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>> The Geneva Association

Patrick M. Liedtke Risk Management and Liability Regimes: Two Faces of the Same Coin?

In the following two articles, The Geneva Association examines two challenges to insurers – regulatory reform in the wake of the credit crisis and the ongoing challenges in liability insurance. With many highly influential international bodies preparing the next draft of systemic risk regulation, Patrick M. Liedtke asks why insurance is so poorly represented in those bodies. In liability insurance, Richard H. Murray looks at the growth and developments in liability law across the globe and highlights potential implications for the liability insurance business.

Why The G-20 Must Focus On Risk Management

by Patrick M. Liedtke
The past twelve months have been especially intense for the insurance industry. On the one hand, the brunt of the credit crisis is over and following a period of very active crisis management and concerns about survival strategies, companies have begun looking forward again with more optimism and are getting ready to exploit a post-crisis world where new business opportunities and prosperity await. On the other hand, public-policy efforts to draw the right lessons from the crisis, to improve the stability of our global financial system, to set the right incentives for economic risk takers, and to properly regulate the financial sector have just begun.
Although the large majority of new initiatives to increase financial stability and economic resilience are triggered by the massive failures that emanated out of banking activities, their effects are already encompassing the insurance sector and will continue doing so. Insurers need to find out which new initiatives under discussion amongst policy-makers and regulators will affect their industry, how they will impact the business, how they should respond to it – both to regulation under discussion and to regulation to be implemented – and then define the relevant action points. What is different about this crisis is not only the degree to which insurance companies are affected by the global crisis and the emerging regulatory debates, but also the way in which these initiatives are now applying to virtually all insurance companies regardless of size or domicile. Confronted with this new reality of global and encompassing regulation, insurers have realised that they need to be more proactive on the global stage.
However, while the insurance industry wants and needs to play a more active role in the global financial debates, some very relevant non-insurance actors (like the FSB and many central banks) seem to believe that the new financial stability architecture does not need insurance. Unfortunately these are some of the most influential actors driving the development of the new international financial stability architecture. They largely accept the analysis of The Geneva Association that insurance activities do not pose systemic risk to the financial system but unfortunately they erroneously deduct from it that insurance plays no significant role for financial stability. Consequently, if insurers do not trigger financial instability they need not be involved in any discussions about it. While this might seem vaguely plausible at first sight, it is nevertheless wrong.
True, insurers do not pose any significant systemic financial risk in the same way banks do. However, insurance companies have an important role in how any financial crisis might play out. Insurance companies, faced with an ongoing financial crisis, can have an influence on the crisis, either exerting a stabilising effect or potentially amplifying any problems. This depends on the exact nature of the crisis and the mechanisms that will dominate the decision-making processes at the insurance companies, which includes pressure from the relevant outside agencies such as regulators and supervisors. While in this respect more research is clearly needed—especially to use the potential function of insurance companies as circuit-breakers—one only has to picture what would happen in a severely depressed market if large (life) insurers were pushed to eliminate long-term investments to meet short-term solvency requirements.
Inasmuch as any rigorous and comprehensive catastrophe risk management plan requires the integration and cooperation of all concerned parties—and not only those that pose the original risk!—insurers need to be part of ongoing discussions about the international financial stability framework and any plans that define the operations of the financial markets where they play such an important role. On the investment side alone, insurers manage something in the region of 11 per cent of world assets, not to mention their role in protecting other parties’ assets too. It would not only be extremely short-sighted to exclude the knowledge that insurers have in managing financial risk and especially tail risk—an understanding so much in demand precisely when events move into the tail of the probability distribution-it would also be counterproductive to the stability of the system if one of the potential sources of re-stabilisation, or an element that if mismanaged during a crisis could multiply negative effects, were not consulted properly on all aspects of the new financial architecture. The new financial stability architecture must have adequate insurance participation.
The Geneva Association has been occupying a crucial place for the insurance industry as the intellectual centre for advanced research into strategic insurance and risk management issues. While very limited in its own resources to carry out research, it has played an important role in identifying new challenges, helping to prioritize them and setting up industry-wide initiatives as a catalyst for change. Its capacity to organise global high-level discussion platforms for the industry and its key stakeholders, including, in particular regulators and supervisors, has become an even more valuable asset to the industry but also to the larger economic system, its performance and future development. To aid in this mission, The Geneva Association has complemented its traditional role as a distributor of high-quality information on insurance matters by emphasizing its position as champion of insurance through more advocacy.
There is no doubt that a deeper and more nuanced understanding about the role that insurance and insurance companies play for modern economic systems is required. Most observers agree that the performance of our financial and social systems and their ability to cope with adverse situations and spontaneous stress can be considerably improved. Many solutions will find their way in exactly the area that generated the problems in the first place. However, for many others the solution will have to be an added dimension of good risk management and probably also some specific insurance mechanisms that will allow our societies to cope with the challenges than an uncertain future brings. The resilience not only of our financial architecture but that of societies in general depends on an appropriate toolbox to avoid danger, mitigate the consequences of disasters and deal with any remaining fall-out. As insurance plays a key role for the functioning of many markets, its possible contribution needs to be better taken into consideration and made an inherent part of coping strategies. The Geneva Association has been working on this set of issues intensively and will continue to do so. At the same time, it calls on the industry and other third parties to take a more active role in the debate.
The Dynamics of Liability Regimes: Legal, Political and Social Influences

