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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2 theEdge 3theEdge

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.

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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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5theEdge

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.

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6 theEdge 7theEdge

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.

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7theEdge

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

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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

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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.”

026End.indd 10 8/24/09 9:06:43 PM

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.

Bermuda

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Endurance Worldwide Insurance Limited

London

4th Floor, 2 Minster CourtLondon, EC3R 7BBPhone: 44 (0) 20 7337 2800Fax: 44 (0) 20 7337 2900

Endurance Reinsurance Corporation of America

New York

750 Third Avenue, 19th floorNew York, New York 10017Main Phone: 1 212.471.2800Main Fax: 1 212.471.1748

333 Westchester Avenue

White Plains, New York 10604

Main Phone: 1 914.468.8000

Main Fax: 1 914.468.0331

Endurance U.S. Insurance Operations

New York

767 Third Avenue, 5th floorNew York, New York 10017Main Phone: 1 212.209.6500 Main Fax: 1 212.209.6501

Endurance Services Limited

New York

333 Westchester Avenue

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

at ecanelo@endurancereusa.com

or call 212.471.2800.

www.endurance.bmYOUR RISK IS OUR FOCUS

026End.indd 12 8/26/09 1:25:46 PM