Suki Basi writes in Re-Insurance about the challenges and risks posed by Connected Risk.

Lloyd's regulators - and regulators like the FCA, in a wider sense - are cracking down on under-performing Syndicates and carriers. Global capital is increasingly frictionless, connected and transportable across territories and the traditional hard/soft market cycle appears to be broken. In this difficult underwriting environment, many Syndicates are closing books in marine, energy and aviation business, while Lloyd's 2017 combined ratio of 114% equates to a £3.4bn loss.

At the same time the (re)insurance value chain is making the London market, for example, uncompetitive compared to other markets in Asia, the U.S. and Bermuda. In the Lloyd’s market for instance, for every $1 paid by clients in premium, the market pays 40 cents in expenses.  Meanwhile, there is a growing sense that one-in-100 or one-in-500 year events are no longer a valid concept when they seem to crop up with alarming regularity.

In this challenging environment, underwriters need to have a better understanding of their underlying risks to get those combined ratios down, manage peak exposures better, and smooth out peaks and troughs in the underwriting cycle. Connectivity caused by the onset of the new digital age is adding new layers of hitherto unknown exposures. Connected risk is fracturing balance sheets in the corporate world, which in turn threatens to create a feedback loop in the global (re)insurance market.

In this connected environment, I have been having multiple conversations with underwriters, corporate risk managers and regulators to find out how they define the concept of connected risk and the way it impacts their business models. What is becoming increasingly clear is that there is a real thirst to understand how to quantify known and unknown exposures, so that opportunities can be pursued knowing the inherent risks.  

The upshot of those conversations is that my risk modelling business, Russell Group, which has worked hard to define Connected Risk, is finding increasing traction within the marketplace for this definition. In fact, our definition has been so well received that this year I was invited to give talks to the Bank of England and Chatham House.  We define Connected Risk as the systemic exposure of commercial organisations, their partners, suppliers and clients to cumulative and cascading financial, operational and reputational vulnerabilities.

It has been caused by a succession of initiatives from just-in-time processing, outsourcing, on-demand processing and more recently digitisation, which have left companies more inter-connected and reliant on each other.  Moreover, this has led to the blurring of boundaries between companies, meaning that trade now operates over an extended business network in which a company’s partners and suppliers work with that company to serve the needs of the end-client. This increasing business connectivity creates fault lines over which connected risk events can propagate between companies and result in a single negative event causing severe economic damage both within and between companies.   As a result, local events can affect global operations and global events can affect local operations.

The key drivers for Connected Risk are the ways in which political, environmental, supply chain, cyber and credit risks combine to cause financial, operational and reputational loss.

If we accept that the business landscape is interconnected, and business activity and associated risks are connected, then it must follow that the upside opportunities are also connected, and business strategy can only benefit from a clearer understanding of the connection between opportunity and risk.  

It is the increasing need to connect opportunity and risk which will separate the winners and losers in business, since companies and their (re)insurers will need to quantify known/unknown exposure and manage increasingly complex risk to deliver value to the end-client and superior return on equity. 

In my next article, which will be published in tomorrow’s Monte Carlo issue of Reinsurance, I will outline a solution to this.