophic
  risk can by these options as a hedge
• sellers money acts as capital for insurer
• spreads the risk
• Event bonds
• California Earthquake Authority has a number of
  these bonds on issue

15
Political risks
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Methods of global interaction

• Exporting
• Simple export can face many foreign risks
• Joint ventures
• foreign direct investment is the next phase
• with capital abroad, more risks
• Wholly owned subsidiaries
• highest form of risk

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Political risk

• Definition Any governmental action that
  diminishes the value of the firm operating within
  the political boundaries or influence of that
  government
• Example Manuel Noriega shut off water and
  electricity after US firms were forbidden to pay
  taxes in Panama

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Classification

• Confiscation, expropriation and nationalization
• Contract repudiation and frustration
• Unfair regulatory environment
• Currency inconvertibility
• War risk
• How do we measure them?

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Country Rating by SP
India BB Indonesia BBB Italy AA Japan AAA
Mexico BB Nigeria NR Peru
NR Singapore AAA
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Providers of country risk assessment
Bank of America World Information Services
Business Environment Risk Intelligence (BERI)
S.A. Control Risks Information Services (CRIS)
Economist Intelligence Unit (EIU) Euromoney
Institutional Investor Standard and Poor's
Rating Group Political Risk Services
International Country Risk Guide (ICRG)
Political Risk Services Coplin-O'Leary Rating
System Moody's Investor Services
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How to manage political risks

• Develop channels of communication
• Implement good pre-departure training
• Localize firms
• Structure contracts so that they can be
  renegotiated
• Assist with local projects and local issues

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Integration strategies

• Establish joint venture with local firms
• Transfer pricing is done fairly
• Establish open financial reporting
• Example Hong Kong firms have strong links to
  China well before hand over, allowed Chinese
  princelings to hold extensive equity in Hong Kong
  companies

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MIGA

• Multilateral Investment Guarantee Agency was
  established in 1985
• MIGA acts as a primary insurer for war risk,
  nationalization risk, currency inconvertibility
  risk and contract risk
• MIGA now has 107 member countries
• It is formally associated with the World Bank but
  financially independent

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Government agencies

• US
• Overseas Private Insurance Corporation
• Foreign Credit Insurance Association
• Europe
• Export Credits Gurantee Department was introduced
  early 1919
• Trevarbeit is a private but German government
  backed company

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Private providers

• US AIG, CIGNA, Chubb
• Europe Lloyds of London