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Good article about how a decade of disaster has made predicting loss impossible.

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  • 1. September 5 September 11,2011Bloomberg BusinessWeekAT9:03A.M.ONSEPTEMBER 11,2001, BRITTNEWHOUSESTOOD INTHE LOBBYONTHE 52NDFLOOR OFTHE SOUTHTOWER OFTHEWORLDTRADE

2. CENTER.AFTERUNITEDAIRLINESFLIGHT 175BANKEDABOVE THEHARBORBEHINDHIM, ITWASPOINTEDAT THE50THFLOOR. IFNOTTRIMMED 3. CORRECTLY, ANAIRPLANEWILLRISE AS ITACCELERATES, ANDTHE MANWHO HADKILLEDANDREPLACEDTHEAIRPLANESPILOTADDEDPOWER 4. UNTIL HEHIT THESOUTHTOWER 24FLOORSABOVENEWHOUSE. HEDOESNTREMEMBERTHE SOUNDOF THEIMPACT.At the time,hurricaneNewhouseoranranGuyearthquake-Carpenters causesAmericaslosses on aoperation.largeGuy number ofCarpenter policies.brokers Re-reinsurance insurance,treaties, in essence,which is insuranceprotect forinsurersinsurers.whena Consumcatastrophers donte-a tend to 5. know whatultimatelyreinsuranceresponsibleis because foreveryit never new thingtouchesthat Godthem can comedirectly.up with. AsReinsurers,losses grewmassivelythis decade,capitalizedyearbyand oftenyear,named afterreinsurersthe places have beenwhere they working towere figure outfounded- what theyCologne Re,can do toHannover make theRe, Munich God clauseRe, Swisssmaller, toRe-makereduce theirtheir living exposure.thinking They haveabout thebillions ofthings thatdollars atalmost stake. Theyneverareveryhappen and good atarethinkingdevastatingabout thewhen theyworld todo. Butcome.even Lloyds,reinsurers thecan be London-surprised. basedAndthe companyinsurers thatwho make inventedup their the modernmarket put professionthem on theofhook for insurance,everything,publishes afor all theyearly listrisks that of what itstretch thecallslimitsof "RealisticimaginationDisaster. This isScenarios."what the Thelistindustry imaginescasually such eventsrefers to as astwothe"Godconsecutiveclause": AtlanticReinsurers seaboardarewindstorms oran earthquake at the New Madrid fault in the Mississippi Valley, eitherof which could strain or break an insurers balance 6. sheet.Byhull2001, insuranceLloyds had for thealready planes,envisionedpropertytwo airliners insurancecolliding andover a city,workmanslaunching comp onclaims on 7. September 5 September 11,2011Bloomberg BusinessWeekthe ground, and life insurance everywhere. But even Lloydsfor cyclonic storms. No, he explained, little of that value was in-lacked the imagination to anticipate September 11. "People sured. "Honestly," said someone else, "Ive never understoodfind it hard to believe in a risk unless they can see it in theirwhy those people dont just leave. Its a dangerous place."mind," says Trevor Maynard, head of exposure managementBy definition, reinsurers work at the edge of suffering, andfor Lloyds. "When you try and describe a risk like this-someso have developed euphemisms to help them stand at a dis-terrorists are going to teach themselves how to fly a plane, tance. A catastrophe is called a "loss event." A catastrophe bigthey will fly into property, the buildings will be weakened-by enough to affect several reinsurers is called an "industry lossthe time you get to your third point, peoples eyes are glaz-event." Reinsurers both need and fear these. The first dedicat-ing over." ed reinsurer, Cologne Re, formed after a fire leveled about aFloors 49 through 54 of the south tower housed Guy quarter of the city of Hamburg, Germany, in 1842. A loss eventCarpenters home office and its 750 employees. To any of reminds insurers of the value of the product; reinsurers canNewhouses clients-insurers-professional employees in an raise rates, and the higher rates attract new capital. Accordingoffice tower would have presented an attractive bet in terms to Dowling & Partners, an investment adviser for the insuranceof risk and reward. There are few slips and falls in white-collarindustry, after Hurricane Andrew ran across southern Flori-work and not much dangerous equipment lying around. New- da in 1992, eight new reinsurers entered the market, togetherhouse indulges in mild profanity and, thinking like a broker,valued at $2.9 billion. Although hurricanes seem frequent, theoften lapses without warning into the voice of his customers insurance industry defines them as "low frequency" events;as they think about risk. "If I insure 40 of these firms in twothere are perhaps 10 a year and not tens of thousands. Unliketowers across 200 floors, probably the worst is that eight ofcar accidents, you cannot look at the last decade of hurricanethem, maybe six of them, could be involved in the same loss,"results and predict this years losses with any accuracy.he says. "Because the fire department can get there... usually Andrews $25 billion in losses, along with the then-newa fire never spreads, historically, beyond six floors."availability of cheaper computing power, helped push insur-The insurance industry describes these kinds of risks as ers and reinsurers toward computer-driven modeling, which"high frequency": The more often a