nanotechnology: the smallest big risk in this issue...project on emerging nanotechnology (pen),...
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In this issue
Nanotechnology: The Smallest Big Risk 1
What Is the Next Chinese Drywall? Nailing Down Construction Risks 5
Beware Inflation: Why Insurers Can’t Ignore It 9
news & views from Endurance
fall 2009
It’s in your JCPenney wrinkle-free
shirts. It’s in your Sony Playstation.
It’s in your microwaveable lasagna.
It’s in your tennis balls, the thousands
of parts in your car, and your prescrip-
tion medicine. It’s in your homes, your
stores and maybe even inside of you.
What we are talking about is nano-
technology.
Nanotechnology isn’t science fiction, al-
though it comes as close to it as anything
we have seen. Nanotechnology is at the
edge of innovation and is a top priority
of researchers, designers, engineers,
and pioneers in science, manufacturing,
production, economics, art, medicine
and even ethics. This term has spurred
what will almost certainly be dubbed a
“nanotech bubble” as patents for and
investments in “nano” related products
skyrocket. Medical breakthroughs are
touted by advocates; doomsday scenari-
os are hyped by cynics. Only one thing is
certain — the impact of this technology
will be miniature only in name.
To comprehend the vast array of applica-
tions and potential risks associated with
nanotechnology, it’s important to first
understand what nanotechnology is and
how it will lead to a paradigm shift in the
world ahead.
What is Nanotechnology?
Nanotechnology refers to the scale of
innovation, in this case mechanisms and
reactions that occur on a molecular level:
the nanoscale. One nanometer (nm) is one
billionth, or 10-9, of a meter. To give some
reference points, the diameter of a human
hair is 100,000 times that
of a nanometer and the
size of one nanometer
compared to a meter is
akin to the size of a marble
compared to the Earth1.
Essentially, nanotechnology
involves altering or creating
new elements or enhancing
existing elements for use
in manufacturing, scientific
and biological processes.
An infinitesimally small
mechanical process called
“nanorobotics” can per-
form tasks like the robotic
arms on a car assembly
line, except in this case on
the subatomic level!
But here is where nanotechnology
differentiates itself. Where other forms of
molecular manufacturing “move atoms in
great thundering statistical herds…[with
Continued next page
Nanotechnology: The Smallest Big RiskBy Joshua Hackett
Assistant Underwriter, Casualty Treaty
Endurance Reinsurance Corporation of America
YOUR RISK IS OUR FOCUS1 “Nanotechnology,” National Geographic, June 2006, p. 98-119.
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nanotechnology] it’s like trying to make
things out of LEGO blocks with boxing
gloves on your hands…nanotechnology
will let us take off the boxing gloves…
we’ll be able to snap together the funda-
mental building blocks of nature easily,
inexpensively, and in most of the ways
permitted by the laws of physics.”2
In short, nanotechnology encompasses
a spectrum of “nanomaterials” which, by
moving elements on a miniature scale,
changes their chemical, physical, and
structural properties to create something
new. Nanotechnology has the potential to
create new paradigms in the world going
forward.
What is Nanotechnology’s Global Reach?
According to the Woodrow Wilson
Project on Emerging Nanotechnology
(PEN), there are more than 800 con-
sumer products and product lines in the
commercial and retail market, the result
of a remarkable 289% growth rate since
the study began in 2006. Worldwide
nanotechnology inventory is present in
21 nations and is increasing, with the
US comprising the greatest market with
nearly 450 product lines, which is double
the next closest region — East Asia —
with 227.3 In fact, the annual market for
nanotechnology is projected to be around
US $1 trillion by 2015.4
Nanotechnology products have inherent
advantages over existing manufactured
products: they are faster, lighter, can
scale more easily, are cheaper to mass
produce, are more energy efficient, and
can be automated. Therefore, it is not
surprising that there has been significant
worldwide investment and a considerable
increase in nano-related products and
materials.
