A risk management look beyond the horizon

Many companies want to insure themselves against all the uncertainties that can occur in their value or supply chain, including market risk and price fluctuations. However, this is where the insurance industry reaches its limits. As in traditional insurance, innovative risk transfer solutions such as NDBI must meet criteria such as randomness, uniqueness, estimability and independence.

Here is a brief insight into the small 1 x 1 of insurability:

 Randomness means that the risk is uncertain and uncontrollable when the contract is concluded. To eliminate moral hazards, uncertainty must be present in both contracting parties. Besides moral hazard, information asymmetry is one of the biggest challenges for the insurance market. Often, the insurer does not have the same level of knowledge about the circumstances that may lead to a loss and may impose limitations on the scope of coverage. Customised solutions based on weather events as triggers, offer the advantage of objective risk assessment here, as the data is often provided by an independent third-party provider, such as NASA, satellites or weather stations.
 
Uniqueness requires that all essential characteristics of the event as well as the obligation to perform must be definable. Any residual risks must be borne by the policyholder. For example, the values from a weather station may have to be extrapolated to cover a larger area or region. In this case, the damage presented may deviate from reality.
 
Estimability is the ability to determine the expected value and spread of the loss distribution to be insured (loss amount and probability of occurrence). Estimability is not sufficiently ensured if there is not enough meaningful data to be able to create an appropriate risk model. Otherwise, subjective risk assessments – but with an increased risk of error – can also be considered.
 
Independence ensures that the risk can be diversified for the insurer. This means that many risks that do not materialise in the same event must be insured in the risk community of the insured. The aim is to avoid accumulation risk, i.e. the probability of a simultaneous or staged occurrence of loss for many insured risks. In a global value chain where just-in-time delivery is required, a strong correlation of various events can be assumed. A disruption at a manufacturer of certain components in Asia can cause massive damage and interruptions in Europe and vice versa.
 
These basic principles essentially define the limits in risk transfer. The criteria for insurability do not necessarily have to be met in full; a level at which risk equalisation is sufficiently ensured is adequate.