kind of accident occurs,leaned on meteorology and seismology to more preciselythe easier it is to guess its chance of happening and the easier define potential losses by estimating storm paths and cate-it is to price insurance coverage. For slips, lawsuits, and fires, gories and fault lines and tremor strengths. The models arehistorical trends predict future probability. "What they hadntsophisticated, but reality is wily.imagined," says Newhouse, picking his words carefully, "wasAfter September 11, another eight new reinsurers followedan intentional act of human causative agency." the higher rates and entered the market, together valued at Guy Carpenter lost 29 employees on September 11. When S8.6 billion. Hurricanes Katrina, Rita, and Wilma lured fivethe plane hit his building, most of Newhouses employees weremore new reinsurers with $5 billion in capital. Between catas-well below him or out of the tower already. Guy Carpenterstrophes, the new capacity drives premiums back down andchief executive officer had traveled to an annual conference inreinsurers are forced to undervalue risks to stay in ^^Monte Carlo, leaving Newhouse as the most senior manager.After American Airlines Flight 11 hit the north tower, he toldeveryone to leave. The company had been in the World TradeCenter in 1993 when a bomb exploded below the north tower.His employees did not need to be reminded that the worldwas a dangerous place, even if the buildings collapse still lay youtside of the realm of imagination. By the time Newhousereached the plaza level, a cordon of police officers waited todirect him through the mall below. When he got back to streetlevel both towers were still standing. The hole in the northtower glowed, he says, like a dragon in a cave. He saw the chaos on the ground beneath the towers andlooked for a Hudson River ferry. He had no trouble gettingon board; there was no rush. "There were people hangingaround," he says, "working their cell phones and watching."They were still there in the streets, watching, when his ferrybacked out and the floors of the south tower began to collapseand accelerate down. Until that second, they hadnt believedthat anything more could happen to them. No experience offear drove them to get far away, as fast as they could, until itwas too late. I was standing there, too. I survived by dumb luck.In the fall of 1998 I started a job in New York with one ofthe worlds largest reinsurers. Soon after, at a meeting in a con-ference room above Park Avenue, someone complained that themarket for reinsurance had gone soft. "What we need," he said,"is a good catastrophe." It was a joke, but true, too. I offeredthat a cyclone had hit Bangladesh and it had been an active year 8. September 5 September 11,2011Bloomberg BusinessWeekthe market. Vincent J. Dowling of Dowling & Partners refers tothis as the "cheating phase" of the cycle. That is, even thoughcatastrophes present an existential threat to insurers, and thesober assessment of risk is a firm-defining competency, insur-ers, like people, can get complacent."The psychology piece dominates, even in boardrooms,"NOTHING SAYSTHEREsays David Bresch. "People measure against the perceived re-ality around them and not against possible futures."Bresch is in charge of sustainability and risk managementfor Swiss Re, founded in 1863 after a city fire in Glarus, Swit- CANT BE 10 WORLD TRADEzerland, and now the worlds second-largest reinsurer. "If thegap between modeled reality and perceived reality is too big,"says Bresch, "that tells you something about the market shareyoud like to achieve." In other words, what the models show CENTER EVENTS IN A YEAR,"as a best guess of a risk may not be what the insurers perceivethe risk to be, and it can take more than just data alone to scareinsurers into paying for risks at a rate that keeps reinsurerssolvent over the long term. That takes an industry loss event. SAYS TRILOVSZKY.It takes a catastrophe.Heike Trilovszky runs corporate underwriting for MunichRe, the worlds largest reinsurer. The afternoon of Septem-ber 11, the press and the companys shareholders needed to "THERE CANNOT BE Aknow what Munich Res losses would be. "To get answers wehad to ask the brokers." she says. "Aon Benfield, Guy Carpen-ter, they had offices in those buildings. It was odd. Is my coun-terpart still alive?" Before the end of the week, Munich had MATHEMATICAL MODEL FORan initial estimate. In October, Trilovszky was at an off-sitemeeting when a board member arrived late. He had seen therevised loss estimate and he was pale. "We will survive," hesaid, "but its serious." Munich Res losses after September 11 PEOPLE LIKE BIN LADEN"be one of them. Most reinsurance treaties renew on Jan. 1 andultimately came to S2.2 billion.the meeting oriented itself around a new question: What doReinsurance treaties are full of exclusions, but before Sep-we do on 1/1/2002? "There were 15 managers, all with a back-tember 11 terrorism was not considered significant enough toground in property," says Trilovszky. "We had flip chart paperand w