Due to the ever continuing trend of “small-
er, better, cheaper,” the number of compa-
nies that are “nanotechnology companies”
will likely increase in the near term and,
over the longer term, may well comprise
the majority of companies with such famil-
iar names, such as Kraft, L’Oreal, Toshiba,
GE, BMW, Nokia and Bayer.5
In fact, nanotechnology is interconnected
to nearly all products, making it more of
“an enabling technology” than a “stand
alone industry.”6
Nanotechnology Rewards Come With Risk
The positive aspects of nanotechnology
are undeniable. Already it is being used
to create stronger fibers for clothing
and fabrics with the ability to incorpo-
rate “wrinkle-free” and “stain-resistant”
properties. Sunscreens use
nanoparticles to reduce UV
ray exposure. Carbon fiber
nanotubes have greater
tensile strength and are
more durable options for
public bridges and dams.
Paints are lighter and less
toxic. Fuel cells and batter-
ies are smaller and more
efficient. Lubricants enable
“self cleaning” windows.
Water is more easily purified. Hydrocar-
bon pollution in ground water is drasti-
cally reduced. Medical implants are made
“bio-corrosive free” and don’t need to be
replaced. Magnetic imaging equipment
is made more scalable, reducing the
cost of numerous healthcare procedures.
Soldiers utilize breakthrough body armor
to clot and repair tissue in case of injury,
like wearable medicine. Synthetic skin
grafts help heal burn patients. Selective
“smart drug” delivery systems target spe-
cific cancer cells in the body and destroy
them, like trained warriors. Can this be
real? Is it too good to be true?
Yes, it is real, and if it seems too good, it
may be. By definition, nanotechnology’s
greatest asset, that it changes the basic
nature of elements and their reactions,
may also prove to be its biggest liability,
creating an exponentially growing uncer-
tainty about how interactions will take
place. In fact, nanotechnology can actu-
ally reverse the way normal elements re-
act to each other. For example, “opaque
substances become transparent; stable
materials turn combustible; solids turn
2 Dr. Ralph C. Merkle, Nanotechnology, http://www.zyvex.com/nano (22 July 2009). 3 Project for Emerging Nanotechnology (PEN), http://www.nanotechproject.org. 4 “Scientists advance safety of nanotechnology,” Advisen Front Page News, 29 June 2009, http://fpn.advisen.com.5 Ibid.6 Cientifica, 2007.
026End.indd 2 8/26/09 4:40:06 PM
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3theEdge
into liquids at room temperature; insula-
tors become conductors; inert elements
become catalysts.”7 Nanotechnology can
turn static and controllable variables into
unknown black swans capable of creat-
ing a systemic risk where none previously
existed.
Implications for the Insurance Industry
As with other emerging technologies, the
insurance industry will need to learn how
to manage the uncertainty of nanotech-
nology risk, and better understand the
types of exposures that will be prevalent.
Workers’ compensation, environmental
impairment, product and general liability
lines will likely need to address nano-
technology risks sooner than other lines
given the exponential growth and use of
nanotechnology in the products we use,
the food we eat and the air we breathe.
As nanotechnology proliferates to en-
compass nearly all manufacturing, those
working in factories, plants, and shipping
facilities may be at risk for exposures
similar to asbestos. “Certain carbon-
based nanomaterials share qualities with
earlier substances such as DDT and
PCBs — they may bioaccumulate…these
risks are heightened by the ease with
which nanoparticles are so easily ingest-
ed by humans.”8 The potential long-term
health effects of ingesting nanoparticles
are still unknown, and “without hard data
that specifically addresses the issues of
synthetic nanomaterials, it is impossible
to know what physiological effects will
occur, and more critically, what exposure
levels to recommend.”9
Product and general liability lines remain
heavily exposed to nanotechnology
risks as well. Product recalls, potentially
harmful long term medical side effects to
consumers, and even unintended uses
of products could lead to a man-made
catastrophic exposure for insurers and
reinsurers if they do not understand the
potential for losses resulting from the use
of nanotechnology.