by Richard H. Murray
Liability insurance has characteristics unlike other lines that provide unique management, underwriting and claims challenges. It is only an aspect of insurance that serves to distribute the costs of human fault. Natural catastrophes, the inevitability of mortality and morbidity or other forces beyond human control may trigger a liability-inducing event, but they are stage pieces rather than active agents. It is a primary mechanism for distributing the costs of human imperfection. The availability and terms of liability insurance have influenced the development of liability law. That is a vital role in modern society and can generate significant premium opportunities, but it also creates challenges not encountered in other lines.
One of the challenges that contributed to the securities liability losses of the 1980's, and again in the financial and product liability burdens in the 1998-2002 period, and has generally been recognised since then, is the willingness of political and judicial forces to apply wider duties and greater recoveries with retroactive effect. The decisions to offer liability cover, and the terms and prices of the offer, are made under a defined set of risks faced by the insured when the insurance promise is made. But the scope and size of the insured's risk can greatly escalate by the time a claim arises and is ripe for payment on that promise. One need only reflect on the recent traumas of asbestos, tobacco and environmental liability to recognise what enormous loss ratios can be generated by acts of the insured which were in compliance with all standards of law and regulation at the time of the insured event.
Liability insurance also suffers from the naïve assumptions of policy-makers, courts and juries that insurers have an endlessly elastic ability to absorb and distribute the escalating burdens of liability. It is understood, for instance, that natural catastrophes can exceed insurance resources and therefore policy limits or underwriting restrictions are accepted. It is far less well understood that insured liability losses cannot be absorbed to the extent necessary to achieve the social objective. When an auto manufacturer places gas tanks in a location approved by the regulators, but results in widespread harm, the atmosphere in which those claims are resolved is dominated by the desire to deter future behavior (newly deemed negligent) by awarding large damages, all in the belief that doing so will encourage business responsibility while the life-threatening size of such awards will be insured.
The liability insurance landscape of the past forty years in America, and more recently in Europe and elsewhere is littered with the scars inflicted by the confluence of these two conditions. Some insurers have not survived those experiences, or not survived independently, and the entire industry has suffered from the resulting earnings volatility and its effect on P/E ratios.
This look at how liability law has evolved, and how it has been influenced by the presumed universal availability of liability insurance, was the platform for the panel's discussion of the approaching risks that could repeat or exceed the damage of earlier unforeseen bursts of liability losses. Several concerns were identified.
• A SPREADING COMPENSATION CULTURE. The recent Lloyd's "360 Degree Report" on liability conditions captures the concern. What was once assumed to be a cultural condition in the U.S. only is rapidly globalizing, namely the assumption that for every injury there should be generous compensation. The culture of entitlement is overcoming the traditional legal conditions of tort law in the U.K., Europe and increasingly on a global basis. Tort liability was created in common law tradition as a reasonable financial obligation of a party whose negligent breach of duty has caused harm to another party with a legal right of reliance on compliance with that duty. The constraining requirements of proving Duty, Negligent Breach, Causation, Reliance and Reasonable Damages began to erode under the U.S. compensation culture revolution that began after World War II is found to have infected large parts of the world, accelerated by the influence of telecommunications technology that ignores geographic and cultural borders. Those traditional standards have been replaced by interpretations and revisions of traditional laws that ensure the steady and sometimes explosive growth of compensation through eviscerating liability standards. Populism that supports indirect wealth distribution through liability systems is rapidly globalising.
• GOVERNMENTAL POLICY. While the tort model evolved in the judicial traditions of common law countries, civil law jurisdictions have produced similar reliance on private sector liability practices as governmental and regulatory choices. Continental Europe has been a leader in the transition. Countries which had long provided statutory schemes of compensation for a wide variety of injuries, paid for out of public funds through the use of taxing power, have been forced to adopt new compensation systems as demographic factors swelled the ranks of those with injuries and shrank the roles of earning taxpayers. The chosen alternative is transference of compensation duties into the private sector, using adaptations of the common law tort system as the favored model. The early experiments involved the costs of environmental cleanup, where European policy-makers were even more aggressive than their American counterparts in establishing "strict” liability standards that made commercial enterprises liable for any contribution to environmental degradation, even where legitimate business activities could not have been conducted without environmental impact.
