With a clear position on traditional risk analyses in particular from the financial sector, Taleb, now Distinguished Professor of Risk Engineering at New York University, analyses the power of the most unlikely events and their consequences. And now? Are the core subjects of Taleb’s eleven-year-old book on “Black Swans” still valid today? Are we still surprised by unlikely, impossible or unexpected events?
Solutions: Dr Mahnke, “Black Swan” was the main topic at the Risk Manager Conference AIRMIC 2018 in London. Have you noticed an increasing awareness of unpredictable risks among GVNW members?
Dr Alexander Mahnke: This year’s GVNW symposium was entitled: “Safe Action in Times of Uncertainty”. The meaning behind it is similar. In English, I think the black swan metaphor symbolises the “impact of the highly improbable”. In other words, the black swan is something you cannot see or could not predict in and of itself, no matter how much you contemplate it. If we look into the meaning behind the term, then, the downside of dealing with “Black Swans” is that we are taking about things we don’t know. All we know is something MIGHT happen but we don’t know WHAT it is or what the ramifications will be.
It is of course sensible to think about the “highly improbable”. However, one should not disregard dealing with events, which will occur with a certain probability. So, before turning our attention to Black Swans, the question should be raised as to whether the other birds have been dealt with sufficiently. Because this is the principal behind dealing with unforeseeable events in a professional manner, too. For example, this includes natural catastrophes like those in Japan or Indonesia with unexpectedly high sizes of loss. But we also have to see whether something can be anticipated after all and compared with experience from the past.
Solutions: Insured losses from natural catastrophes in 2017 spiralled to around USD 143 billion. What impact has that had on the ability to insure risks, particularly in relation to gigafactories planned by German enterprises in Asia and the USA?
Dr Mahnke: These days the weather can be modelled, and thus the associated phenomena of natural catastrophes can be analysed, in nearly every region of the world – at least to a certain extent. So such extreme weather events can be predicted to a degree. However, whether the likelihood of the event occurring matches up with the reality will naturally only be revealed later. Of course, we all know that this is not a precise science. If new sites are built today, for example in the form of gigafactories in countries where elemental damage such as torrential rain or even earthquakes cannot be ruled out, it is certainly very important for us to be aware of the risks in advance and in due time, as this ideally needs to be taken into consideration when making decisions on the associated investment. This mainly affects the automotive and supplier industries. With today’s worldwide connections, possible risks to the supply chain could lead to considerable losses. This is particularly true of gigafactories. At some point in the future, there may well be problems when searching for appropriate insurance cover here.
“The risk awareness of the correlations between natural catastrophes has significantly increased!”
Solutions: We have noticed that large-scale industry is becoming increasingly aware of flooding risks. Has the relative risk or the risk awareness for fire/elemental damage shifted?
Dr Mahnke: It would certainly be wrong to claim that the risk of major fire damage and its impacts on supply chains have lessened, while it is true to say that the risks from elemental damage have increased. This is particularly relevant to production sites abroad, some of which may even be built in overseas regions. In any case, the risks of regional natural hazards must be precisely identified, and their probability of occurrence estimated. According to my observations, it is true that the risk awareness of these correlations has significantly increased, especially in large-scale industry – and rightly so.
Solutions: When major damage is done, decisions need to be taken quickly so that the company in question can keep the business risks under control. Which challenges do you see here with regard to the roles distributed between top management and risk managers?
Dr Mahnke: In large firms with their own team of loss experts in their insurance offices, rapid decision-making to prevent further damage to the company should be a matter of course. As I understand it, and this is what I also tell my colleagues, in the event of loss, we must always behave as if we were not insured. In this way, I must personally answer to the board. If I had to concede that I didn’t have a handle on such basic matters, it would be fair to say that I am not the right man for the job. However, I still think that not enough has been done to resolve the issues relating to correct claims processing. I do believe that, in principle, those at the interface between business and insurance cover, i.e. employees in insurance risk management, have sufficient understanding of this. Nevertheless, we must always ask ourselves whether our voices are sufficiently heard in the event of an emergency. In other words, whether we are loud enough within the company. And when addressing the topic of the Black Swan, or unforeseeable risks, it is even more difficult to be heard. Because these issues are uncomfortable. In the role of insurance risk manager within a company, it is always nicer when you can
report to management and say: “I have managed to negotiate lower premiums!” or “You’ve just received a payout for your claimed losses.” But part of the job is to point out the things people don’t want to hear. When it comes to investment decisions, particularly investments in major projects, the calculation is always somewhat more positive because the business expects to see success as a result. But maybe we should be more realistic in our assessments.
Sometimes you have to point out: “Listen, building a factory or extracting oil at this site is associated with the following natural disaster risks. Have you taken this into consideration in your plans and calculations? Let’s consult with the experts on this.” This also helps to ensure that these kinds of projects can be insured and that your company remains credible on the insurance market in the long term.
Solutions: This doesn’t always make you popular, does it?
Dr Mahnke: It depends. To a certain extent, it’s an internal “policing function” that we have. You could look at it as loss prevention. You have to be able to put up with that from time to time. However, if the importance of risk management in companies increases, this immediately becomes easier. This is a point which still needs to be worked on in many places. At the same time, this also paves the way for dealing with Black Swans. But in the long term, the fact that the projects in question have the best possible insurance cover and that any claims are paid out quickly proves us right. This is how top management see it, at least. Each piece of advice needs to be backed up by the right information and the consequent arguments.
As market experts, we can certainly become more professional in this area than what we currently are.
Solutions: In the property and third-party liability insurance market, it is said that 98% of insurance firms refer to geodata from the ZÜRS zoning system for floods, backwater and torrential rain as an “objective” foundation for calculating premiums. Has this basis been challenged in light of recent freak weather/events?
Dr Mahnke: If you rely solely on past observations and empirical values, I think you run the very serious risk of getting it wrong in reality. And latest phenomena like the youngest Black Swans – that is unforeseeable natural events of huge magnitude – are not included. We aim to always offer appropriate cover at fair prices. In so doing, the risks must be assessed in every individual case. This is also the policyholder’s responsibility: they should closely consider these matters when planning new sites. Based on personal experience, I am sceptical as to whether you should always rely on the assessment and ensuing calculation from the insurance provider. This, of course, also applies to the method the insurer uses to calculate their premiums.
Solutions: Black Swans might represent the unlikely, but this doesn’t always have to be negative. It can also be completely positive. In this sense: what would you like the “positive Black Swan” of the future to be for GVNW members?
Dr Mahnke: Just like most people who handle risks in their work, I actually just want there to be no surprises whatsoever. For our members, whatever it is that they do professionally, I hope that their role and their activities continue to be seen as relevant to achieving their company’s mission. I would be pleased if the role of insurance risk management in Germany could be expanded even further. Indeed, that would not be a Black Swan as such, but something totally positive!
Solutions: Dr Mahnke, thank you for talking to us today!