Another risk involves environmental liabil-
ity. Because nanomaterials can ultimately
behave unpredictably, it is as yet still
unknown how they will decompose in the
environment. This produces a whole new
set of questions about pollution and con-
tamination during manufacturing, storage
and disposal as well as broader public
health concerns. Free nanoparticles may
have much longer half lives than natu-
rally occurring elements, and thus could
extend the long tail on liability claims even
further.
Unfortunately, the research being done
to quantify these exposures isn’t keeping
pace with the growth in new products
and applications. Of the $700 million in
federal funding allotted for the National
Nanotechnology Initiative in 2003, less
than $500,000 was used to study the
impact on the environment, because in
a competitive market, “the immediate
payback for research that demonstrates
ways of using nanomaterials to cure
disease, for example, is greater than the
reward for uncovering the fact that a
nanomaterial may cause disease.”10 With
the deck stacked in favor of pro-nano-
technology research, it is no wonder that
insurers and reinsurers remain cautious
about the potential unforeseen liabilities
that they may unintentionally be writing or
assuming.
Underwriting Uncertainty
Nanotechnology is moving faster than
regulation, as often happens with innova-
tion. The FDA, EPA, and various other
scientific organizations have yet to des-
ignate an entity with authority to police
it. Also, nanotechnology products and
processes are being distributed glob-
ally, which only increases the complexity
of regulating nanotechnology across
borders.
Ultimately, insurers need to consider
how to underwrite this potentially huge
exposure, especially when they can not
understand the full extent of the risk. It
is important to be vigilant, informed, and
proactive. Continued next page
© 2003 The New Yorker Collection from cartoonbank.com. All Rights Reserved.
7 N. Lubick, “Silver socks have cloudy lining” (Environmental Science Technology, 42(11): 3910.) 8 Kevin M. Hass, “Nanotechnology: Risks and Rewards,” Best’s Review, June 2009, p. 92.9 Vivki Colvin, “Responsible Nanotechnology: Looking Beyond the Good News” (Center for Biological Environmental Nanotechnology, Rice University), www.eurekalert.org. 10 Ibid.
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Areas underwriters should explore include:
What nanotechnologies does •
the company use, including those
supplied and created?
Have they performed an analysis of •
their product’s entire lifecycle?
What are the known hazards? •
Potential hazards?
Have the products or processes •
been studied for their toxic effects?
Environmental effects?
Does the company follow any •
guiding Board level principles
managing nanotechnology risks?
Does the company follow any risk •
frameworks for managing the poten-
tial hazards to their employees?
Does the company inform its custom-•
ers about the nanotechnologies it
uses or sells?
With the proliferation of new products
and uses, there are also initiatives to
begin developing best in class practices
to address and manage nanotechnology
risks. A group of stakeholders, includ-
ing 17 European companies engaged in
various sectors at the forefront of nano-
technology, developed the “Responsible
NanoCode”, a code of conduct which
addresses best practices for health,
safety and environmental risk manage-
ment among other topics.11 In a similar
vein, the Environmental Defense Fund
and DuPont formed a partnership which
resulted in the “NanoRisk Framework,”
outlining an approach to managing the
risks associated with nanotechnology
across the product lifecycle, from devel-
opment through disposal and recycling.12
But risk management for nanotechnology
will likely need to develop more exten-
sively as the true nature of exposures
become clearer.
Attempts by insurers to reduce uncer-
tainty from nanotechnology include policy
exclusions, exclusions and write backs
with limited cover, and the introduction
of claims-made triggers for nanotechnol-
ogy related claims. Continental Western
Insurance Group was the first carrier
to adopt commercial nanotechnology
exclusion for bodily injury and property
damage beginning in 2008.13 While the
jury is still out on what impact this move
will take on Continental’s business model,
it may prove to be a very savvy move to
mitigate and control a risk they knowingly
do not understand yet.
