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Wild risks that could dramatically change the world

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By Dave Ingram , Tim Hodgson and Liang Yin | August 7, 2019

Strategic CROs typically do not pay attention to wild risks, but their extreme danger should be carefully considered.

A strategic chief risk officer (CRO) will want to engage the company planning group in a brief discussion of whether the board and management would want to be able continue in business after an event caused by a wild risk. This is another article in A Year in the Life of the Strategic CRO series.


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About our ‘A Year in the Life of the Strategic CRO’ series

In our ongoing A Year in the Life of the Strategic CRO series, risk experts from our Insurance Consulting and Technology team, Willis Re and other parts of Willis Towers Watson cover how how a strategically focused CRO can drive corporate strategy through the enterprise risk management planning process and throughout the year.

Like a game of roulette, an insurance company runs within largely knowable statistical boundaries. Working with “wild risks” is more like Russian roulette. When things line up the wrong way, the player is dead. The extreme danger of wild risks should cause strategic CROs to pay careful attention to them. But just the opposite happens. Wild risks are usually ignored.

‘Wild risk’ defined

Insurance company risk managers can group risks in any number of ways. One way is in terms of consequences. Risks would be classified according to the largest loss that might result at some very low likelihood level such as one in 500 years. Note that under this classification scheme, disruptive risks may cause mundane losses, but not dangerous losses and so on. Risks are classified by the largest loss that they might cause.

Mundane risks might cause a loss that results in a bad quarter, but would not necessarily be an important item in terms of the official explanation of the full year results. They may be mundane because:

  • The exposure base may be small, such as a small line of business
  • They only affect operational processes that are fundamentally small financially
  • The exposures might be particularly secure, such as a high quality bond portfolio

Disruptive risks might cause a loss that would seriously reduce an entire year’s income and perhaps be a featured item in the official explanation of an off year. Disruptive risks come from the larger insurance lines or from investments, such as a stock portfolio, that have a tendency to fluctuate widely.

Dangerous risks might result in a loss that seriously impairs surplus. These risks often will have low losses much of the time, but infrequently may have very large losses. Property insurance exposure to natural catastrophes has this characteristic in many locations. Leveraged financial investments might also operate in this manner.

Wild risks, as defined by Benoti B. Mandelbrot, are risks that are so extreme that they can end up changing the world.

Usually, risk management programs focus on disruptive and dangerous risks.

A strategic CRO will want to engage the company planning group determine if the board and management would want to be able continue in business, paying claims and writing insurance coverage after a possible wild loss event or a dangerous or disruptive loss event from each potential wild risk. For example, consider surviving a partial trade collapse, which may be much more likely than a total global trade collapse.

When the answer is to continue writing insurance, the company needs to create response plans. Remember, these are generally remote risks. Creating one new response plan per year may be a fast enough response.

The following are 15 wild risks to consider.

Wild financial risks

  • Banking crisis: Central banks are unable or unwilling to supply sufficient liquidity to institutions. Failure to make payments cascades rapidly through the financial system, causing banking and eventually real economic activity to stop.
  • Sovereign default: Nonpayment by a major sovereign borrower causes market panic and severely disrupts the global economy. Failure to make payments could cascade rapidly through the financial system, especially if there is a loss of trust within the system.

Wild economic risks

  • Currency crisis: A significant devaluation of a major currency that becomes self-fulfilling, with loss of purchasing power.
  • Depression: A rapid and painful contraction in economic activity leading to a deep decline in economic output, massive increases in unemployment, restriction of credit and shrinking investments.
  • Stagnation: A prolonged period of little or no economic growth, usually accompanied by high unemployment and growing political dissatisfaction.
  • Abandonment of fiat money: A collapse in confidence in the purchasing power of paper currency and the consequent return to a gold standard.

Wild political risk

  • Global trade collapse: A protectionist backlash against cross-border mobility of labor, goods and capital, causing global trade to collapse.

Wild environmental risks

  • Global temperature change: Earth’s climate tips into a less habitable state (hot or cold), disrupting social and economic systems.
  • Biodiversity collapse: Destruction of the world’s ecosystem, leading to problems with human food and water supplies, disease or climate issues.

Wild societal risks

  • Food/water/energy crisis: A major shortfall in the supply of or access to some combination of food, water or energy, causing severe societal issues.
  • Health progress backfire: Massive rise in morbidity or mental illness, perhaps due to an unintended consequence of a new health practice.
  • Extreme longevity: A significant increase in life expectancy overwhelms society’s support systems.

Wild technological risks

  • Cyber warfare: Computer sabotage or espionage on a major scale, with severe damage to infrastructure, financial, medical or defense systems, possibly acting as a precipitant to economic or financial risks.
  • Infrastructure failure: An interruption of a major infrastructure network, disrupting economies or impacting basic needs (e.g., loss of the electricity grid for an extended period, particularly during the winter).
  • Nuclear contamination: A major nuclear event or large radioactivity release, leading to lethal effects on individuals.

A failure to even consider these risks in the risk management program is effectively presuming that the likelihood of their occurrence is zero.

Previously in the A Year in the Life of the Strategic CRO series: 7 factors that could drive enterprise risk management in 2030.

Contacts

Dave Ingram
Head of Willis Re ERM Advisory

Tim Hodgson
Head of the Thinking Ahead Group

Liang Yin
Thinking Ahead Group

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