Latency Catastrophe and the Occurrence Form.
Latency Catastrophe and the Occurrence Form
As latency catastrophes silently emerge, insurance carriers face a dual problem: understanding how and when scientific theory reaches a tipping point giving rise to lawsuits, and then dealing with questions of coverage triggers and allocation of claims under occurrence liability policies. Praedicat, which has been tackling the first problem in recent years, has just released a model of the occurrence form to address the allocation issue.
Over the last 30 years, natural catastrophe modeling has transformed property insurance. When Hurricane Andrew devastated Florida in August 1992, seven domestic insurance companies and one foreign insurer became insolvent, according to the Insurance Information Institute. In 2017, the insurance industry is likely to absorb three hurricanes comparable to Andrew (Harvey, Irma and Maria), but it is likely that no insurance insolvencies will result. The difference is that with the adoption of natural catastrophe modeling after Andrew, insurers now efficiently transfer natural catastrophe risk to global reinsurers and capital markets.
Liability insurance is subject to a different kind of catastrophe that has also resulted in multiple insurer insolvencies over the last 30 years: latency catastrophe. Asbestos, pollution and pharmaceutical litigation are examples of latency catastrophe; all resulted in multiple insurer insolvencies and billions of dollars of losses for insurers. Latency catastrophe is one of several types of catastrophes that are increasingly receiving the attention of modeling companies, reinsurers and brokers under the larger umbrella of casualty catastrophe modeling. Casualty catastrophe modeling promises to drive significant innovation in casualty insurance and reinsurance while also supporting better solvency practices.
In latency catastrophe, the hazard emerges over several years as a new product or business practice comes into widespread use before larger health or environmental consequences are fully understood. This silent emergence causes the risk to spread to multiple industries, potentially affecting insurers on the risk across multiple policy years before the actual losses emerge in the form of claims. Modeling the latent hazard emergence has been one of the key challenges of latency catastrophe modeling.
Praedicat has relied upon tracking the peer-reviewed science across hundreds of risks and modeling how the progress of science translates into claims. But hazard emergence turns out to be only part of the puzzle and may even be the easier part. Things get really interesting when catastrophe modeling confronts the occurrence trigger.
In general liability, coverage is triggered when bodily injury "occurs" during a policy year. If a visitor slips on the ice in a company's parking lot and breaks her hip, there is no question about what policy year of the company's general liability policy is triggered. There is similarly no question about what year's property insurance is triggered when a hurricane takes out the company's roof. But what happens when a company has been dumping a solvent into the woods behind the property for 10 of the last 20 years and the solvent hits the water table this year? What happens when a product the company has sold for the last 20 years turns out to cause a rare cancer and the resulting claims emerge over the next 20 years? Which policy years respond to claims? How much does each policy pay? Can the insured "stack" limits across policy years? How many occurrences are there?
Courts across dozens of cases have established enough legal interpretation to occupy an entire law school seminar series. These rulings attempt to resolve ambiguities in contract terms, which often were written not anticipating long-latency situations. Some courts sought an equitable solution; others tried to maximize coverage. The outcomes of these cases, which vary widely, have been critical to the solvency and profitability of the insurers involved. Sometimes the insurer on the risk during the early years has been on the hook; in other cases, the insurer during the later years is held responsible; and, increasingly, insurers for all years are called upon to respond to claims. In the latter case, the stacking of 20 years of limits can be catastrophic all by itself.
Actuaries have similarly struggled with this problem. When a policy year closes, actuaries establish reserves for both reported claims and any claims "incurred but not reported," which can include a lot of emerging risk written with the occurrence trigger. These reserves are released when claims fail to emerge in subsequent years compared to a target rate of emergence estimated using actuarial models based on historical claims. With latency catastrophes, however, the claims may emerge much later and at a much higher volume than what might be estimated based on historical claims. This resulting reserve inadequacy is one of the largest drivers of insurer insolvency today. Latency catastrophe modeling is supplementing the traditional actuarial approach by providing the tools to estimate the risk of significant adverse reserve development in a portfolio.
Latency catastrophe is a two-tailed risk. Catastrophe modelers talk about tail risk, by which they mean the risk of a low-probability, large-scale catastrophe. Casualty insurers talk about the long "time tail" of the occurrence form. Latency catastrophe brings them together as one.
When Praedicat first launched its science-based emerging liability risk models, insurers quickly gave them feedback that they needed to go further. While they believed that using published science to describe emerging risk was definitely useful, they told us that to connect the risk to the insurance business, you need to have a rigorous model of the occurrence form.
(http://carriermag.com/8dswt) Melissa Boudreau, VP of modeling for Praedicat, led a team of modelers to solve the problem of the occurrence trigger. "Our approach is multidisciplinary. We had lawyers reviewing the ways courts interpreted the occurrence trigger, bioscientists describing the latency of various diseases from autism to cancer and quants pulling it all together into models." (See also, related article, "(http://carriermag.com/8dswt) Meet the Modeler: Praedicat's Boudreau Takes the Road Less Traveled for Actuaries")
The resulting model probabilistically assigns losses to policy years and presents the estimated risk by year as though the loss assignment itself is the outcome of a catastrophe model, with some probability the loss will be assigned to the past, some probability it will be assigned to the current year and some probability it will be assigned across all years. Praedicat released the new occurrence model in October.
The goal of our latency catastrophe model is to provide insurers and reinsurers with truly new insights into aggregation in casualty - allowing underwriters to make informed decisions about accounts with legacy exposures, actuaries to set the right level of reserves and financial executives to allocate capital optimally.
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|Date:||Dec 7, 2017|
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