The main challenges of nanotechnol-
ogy are that the industry landscape is
dynamic, the technology is so cutting
edge that its outcomes may often be
unpredictable, risk management prac-
tices are immature at best, and there
is no historical experience on which to
base underwriting decisions. As with all
innovation, what is standard fare today
maybe become obsolete, dangerous, or
unrecognizable tomorrow. Underwriters
shouldn’t be fooled - the smallest of risks
may be immense. O
11 The Responsible Nano Code, http://www.responsiblenanocode.org, August 2009.
12 NANO Risk Framework, http://www.nanriskframework.com, August 2009.
13 First Commercial Insurance Exclusion for Nanotechnology, http://www.nanolawreport.com/tags/continental, September 2008.
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What Is the Next Chinese Drywall? Nailing Down Construction Risks By John O’Connor Senior Vice President and Director of Claims, Endurance Reinsurance Corporation of America
and Alex Rosati Vice President and Counsel, Endurance Specialty Insurance Ltd.
While numerous risks are present in
every construction project, construc-
tion product defects can cause
financing problems, time and cost
overruns, and disputes where the
construction fails to meet both
contractual and user expectations.
In addition, construction defects
often require remediation, leading to
further disputes and litigation. With a
globalized manufacturing economy,
contractors are more likely than ever
to source construction materials from
all over the world. Litigation involving
international products is an emerging
area of concern for insurers as foreign
produced products used in construc-
tion often can be more complex than
those products manufactured in U.S.
markets. Therefore, it is important
for insurers to formulate suitable
strategies for understanding the
risks of foreign sourced construction
materials as early as possible in order
to prudently underwrite and price for
these risks.
But what are the major risks involved in
construction defects which many con-
struction firms and insurers face today?
The answer is complex and requires that
we examine past and present experience
in this area.
Continued next page
We can expect construction
defects to continue to emerge
as technical innovation and a
more global economy continue
to evolve the complexity of
construction products.
026End.indd 5 8/24/09 9:06:27 PM
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Globalization and New Technologies Introduce New Products and Risks
Construction defect litigation histori-
cally focused on issues such as water
intrusion, structural integrity (building
collapse) and land subsidence; however
the past several decades have witnessed
a marked increase in claims of either
property damage or bodily injury caused
by a subcomponent of construction as
opposed to either the structure itself or
surrounding land. In many of these in-
stances, the defect arose from a product
thought to be a technological advance
in construction. This issue first surfaced
with asbestos litigation, but over the past
several decades, products as diverse as
Exterior Insulated Finish System (EIFS),
Kitek piping, hurricane straps and, most
recently, Chinese drywall are among ad-
ditional products found to be defective.
In the late 1960s, EIFS, also known as
synthetic stucco, was a “cutting edge”
building technology widely introduced in
commercial construction in the U.S. due
to its ease in creating faux stonework or
stylized exteriors. It was not long before
its use became widespread in residential
construction as well, where it is estimated
that it was used in 25,000 to 30,000
homes nationwide per year.1 In the late
80’s and early 90’s, decay and water
damage problems associated with EIFS
began to emerge. The problems resulted
from water becoming trapped under-
neath the product, eventually resulting
in rot and complete destruction of wood
timbers and sub-walls. The cost of reme-
diation led to a number of class action
lawsuits and the exclusion in almost all
builders’ policies of EIFS and EIFS type
products.2
In the last few years, Kitec piping
issues have emerged, involving between
35,000 to 50,000 homes concentrated
mostly in Clark County, Nevada.3 The
pipes suddenly “sprung a leak,” lead-
ing to numerous water damage claims
and class action litigation filed in 2006.
Investigations revealed that Kitec pipe
fittings fail when exposed to hard water
because of a chemical reaction known
as dezincification. Dezincified Kitec pipe
fittings cause damage not only when they
burst and leak, but they can also impair a
home’s plumbing system so that water is
not properly furnished to appliances and
fixtures.
