Avoiding accumulation risks
Global transport capacities, value concentrations and insured values are all rising to unprecedented levels. Companies which fail to adjust their risk management in good time can soon run aground under Solvency II.
As a rule, when the insurance sector turns its attention to accumulation losses, property insurance takes centre stage. Major natural catastrophes in recent years have heightened risk managers’ awareness of the fact that extremely high losses can accumulate here in the worst case. In the special line of marine insurance, on the other hand, the problem of accumulation continues to receive far too little attention. Quite a risk, considering that this sector is taking up an increasing proportion of insurers’ portfolios.
The reasons are various: Transport capacities by sea, land and air are increasing throughout the world and both port logistics and speed of trans-shipment are keeping pace with this development. This results in higher value concentrations and consequently higher insured values. Offshore energy is also gaining in importance. The Gulf of Mexico alone has around 4,000 oil platforms. Even a moderately severe hurricane could lead to enormous losses there.
However, there are already enough sophisticated, state-of-the-art modelling tools for offshore energy risks to ensure that accumulation risks are adequately assessed. With these tools, leading providers of offshore energy capacity can successfully control their accumulated liability commitments.
Risk of multi-line loss accumulations
Considered in isolation, marine exposure should not pose any great problem for the majority of property-casualty insurers. Despite this, companies operating predominantly in property insurance should not neglect supposedly less highly exposed lines of business such as marine insurance, for the problem of accumulation can intensify existing negative trends in the property sector or jeopardise tightly calculated profitability margins. The extreme case of a multi-line accumulated loss can even escalate into a threat to a company’s continued existence.
Unlike the stationary risks encountered in property insurance, marine risks are normally mobile. Nevertheless, goods can easily remain in one place for a longer period of time (up to 60 days according to the Institute Cargo Clauses (ICC) and sometimes considerably longer); major fluctuations in insured values and accumulations at the storage locations are consequently characteristic features of cargo business. It is often claimed that potential loss accumulations cannot be determined in advance because it is impossible to say exactly when any given number of risks will aggregate in a certain place. The loss accumulation scenarios, risk models and vulnerability curves which have proved their value in property insurance are therefore unlikely to yield satisfactory results when determining the probable maximum loss in marine business.
The largest container ships in comparison
Special features of mobile risks
However, this stance does not stand up to closer scrutiny, for parallels do indeed exist: a significant number of marine risks are likewise stationary and subject to assessment criteria very similar to those used in property business. They include the majority of offshore oil and gas platforms, shipyards, marinas, exhibition goods (fine art) and warehouses with revolving stocks. They all have a fixed location, but fall within the domain of marine insurance.
The accumulated insured values or insurance limits can therefore be determined fairly accurately. Another feature common to many mobile risks is that they come together for a certain period of time in such trans-shipment and trading “hubs” as distribution warehouses, ports, exhibitions and museums.
This basically means that no line of marine insurance business can be excluded when considering accumulations. The following trends and developments must be noted:
Increasing trade flows
Foreign trade volumes are being driven steadily upwards by globalisation and the associated interconnection of otherwise distant economic regions. Stockyards, warehouses, trading centres and ports are exposed to the perils typical of coastal regions – particularly floods, earthquakes, tsunamis and windstorm – with corresponding accumulation risks for insurers’ global marine portfolios.
Growing transport capacities
Modern container vessels can carry roughly 15,000 standard twenty-foot containers instead of the 700 carried in 1967. As a result, the insured value of the cargo is frequently in the range of €1bn or more. An accumulation of individual major risks, such as a collision between two “mega-ships” (tankers, container vessels), is a possible scenario, considering the steadily rising tonnages and increasing density of shipping traffic. Furthermore, the marine lines are also strongly linked: a collision may not only result in the total loss of cargo and vessel, the ship-owner’s liability insurance may also have to pay the cost of remedying the environmental damage.
Higher exposure in shipbuilding
The trend towards bigger tonnages and better technological standards is driving up the hull value of shipbuilding projects. In the event of a builders’ risk loss, substantial additional exposure must be expected in the form of delayed delivery and the resultant consequences for business interruption insurance.
Accumulation potential of port facilities
Port facilities (including piers, wharves, docks, dispatch terminals, loading and loading logistics, warehouses) are essentially stationary risks of a predominantly property nature and consequently have similar accumulation scenarios.
Since port facilities are often located near large cities or even form part of an industrial city, they should always be included in the overall assessment of accumulation risks.
Value concentration in marinas
The large number of geographically concentrated individual risks makes pleasure craft business a potential source of major losses in conjunction with such natural hazards as windstorms, tsunamis or floods. As a result, the potential accumulation is high, particularly as the yachts are being increasingly luxuriously equipped, driving up the sums insured.
Higher risks with offshore energy
Oil companies are making ever greater efforts to tap the deposits under the seabed. According to the International Energy Agency (IEA), more than half the new reserves discovered since the turn of the millennium are located in deep water. This has led to a steep rise in insured values and value concentrations per platform, a higher risk of pollution (Deepwater Horizon 2010) and above all higher accumulation risks due to the higher exposure to natural hazards (wind, huge waves, earthquakes and seaquakes).
Solvency II calls for accumulation control
The trends outlined above show how important it is to look beyond the immediate horizons and to establish the level of exposure over all the various fields of business. Insurers can only take account of worst-case scenarios in their underwriting policy and adequately include accumulation risks in their premium and liability calculations if they are aware of the possible accumulation potentials. Solvency II makes accumulation control more important than ever, as the new regulations not only demand that risks be made fully transparent, but also require a capital base commensurate with the risk.
Risk management in three stages
For marine insurance, a balanced and sustainable risk management system within the meaning of Solvency II should comprise three stages in practice:
- Micro-assessment of the accumulation risk
- Macro-assessment of the accumulation risk
- Solvency assessment and determination of the need for reinsurance
New risk models under development
Solvency II requires a distinctly heightened awareness among primary insurers if they are to underwrite marine risks on a profitable basis in the long term. This requires precise knowledge of all the risks written (underwriting limits, scope of cover, exposure, geographical location, vulnerability to loss), maximum transparency of the portfolio and compliance with certain data standards (geographical data, liability data, policy data). However, it also includes collecting risk data as the non-leading primary insurer, for example in relation to warehouses separate in terms of fire risk, or in order to determine the development of container stock (empty/loaded/average values) in a given harbour.
Information on how to prepare a suitable risk data model (KISS) can be obtained from the German Insurance Association (GDV). One positive side effect of this heightened risk awareness is that it can create an incentive to develop new risk models or adapt established risk models from property insurance to meet the needs of marine insurance.
You can find a detailed version of this article and extensive background information on risk management in marine insurance in Topics Magazine.