Friday, July 25, 2008 |
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Impact management:
Anthropologists tell us that humans, by nature, are a risk-taking species - this is what explains our phenomenal success. Whether it's daring to hunt mastodons with little sharpened sticks or build skyscrapers a quarter-mile high, we continually push the odds. Sometimes too far. This is why professional risk planning – whether it's for a business or a hedge fund or, say, a municipality that's largely situated below sea level – should be a rigorous and even ruthless process of sorting out all the assumptions and wishful thinking from hard and often underrated realities. Above all, risk and disaster planning requires imagination: an ability to "think around the corner," five or six questions ahead … and a top-down willingness (we might even call it courage) to confront what is inconveniently obvious. Consider this risk calculation: A direct hit to New Orleans from a Category-5 hurricane was often and (as it turned out) reliably projected as a 1-in-200-year phenomenon. Katrina was right on time. And though state-of-the-art seawalls and other systems had long been proven effective elsewhere (i.e., the Netherlands), officials clung to what experts, without exception, knew to be an antiquated Category-3 network of levees and canal walls. Why? Simple economics is the usual reason given. Weighed against the mere statistical probability of devastation, the untold billions needed to provide true Category-5 protection were discussed and rationalized and editorialized about – the New Orleans Times-Picayune ran a prize-winning expose only three years ago – but never seriously ventured. New Orleans' levees had last been modernized in 1965. But there was another factor. For decades, long before hurricanes even had names, The Big Easy had somehow dodged every incoming Armageddon. Cheating fate, time and again, can have a subtly mesmerizing, even seductive effect on one's thought process. City planners now freely admit they were complacent about the odds. And many business owners were too. One official of the Army Corps of Engineers put it bluntly: "We knew that if a future hurricane was Category 5, some of the flood walls would be overtopped. But we never did think they would actually be breached." The residual market impact Hurricane season finally is over: the damage is done. Thousands of individual businesses and scores of carriers and reinsurers will spend the better part of 2006 coming to terms with the losses – estimated at a total $50-60 billion, and counting – attempting to recoup and replenish capital. As we enter a "Katrina cycle" of tightened capacity and stiffer rates, virtually the entire property and casualty market will shoulder the burden.
Many property insurance underwriters have been mandated by their management to cease all writings in coastal or wind-prone locations; most have directives to stop rate reductions and aggressively negotiate premium increases ranging up to 50% (depending on the sector and specific exposures). Considering the normal lag-time in loss reporting and claims settlement, it will be some time before many underwriters have a solid grasp of the ultimate financial impact on their reserves. Meanwhile, they'll want to err on the high side in terms of pricing and terms. No hurricane on record has ever reached Detroit or Des Moines. Storm-surges are not usually a threat in Boise. But the fact is, poorly-written coverages or an inadequate business interruption plan – anywhere, in any sector – can be as ruinous as anything the broiling waters of the Caribbean can muster. Tornadoes, severe weather, fire, terrorist attack, construction collapse, multiple deaths, flood … even adverse publicity: these are among potentialities often found in the verbiage of standard policies and plans. But we consider these only a starting point. The complexities of business-interruption and other claims Risk constantly evolves. And every firm's risk profile – its vulnerability – is unique to a given sector, market position, locality, labor force, business model, dozens of other factors. A regular audit of coverages, special endorsements and policy language is so imperative in today's environment, the absence of one constitutes a major risk in itself. For companies with multiple locations, this is exponentially true. Business-interruption (BI) claims often far exceed those for physical or property damages. And they can be infinitely more complex, involving questions such as:
As some businesses on the Gulf Coast are finding, the claims adjustment process, too, can be an element of risk. Maximizing your recovery is seldom the first priority of an adjuster. It's critical at time to have consultative expertise – including legal talent and forensic accounting capabilities – representing your interests. Ultimately, we're not talking just about the need to plan, but to fully imagine – to think the unthinkable and be well-armed for it. Property and casualty insurance, alone, is rarely adequate to this task. Essentially, risk financing is founded on loss trends and loss experience: i.e., measured hindsight.
Katrina and her sisters Wilma and Rita comprised a market-shifting event. The months ahead will test the ingenuity, resourcefulness and above all, the imagination, of every risk manager and chief executive, not just those who've lost their businesses on the Gulf Coast. In case of emergency: beyond "fire drills" In the immediate aftermath of Katrina, planners in one major Midwest city, like executives all across the country, hastily convened a meeting to review their own evacuation plan – only to find the plan missing. Days later the document was found in their archives. It hadn't been consulted since the Cold War, and was designed solely for use in a nuclear attack. We might say this is just as well. An axiom of War College doctrine is that a rigid, hierarchy-dependent battle plan will not survive five minutes beyond first contact with the enemy. To be workable, a plan must include contingencies for failure of the plan itself. This involves thinking far beyond a 1-2-3 "fire drill" or bomb-shelter scenario. Today, for any type of enterprise, disaster and business interruption planning requires a flexible framework of action steps and redundant responsibilities … a realistic assessment of your risk environment … and a detailed, professional situation-by- situation analysis of your risk posture. Now is the time. We urge you to consult with your TF broker. Defining risk: reality vs. perception Risk evolves over time … and so does our perception of it. We can think of no better example than this: Back in 1994, the chances of a killer-meteor striking Earth were reckoned at 1-in-20,000. NASA analysts now say the odds are much closer to 1-in-500,000. What happened? Did hundreds of asteroids suddenly change their trajectories in the last 12 years? No. The answer is that advancements in knowledge and technology – in this case, better astral mapping – have decreased the margin of error. The innate risk hasn't changed, but our understanding of it has improved measurably. By analogy, in a business context, this is one cornerstone of Managed Risk:
Interesting, you might say. But we humans can no more avert an interstellar collision than … divert a hurricane. Yes. But managing the impact is almost entirely up to us.
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