Another source of recent construction
defect claims are hurricane, or construc-
tion straps, which are used to strengthen
and stabilize wooden structures to
protect against wind damage in coastal
areas prone to high velocity windstorms.
Recent problems with hurricane straps
have been centered in Hawaii but have
the potential for global implications as
these straps are widely used in coastal
areas, including the Eastern Seaboard of
the U.S., the Caribbean, the Pacific Rim
and Australia. These straps are tradition-
ally produced from steel, which can
corrode and rust when improperly
installed or galvanized. The straps can
become unstable, as well as be aes-
thetically displeasing and removal and
replacement can be costly.
The most recent and highly publicized
construction product issue is defectively
manufactured Chinese drywall. Drywall
1 J. Kilpatrick, D. Brown & R. Rogers, “The Performance of Exterior Insulation Finish Systems and Property Values,” The Appraisal Journal, January 2009.
2 “Construction Insurance Hits the Roof,” Construction News, 19 January 2004, www.allbusiness.com.
3 Jeff Pope, “Kitec Lawsuit: Judge releases 322 homeowners from class-action plumbing lawsuit, Sun City McDonald Ranch duplex owners settled for $11.6 million in 2007,” Las Vegas Sun, 15 December 2008.
Due to defective or poorly installed hurricane straps, high winds can rip the roof off a
house or building.
026End.indd 6 8/24/09 9:06:32 PM
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Continued next page
was originally designed as a technologi-
cal innovation to replace labor intensive
lathe and plaster construction.4 Due to
shortages in building material during
the post hurricane building boom in the
Gulf Coast of the U.S., use of drywall
imported from China became prevalent
from 2004 to 2006 in new construction
in these areas. Although the majority of
defective drywall was imported into the
U.S. in 2006, there are unsubstantiated
reports that the material was introduced
into the U.S. as early as the 1990’s.
According to early reports, Chinese
drywall emits a high level of sulfur gas
when exposed to heat and humidity.
These gases cause noxious smells,
corrosion of copper wiring and piping,
and respiratory tract irritation. Although
long-term health care concerns have
been raised, no scientific evidence has
been confirmed. It is also unclear whether
Chinese drywall issues will extend be-
yond the United States.
A recent Senate investigation into the
Chinese drywall issue confirmed that
more than 600 complaints have been
received by the U.S. government.6 More
than 550 million pounds of the product,
or enough material to build more than
60,000 homes, have reportedly been
imported into the U.S. from China.7
Problems with the product have been
identified in at least 21 states, although
the majority of the exposure is in Florida
and other southeastern states. Further
complicating this matter, it may be dif-
ficult to obtain jurisdiction in the U.S. or
to enforce a judgment obtained outside
the U.S. against foreign manufacturers,
some of whom are based in China or
have plants in China.
Products such Kitek piping, EIFS, drywall
and others, that appear to offer cost
savings initially, may well end up being
more costly over the long term. Build-
ers involved in the Chinese drywall issue
have reported repair estimates as high as
$100,000 per home.8 With the litigation
in its early stages, it is likely that these
estimates may prove to be too low.
Construction Defect Risks Exacerbated by Foreign Jurisdictions
Other risks relate to the lack of regulation
in many foreign jurisdictions governing
product quality and safety. Products from
a country of origin that has lackluster
quality and safety standards, with little or
no regulatory or oversight mechanisms in
place for its manufacturing sector, must
be carefully vetted. In many countries
in the Pacific Rim and Southeast Asia,
building materials are manufactured
by small, local, closely held concerns
with little or no quality assurance. Full
inspection of a counterparty supplier and
that supplier’s quality control and safety
inspections and/or testing should be
standard procedure for all builders sourc-
ing foreign products.
