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Understanding Foreign Customs, Economics, and Politics Must Be Considered in Pricing Risks Abroad, Actuaries are Told

06/23/2011 — PHILADELPHIA -- When it comes to pricing global reinsurance business, it’s important to remember that “all risks are local,” casualty actuaries were told June 7 at a Casualty Actuarial Society seminar here.

Actuaries need to understand the nuances of foreign customs, economics and politics when pricing risk abroad, said Athula Alwis, associate vice president and actuary with Freedom Specialty Insurance Company, New York City, New York. These items differ greatly from what is found in the United States, and are examples of the differences that actuaries need to consider and work within, he said.

Alwis and Andrew Marcell, chief executive officer of global specialties at Guy Carpenter, spoke on “Pricing Global Risks” at the CAS Seminar on Reinsurance. The moderator was Beth Fitzgerald, vice president of commercial lines and modeling at Insurance Services Office in Jersey City, NJ. Alwis’ and Marcell’s presentations discussed the finer points in pricing global risks and how actuaries can address them.

One key limitation is data - the lifeblood of a typical actuarial analysis. Risks in most countries, Alwis said, lack the high-quality, credible data that U.S. actuaries typically see.

Alwis offered several ways to address the issue:

  • Adjust U.S. data to reflect foreign exposures.
  • Use data from a country with similar laws and cultural norms. For example, data from one Scandinavian country can often be used to price business in another.
  • Use alternative indices that serve as a proxy for information that is unobtainable. For example, Alwis once sought a statistical measure of political risk and ended up using statistics on infant mortality. The reasoning: A country is weakened when it is financially unstable, and a financially unstable country cuts spending on health care first.

Even so, the lack of data means less reliance on quantitative models and more reliance on more subjective input from underwriters and brokers.

“There’s no way to mathematically model every single risk,” Alwis said.

Marcell agreed, while explaining that the models still play an important role. The models, and improvements in the inputs they use, lead to better answers than would have been reached previously, he said.

Alwis emphasized that reinsurance buyers are sensitive to the potential U.S.-bias pricing models contain. They dislike ‘robotic application’ of U.S. models to their business. “If you do this in the international community, you will lose the clients’ trust,” he said.

But the differences in insurance extend well beyond data and models, both speakers said, pointing out that cultural differences, laws and norms play a big role.

A surety risk in Japan, Alwis noted, is far different from one in Italy. In Japan, surety claims are relatively infrequent because the Japanese government protects and subsidizes contractors to preserve jobs, Alwis said.

The use of a risk in Italy as a benchmark to price a similar risk in Japan would lose money, he said, because Italy’s construction market seems to be affected by “fraud and corruption.”

Similarly, Alwis said, directors and officers (D&O) insurance in the United Kingdom is much less volatile than the same coverage in the United States. In the U.K., the loser pays the winner’s legal bills. This tends to limit lawsuits that have little chance of prevailing in court, since the plaintiffs attorney must pay the defense cost of the company sued when the plaintiff loses the lawsuit. Also in the U.K. there is no such thing as a class action.

Also there is less exposure in the U.K. to employment practices liability insurance, usually referred to by the acronym EPLI. “A joke that is OK in London would raise eyebrows here - perhaps a trip to HR,” Alwis said. Since EPLI claims occur less frequently in the UK, the coverage requires a lower rate there.

Political considerations are also important. Alwis recalled how two underwriters - one French and one American - considered a piece of Iranian business.

The American wouldn’t consider writing it - relations between the U.S. and Iran are so poor that the underwriter feared political dabbling would make the risk unprofitable. The French underwriter felt he was more familiar with Iranian business culture, so he could work with the risk.

Sometimes, an actuary can gain valuable insight by learning why coverage is being purchased, Alwis said. In addition to the traditional reasons - to reduce risk - some D&O policies are purchased so a company can attract better directors to its board. Sometimes credit insurance is less about protection and more a formality needed to get a business deal done. In these cases, the risk may be less than imagined.

Marcell noted that economic risks can differ by country. Among Latin American countries, he said, Brazil is expanding and has a relatively steady government. Argentina, by contrast, has more volatile government policies, and an insurance risk must be priced accordingly.

And environmental risks should be considered, Marcell said. Asia and other emerging markets have lenient pollution standards, relative to the United States. They also tend to be at greater risk from the effects of global warming. These exposures will affect casualty insurance prices, he said.

The Casualty Actuarial Society fulfills its mission to advance actuarial science through a focus on research and education. Among its 5,400 members are experts in property/casualty insurance, reinsurance, finance, risk management, and enterprise risk management.

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703-276-3100, mboa@casact.org

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