• JUDICIAL TOLERANCE. Fear of hazards and losses arising from climate change claims are emerging in the U.S. and contemplated in all continents. The first manifestations appeared in the U.S. just after Hurricane Katrina devastated New Orleans. As was the case with the early tobacco and asbestos liability claims, the attempts to apply liability theory to climate related property and mortality losses were dismissed as lacking a supporting duty and its breach. It took the asbestos and tobacco claims about 25 years to break through the legal obstacles into a world where losses overcame the barriers to recovery. For climate risk claims the shift began in three years, as the appellate courts began to accept the principle of "public nuisance" as an acceptable alternative basis for sustaining the claims. Once a class action or mass tort with thousands of claimants successfully jumps the hurdle of early dismissal, each case has significant settlement value due to the costs of defending and the risk of a company-destroying outcome. Insureds will settle, even where it is clear they have little theoretical exposure, as current insurance policies and claims practices inhibit insurers from avoiding losses never contemplated at the time of underwriting.
• SOCIAL DEMANDS. We are rapidly entering an era where the imperative needs of society can, independent of overt government action, become legal obligations. Dow Chemical discovered this when, after careful due diligence to establish that all liabilities were ring-fenced, it acquired Union Carbide many years after settlement of the Bhopal claims . Legal insulation was not sufficient to prevent Dow from a major additional settlement payment. It seems very likely that the same pattern of societal-driven responsibility will emerge from the tragic oil gusher in the Gulf of Mexico, extracting payments and generating insurance claims from a multitude of directly and indirectly involved companies. The trial for socially constructed law was laid by the human rights missionaries whose initial efforts to force liability upon large retailers for abusive working conditions in their supply chain were deemed hopeless. Those efforts now have broad liability and corporate behavior impact. Liability insurers have paid some of the bills to date and will pay increasing portions as insureds become more adept at formulating their claims within policy terms.
• THE COMBUSTION OF GREED AND OPPORTUNITY. The specialty claimants bar in America began as a cottage industry. Through persistence and innovation, combined with political and judicial tolerance it has become major industry with extended resources and political power second only to that of U.S. labor unions. It is widely and genuinely believed that cultural and judicial restraint will prevent the spreading of the claimant industry to Europe. Regrettably, the power of profit will ultimately prevail, though perhaps to a lesser degree than in America. But as the EU presses to adopt collective action mechanisms to support the aggregation of claims, greed will take its toll on European companies and their insurers.
Current conditions in the European liability regimes demonstrate the universality of the risks noted above. Two recent developments illustrate the trend. Asbestos claims have become an increasing burden in several countries. France has now declared that, because the risk of mesothelioma from asbestos exposure was widely understood by 1988, all such claims filed thereafter will be regarded as timely and will be the responsibility of all relevant employers and their insurers. When France leads the way toward private sector liability, surely others will follow.
Secretary General and Managing Director, The Geneva Association.
Special Advisor, The Geneva Association.
Published in July 2010 in The Geneva Association’s “General Assembly Review”
On December 3 1984, more than 40 tons of methyl isocyanate gas leaked from a pesticide plant in Bhopal, India, immediately killing at least 3,800 people and causing significant morbidity and premature death for many thousands more. Involved in what became the worst industrial accident in history, Union Carbide immediately tried to dissociate itself from legal responsibility. Eventually it reached a settlement with the Indian Government and accepted moral responsibility. It paid $470 million in compensation, a relatively small amount based on significant underestimations of the long-term health consequences of exposure and the number of people exposed. The disaster indicated a need for enforceable international standards for environmental safety, preventative strategies to avoid similar accidents and industrial disaster preparedness. [Spanish translator’s note]

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