It is critical that builders, construction
firms and subcontractors understand
that they may not always be able to bring
legal action against a foreign manufac-
turer if a defective product becomes an
issue, such as in the case of Chinese
drywall. Many foreign manufacturers
operate from countries that may not allow
litigation initiated by foreign entities. Still
other foreign companies, although they
may be “present” in the U.S. or another
jurisdiction, may not be legally subject
to service of process, particularly if their
country of origin is not a signatory to the
New York or Warsaw Conventions or if
that country does not have any treaty
that requires mutual recognition and the
enforceability of foreign judgments with
the subject jurisdiction. Even if jurisdiction
is obtained, obtaining meaningful discov-
ery and prosecuting the litigation may be
extremely costly.
Implications for Construction Firms and Insurers
Construction firms and insurance carriers
need to be aware of the potential risks
arising out of new building technologies
or products so that emerging risks can
be identified before they pose a threat.
4 The original “gypsum wallboard” was marketed in 1916 by the United States Gypsum Company and came into wide-spread usage after World War II. M. Gardner, “All Things Gypsum: A Brief History of Gypsum Board in North America,” Walls & Ceilings, 1 December 2009.
5 Stirling Insurance Blog, www.stirlinginsuranceservices.com, June 2009.
6 A. Kessler, “Senators Press for Action on Chinese Drywall,” Herald-Tribune, 29 June 2009.
7 A Kessler, “Drywall Problems May Be Just Beginning,” Herald-Tribune, 1 February 2009.
8 J.P. McQueen, “The Prisoners of Drywall,” Wall Street Journal, 6 August 2009.
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In addition to construction defects in
the products themselves, construction
labor and workplace regulations may
be inadequate, leading to installation
issues. Therefore, construction firms and
their insurance partners must consider
regularly monitoring construction projects
for these types of loss exposures. New
products and their manufacturers must
be carefully vetted and product testing
should include examining the potential
health effects related to being exposed to
a new building product.
The types of policies implicated by
construction defects have been primar-
ily Commercial General Liability, Build-
ers’ Risk and OCIP (Owner Controlled
Insurance Program) policies, the latter
also known as construction “wrap” or
“wrap-up” policies. Commercial General
Liability policies are mostly occurrence
forms as are Builders Risk forms, which
have the additional feature of a “close of
escrow” trigger date. The main features
of OCIP policies are that they are usually
owner purchased and can cover all risks
emanating from a construction project
on that owner’s site, including workers’
compensation, general liability, archi-
tects’ and engineers’ professional liability,
builders’ risk, excess liability and pollution
liability. OCIP policies significantly reduce
the duplication and overlaps from other
policies that may be purchased sepa-
rately and they also generally require an
integrated owner-contractor managed
safety program for the insured project.
To continue underwriting new and re-
newal construction risks, the insurance
industry must give careful consideration
to balancing the needs of the construc-
tion industry with the needs of insurers
so that insurers are able to underwrite
these risks on a financially sound basis.
All possible policy forms, including
Commercial General Liability, Builders’
Risk and OCIP, should be reviewed and
considered to ensure that the policy is
appropriate and tailored to the particular
situation involved. Underwriters must be
cautious and require builders to complete
a detailed questionnaire during the ap-
plication process, requiring full disclosure
of information regarding use of imported
building products. Insurance carriers
would also do well to consider revising
current policy forms to include exclusion-
ary language that may help to mitigate
exposure to defectively manufactured
foreign construction products.
We can expect construction defects to
continue to emerge as technical innova-
tion and a more global economy continue
to evolve the complexity of construc-
tion products. To manage these newly
emerging construction product defect
risks, construction firms and their insur-
ers need to monitor new products as
soon as possible to identify any potential
exposures caused by the product itself
or the manner in which it was installed. In
particular, additional vigilance is needed
with respect to imported construction
products where weak or non-existent
product quality and safety standards can
increase the likelihood of construction
defects. Even more troubling may be the
legal and regulatory challenges that arise
from foreign manufacturers in jurisdictions
that preclude insurers and reinsurers from
achieving a fair resolution of construction
defect claims. O
The GreaT Drywall of SheboyGan
026End.indd 8 8/24/09 9:06:37 PM
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Continued next page
Beware Inflation: Why Insurers Can’t Ignore It Interview with Hans-Joachim GuentherChief Underwriting Officer and Head of Endurance Reinsurance, Europe and Asia
and Jeffrey Dollinger Chief Actuary, Endurance Worldwide Reinsurance
Why is inflation of concern in the current economic environment?
