OPINION: Applying traditional methods to emerging risks is never a good idea

Any attempt to understand the uncertain science of emerging risk is not for the fainthearted and, for many, still requires a DeLorean and a flux capacitor. Combine this with the continued negative outlook for the reinsurance industry, and senior executives around the world are left scratching their heads looking for the next big opportunity.

But as Swiss Re showcased recently in their Sonar: emerging risks insight report, taking emerging risks seriously can be a mind-boggling exercise and may lead to some unpleasant discoveries, but paying close attention to it now will prove worthwhile in the long run.

Easier said than done. Lloyd’s defines an emerging risk as “an issue that is perceived to be potentially significant but which may not be fully understood or allowed for in insurance terms and conditions, pricing, reserving or capital setting”. So unless you are blessed with a bank of scientists or have a dedicated division, navigating and identifying these risks is simply an aspiration for many. Most businesses trying to comprehend these risks are plagued by high volumes of related uncertainty.

There is no data on these risks and so they are unable to price the new opportunity. As a result, a common approach to new risks is to apply traditional pricing methodologies. This is not a good idea. The problem is that if monitored and managed incorrectly, they can cause chaos on a company’s book of business. Combine all of the above and it is easy to see why most businesses choose to steer clear of these risks.

Is there a solution? I have talked in the past about the advantages of creating a culture for harnessing innovation within a business (a point echoed by XL Group chief executive Mike McGavick) – however, I am not so sure this would work for emerging risks. But this does not mean there aren’t simple steps a business can take to better capitalise on future scenarios.

As Swiss Re explained, horizon-scanning is a good starting point, suggesting that constant observation of media, government and research communities may provide the small signals that could be the beginning of something larger. Accompany this with successful knowledge transfer within an organisation and you have the starting point for better preparing yourself for future exposures. Finally, a business needs to ask itself whether it identifies the risk and adds it to existing products, or offers a new product altogether. Either way, future growth will be driven by an ability to adapt to new and emerging risks, rather than ignoring it because it looks too complicated.