Memorandum submitted by Lloyd's (SAGE
45)
Lloyd's is the world leading specialist insurance
market and consists of 87 separate syndicates managed by 55 managing
agents. While managing agents are responsible for the business
of underwriting, the Society of Lloyd's has responsibility for
central functions. As part of this the Society runs a performance
framework to ensure managing agents are taking the actions necessary
to achieve or exceed the targets set for syndicates. The performance
framework is prudential and seeks to ensure the Central Fund,
Lloyd's brand and ratings are protected. A key element of the
performance framework is Exposure Management, which looks at potential
for aggregations of risk arising through underwriting. In this
capacity we have established an Emerging Risks team which monitors
for potential new threats and assesses their possible impact to
the insurance industry. We also have an initiative called "360
risk insight" which aims to bring new risks to the attention
of risk managers in a variety of the companies that we insure,
always with the intention of suggesting action to manage the risk.
The risks of space weather are well known to
space underwriters at Lloyd's due to the direct damage it can
inflict on satellites and Lloyd's assesses the potential impact
of a major proton flare on the market in our annual Realistic
Disaster Scenarios exercise. For the purposes of the scenario
it is assumed that either a single anomalous flare or a number
in quick succession result in an insurance loss of 5% for all
satellites in synchronous orbit, except for those policies that
exclude power loss. Capital held at Lloyd's is therefore annually
tested to ensure adequacy against such an event.
The Emerging Risks team has been looking into
the terrestrial effects of space weather in more detail since
the end of 2009. The impact of space weather on terrestrial systems
has grown along with society's increasing reliance on digital
technology and electrical infrastructure. These risks were captured
in our 2009 emerging risks report on digital risks which highlighted
for example the pervasive use of GPS. Cyber risks will be discussed
further in our 360 risk insight report to be published 1 December
2010 which highlights the actions businesses can take to mitigate
this risk. Space weather has been the direct focus of our most
recent 360 risk insight report entitled "Space Weather: Its
impact on Earth and implications for businesses". This report,
published on 8 November was produced in partnership with Professor
Mike Hapgood from the Rutherford Appleton Laboratory. Professor
Hapgood gave oral evidence to the House of Commons Science and
Technology Science Committee on 10 November 2010 and made reference
to many of the findings in our report.
It is clear that we do not know the probability
of a Carrington sized Coronal Mass Ejection event. We suggest
that a critical first step to guide mitigation strategies would
be to increase the sophistication of modelling of these events—so
that the return period can be estimated with greater accuracy.
Lessons can be learnt from the approach taken by climate scientists
ie a mixture of physical modelling and paleo-science should be
helpful. If the return period were to be shown to be less than
200 years (ie events occur more frequently than a 1/200 annual
probability) then it would require consideration under the regulatory
capital calculations undertaken by the UK insurance industry.
Our report examines the potential effects of
a large space weather event on: aviation, oil and mineral industries,
pipelines, communications, automotive industries, rail, water,
sewage, medical establishments, finance and, most critically,
power. With all these areas of modern society being affected simultaneously
and possibly across an entire hemisphere in a matter of seconds
society should prepare for significant impacts over an extended
period. An extended loss of power could lead to a cascade of operational
failures that could leave the global economy severely disabled.
Other smaller catastrophes, for example hurricane Katrina have
demonstrated how society can struggle to rebuild when critical
services are disrupted simultaneously. These events also show
that, the longer recovery takes the larger the costs. At present
there is much uncertainty surrounding this issue. A scenario leading
to loss of power over many months and possibly years seems extreme
but plausible and the onus on policymakers should be to consider
this seriously unless it can be shown that the probability is
appropriately small.
Our report notes that 90% of critical infrastructure
is not under Government control. Whilst we appreciate the security
implications, it would be helpful, where possible, to share information
on the location of such infrastructure with insurers. This will
enable better modelling of all manner of catastrophes ranging
from flooding, earthquakes and windstorms to space weather. We
believe that businesses owning such infrastructure have a responsibility
to protect it against a variety of threats. However, we also recognise
that commercial competitive pressures are very strong so adequate
regulation is often required to level the playing field: in the
presence of uncertainty only the weakest response will typically
arise.
In January 2010 we published an emerging risks
team report on Behavioural Risks. This report highlights the work
of behavioural theorists of the past 50 years as it applies to
emerging risks management. We believe the impact of cognitive
biases should not be underestimated when considering new risks
like space weather. Cognitive dissonance can lead to people "explaining
away" new risks because they conflict with their desire to
continue life as before. Scenario biases arise because, if people
cannot conceive how harm will occur, they will often miscalculate
its probability (assuming it is far lower than it really is).
Representation bias can distort perception of risk as people argue
a new risk is "like" an old one—"how can
something as pleasant as the aurora borealis be risky?" People
find chain risks (when a number of connected failures occur one
after the other) very hard to envisage and this is linked to our
well known inability to estimate conditional probabilities. Emerging
risks continually expose all these human cognitive failings and
highlight the importance of taking account of behavioural factors
and using computer models to augment our intuition.
Insurance coverage in a space weather event
will be a function of the precise policy wording and we cannot
make general statements here. However it is important to realise
that policies generally only pay out when physical damage has
occurred. Hence a power surge leading to a fire may lead to an
insurance payout; whereas a surge leading to power failure (but
no actual physical damage) lasting many months may not lead to
insured business interruption payouts. Some risks do exceed the
capacity of the insurance industry to respond—material aggregations
over a wide geographical area are typically where the principles
of insurability start to break down. Therefore we believe the
first line of defence with space weather will be to mitigate its
risks up front (for example rail signals that default to red after
a power failure).
We would like to thank the House of Commons
Science and Technology Science Committee for giving Lloyd's the
opportunity to contribute to this debate.
Trevor Maynard
Deputy Head of Exposure Management
Performance Management
18 November 2010
SUPPORTING INFORMATIONwww.lloyds/space
Lloyd's 360 Risks Insight report: "Space Weather:
Its impact on Earth and implications for businesses"
www.lloyds.com/The-Market/Tools-and-Resources/Research/Exposure-Management/Realistic-Disaster-Scenarios
Lloyd's Realistic Disaster Scenarios
http://www.lloyds.com/The-Market/Tools-and-Resources/Research/Exposure-Management/Emerging-risks
Lloyd's Emerging Risk report: Digital risks: Views
of a changing landscape (2009)
Lloyd's Emerging Risk report: Behaviour: Bear, bull
or lemming?
See www.lloyds.com/360 for our forthcoming report
on cyber risks.
For more details about Lloyd's in general see: http://www.lloyds.com/Lloyds/About-Lloyds
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