Liability dynamics and its modelling implications: a fresh approach to Swiss Re's Casualty risk modelling

Risk complexity, lack of transparency and risk driver dynamics are constant challenges in the casualty insurance business. But as Werner Schaad, Managing Director for Casualty Products Underwriting, explains, new models can show a clearer picture of the link between liability events and related claims costs. It is all part of Swiss Re's fresh approach to casualty risk assessment, modelling and pricing.

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Why is “liability dynamics” a key concern for Swiss Re, particularly its Casualty Division?    

Liability insurance has been around for more than 100 years. But hardly any other risk in our product portfolio is as complex and dynamic as liability. It is affected by what we call the "risk of change”. Virtually all developments in society, economy, environment, technology or in the regulatory/legal field may have an impact on liability risk. These can be emerging risks from new technologies or materials, or new threats such as climate change, which is not only a challenge for Swiss Re as a property / natural catastrophe reinsurer, but also an issue for liability insurance, e.g. when it comes to “public nuisance” suits against the automobile and energy industry.   And liability dynamics isn’t just a concern for Swiss Re. In our recent liability dynamics survey of 44 experts, only two risk categories, natural catastrophes and financial crises, were seen as having a more severe impact on the re/insurance industry than liability dynamics.

What was the driver behind Swiss Re's fresh approach to its Casualty / Liability Business? And is there a link to liability dynamics?

There definitely is. Liability dynamics describes the problem or the challenge. The projects we run under Swiss Re's Casualty initiative and their results are part of the solution. Let’s look back at natural catastrophe risks - earthquake, storm, flood:  About 30 years ago, natural perils were considered almost  uninsurable - potentially huge but infrequent, no reliable experience, high uncertainty. However, in the meantime natural catastrophe threats have become quantifiable and manageable risks for the insurance world, thanks to models and computer tools based on scientific and technical information.

In Casualty we have always struggled with the risk complexity, lack of transparency and dynamics of risk drivers. Consequently, in 2007, we launched our project as a multi-year, strategic initiative. Its goal is to approach these risks with a fresh view and to establish a systematic approach, as well as achieve knowledge and modelling progress, for long-tail lines as we had achieved previously for natural perils.

What are the main achievements of Swiss Re's Casualty initiative?

We are pretty excited about the progress we have made. For instance, we have now a liability risk drivers (LRD) model in place that is based on the systematic assessment of all observable risk factors. We think we have a much clearer picture now about the cause-effect chain between a liability event and the resulting claims. It allows us a real exposure-based – instead of experience  only – risk assessment. In other words, we can distinguish all relevant individual risk factors, quantify them individually and determine their impact on an eventual liability claim. And if some of these factors change, for example, in the legal field with the higher likelihood for collective redress, as we call it here in Europe,  or in technology due to the materialization of an emerging risk – we will adjust the respective risk factors in the model. This means greatly improved predictive capabilities, that is, better underwriting and risk selection.

You just mentioned “collective redress,” which is one of the very prominent themes within liability dynamics.

Yes, this is actually one of the important current risks of change in the regulatory/legal field. Collective redress is the EU term for what is known as class actions or mass tort in the US. The EU is currently exploring and enhancing ways to facilitate access to justice for consumer claims or anti-trust law violations. For example, class action regimes have been introduced in Italy and in Poland in 2010, and draft legislation is on the table in Belgium.  Swiss Re fully supports the goal of improving access to justice and higher process efficiency in case of damage. However, we have to bear in mind possible severe negative implications of class actions, for consumers, economy and insurance, as we see them in the US. This includes, for example, excessive liability as an obstacle for economic growth and innovation, exorbitant claims cost and potential abuses of the tort system, high cost for - or reduced supply of - insurance coverage.  That’s why we promote an active stakeholder dialogue at national and international level to improve the understanding of essential criteria for a balanced approach to collective redress– including, for example, the use of alternative dispute resolution (ADR) instruments instead of - or prior to - litigation.

How do you see the way forward?

Underwriting quality matters more than ever. Therefore, it is crucially important to calculate the claims costs right, particularly given the currently record-low interest rates that exert significant pressure and make achieving technical underwriting profits an absolute necessity. The thorough understanding of dynamic liability drivers, and their translation into casualty modelling, are key success factors – in terms of reliable insurance coverage supply and business profitability – for casualty insurance now and in the future.  The new models and results will also help to increase market transparency, improve risk awareness, and the understanding of casualty peak exposures in the industry.  We think we are on a promising track with our new models, and, going forward, intend to continue an active dialogue with our clients and other stakeholders.

Published 9 November 2011

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