Guenther: Government lending in many
countries is creating massive deficits to
resist the worldwide recession and these
deficits increase the likelihood of high
inflation. This is of concern to insurers as
inflation can significantly increase claim
costs, especially for long tail casualty
lines or even engineering coverage.
While insurers may also see nominal
increases in premiums based on sales,
payrolls, etc. and can even revise their
market terms for the current underwriting
year, these don’t offset the inflationary
impact on reserves from previous under-
writing years.
Dollinger: Inflation causes deficiencies
in reserves from past years but also hurts
the asset values of insurers who invest
in bonds with long maturities, because
long-term debt is sensitive to high
inflation and may need to be written
down in value. Duration matching of
assets and liabilities does not protect
insurers against this additional inflation
risk, because for an insurer writing long
tail liability business this strategy would
entail investing a portion of the portfolio in
long duration bonds.
Guenther: When talking about infla-
tion, you also hear from time to time the
argument that high inflation is going to
be offset by a high interest rate environ-
ment which should mitigate inflationary
Many economists are predicting
significant inflation as a result of
increased lending by governments
around the world in their attempts
to counter the effects of the global
financial crisis. We asked Endurance
Worldwide Reinsurance professionals
to discuss the potential implications
of high inflation on reserves, pricing
and investments as well as to identify
some strategies that insurers and
reinsurers can use to mitigate
these impacts.
burdens. Although this premise isn’t
incorrect, interest rate developments
always respond to inflation with a time
delay, i.e. real inflation is going to grow in
high inflation environments.
How does inflation impact ceding companies?
Guenther: Insurers may need to adjust
not only their current reserving levels, but
also recognize that for long tail risks in
casualty lines, inflation can impact prior
year reserves. Typically, ceding compa-
nies may need to reevaluate reserves
going back as many as ten, twenty or
even more underwriting years and adjust
026End.indd 9 8/24/09 9:06:40 PM
10 theEdge 11theEdge
these reserves to account for inflation
expectations. You only need to consider
those lines of business with significant
bodily injury exposure, such as motor or
decennial liability covers.
There is also a significant risk that insur-
ers will not price new business adequate-
ly as the industry relies on historical loss
experience that doesn’t always appro-
priately predict future loss trends. Given
uncertainty and the divergent views in the
market, even if an insurer could accurate-
ly predict inflation, competitive pressures
would likely prevent them from realizing
adequate rates.
How can ceding companies address these impacts?
Dollinger: From an investment perspec-
tive, insurers can manage their asset
portfolio to a short duration to man-
age inflation risk. Cedants with longer
term debt can invest in inflation indexed
bonds, such as Treasury Inflation-
Protected Securities (TIPS) and I-Bonds
issued by the U.S. Treasury or other kinds
of floating rate notes, as well as asset
classes whose underlying investment
exposures are related to tangible assets
whose value tends to keep better pace
with inflation than other investments.
Cedants may also wish to consider
the high degree of correlation across
accident years and work with their
reinsurance partners who understand in-
flation risk to develop appropriate reinsur-
ance strategies. Appropriate structures
can be tailored to provide both inflation
protections for the ceding company, such
as risk sharing, and adequate pricing to
the reinsurer for the ceded risks.
How are anticipated inflation increases impacting the current rate environment?
Guenther: Reinsurers may well need to
increase rates in anticipation of inflation-
ary increases in claims. However, with
inflation expectations varying across
reinsurers, ceding companies will likely
see wider ranges in pricing. In this type
of market, it becomes especially critical
to partner with a knowledgeable reinsurer
that can differentiate between real claims
movements and inflation effects. Insurers
may also see greater use of sliding scale
terms or other price adjustment method-
ologies to address inflation risks beyond
those covered by indexation clauses.
