Scientific advice and evidence in emergencies

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 i.e. 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 (i.e. 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 Information

www.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