Don’t indexation clauses cover inflation risk?
Dollinger: To some extent, but not all
costs are covered by indexation clauses.
For example, increases in the cost and
utilization of at-home and other types of
medical care have greatly outpaced infla-
tion indices commonly used for workers
compensation, motor liability and other
liability lines reinsurance treaties. These
costs can drive up claim costs, particu-
larly for motor liability, where they account
for over 50% of the costs of serious bodily
injury claims in most major countries.
“I’ve called the family together to announce that, because of inflation, I’m going to have to let two of you go.”
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www.endurance.bm
11theEdge
Does inflation have a greater impact on insurers or reinsurers?
Guenther: Despite indexation clauses,
the leveraged effect of loss trends under
excess of loss treaties causes reinsurers
to assume proportionately more inflation
risk than insurers. A simple example of a
fully indexed layer might help to under-
stand this effect: if an unlimited excess
of loss program with a €1 million attach-
ment point is impacted by a €4 million
gross loss, the reinsurer would need to
pay out €3 million. But were there to
be 50% inflation over a period of time
prior to payment, the gross loss would
increase to €6 million; an indexed reten-
tion would increase to only €1.5 million
resulting in a loss of €4.5 million to the
reinsurer. In this example, the economic
impact to the reinsurer increased by €1.5
million while the cedant’s retention only
increased by €0.5 million.
Is the impact expected to be more severe in certain markets?
Guenther: Overall, because inflation
tends to be a global phenomena,
geographic diversification does not
700
900
1,100
1,300
1,500
1,700
1,900
10/1/07 1/10/08 4/1/08 7/1/08 10/1/08 1/1/09 4/1/09 7/1/09 10/1/09
The Fed Doubles the U.S. Monetary Base
U.S Monetary BaseFederal Reserve/Boardof Governors
$-Bil.
With the advent of the
current financial crisis, the
U.S. government doubled
the monetary base which
may be a leading indicator
of escalating inflation. This
increase can have significant
implications for insurers and
reinsurers.
Source: The Argus Research Group, Inc.
mitigate inflation risk. Moreover, inflation
risk is greater where claim payments
are pushed further into the future due
to certain specific regulatory and legal
requirements of some countries. For
example, the Court Act in the UK encour-
ages periodic payout of claims rather
than lump sum payments and in France it
is common for motor liability claims to be
eventually reopened. In fact, it is widely
believed that the Fifth European Union
Motor Insurance Directive will increase
bodily injury exposure in some countries
as the limits for motor liability are harmo-
nized across the Continent. O
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12 theEdge
Editorial Board
Principal Offices
Emily Canelo, Editor-in-ChiefEVP & General Counsel
Endurance Worldwide Reinsurance
Catherine A. Kalaydjian, Senior EditorEVP & Chief Claims Officer
Endurance Specialty Holdings Ltd.
Kevin Rooney, Contributing EditorSVP & Professional Liability Global Practice Leader
Endurance Reinsurance Corporation of America
Shannon Totten, Contributing EditorVP, Transportation, Energy & Diversified Industrial Industry Practice Leader
Endurance Specialty Insurance Ltd.
Ellen Erhardt, Production EditorVP, Corporate Communications
Endurance Services Limited
Endurance Specialty Insurance Ltd.
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Main Phone: 1 914.468.8000
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New York
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Endurance Services Limited
New York
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White Plains, New York 10604
Main Phone: 1 914.468.8000
Main Fax: 1 914.997.0331
The Edge is a publication of
Endurance Specialty Holdings Ltd.,
a global provider of property and
casualty insurance and reinsur-
ance. The Edge is intended to offer
current information and opinions
on issues facing our valued clients
and brokers. If you have any com-
ments, suggestions, or would like
to have us address a specific topic
in our next issue, please email us
or call 212.471.2800.
www.endurance.bmYOUR RISK IS OUR FOCUS
026End.indd 12 8/26/09 1:25:46 PM