Most of us still very well remember the pictures of Tianjin harbour after the two explosions in August 2015. The event was a human tragedy with 173 victims, along with an immense property damage (1). The photo on the right showing the forceful explosion brings back pictures of the huge destruction: The event caused a crater with a radius of 50 meters, complete demolition within a ten times bigger zone and an even larger area of partial destruction. Tianjin reminds us of the potential destructiveness of man-made disasters. We humans tend to forget about such extreme scenarios which could be caused by fire, explosion or radiation as they do rarely occur. But what about risk management?
Do our models sufficiently reflect the next Tianjin-like event?
While this question is hard to answer comprehensively, we have a clear answer for property losses under the European regulation Solvency II.
The standard formula under Solvency II does indeed consider such scenarios to happen once every 200 years. The assessment of man-made catastrophes assumes that the total insured value within a 200 meter radius is lost. This forces insurers to analyse and monitor their biggest risk concentrations. Traditionally, probable maximum losses are estimated which take into account successful loss mitigation actions, e.g. fire fighters and sprinkler systems, resulting in significantly smaller losses. By assuming total losses, Solvency II challenges this approach for extreme scenarios. With reinsurance usually being based on probable maximum losses, insurers have to bear a major part of the risk and have to set aside high regulatory capital buffers. Therefore, some insurers do restructure their reinsurance programs to cover the risk accumulation as defined under Solvency II.
The assumption of total losses within a 200 meter radius seems extremely strict on first sight. But taking into account the 500 meter radius area which was levelled to the ground by the Tianjin event, it seems reasonable to look at such a scenario. Tianjin is one example, besides many others, which reminds us of the potential destructiveness of man-made catastrophes.
Would you be prepared?
I am very interested in your take on this topic. Please feel free to reach out for any discussion or exchange.
An interesting read on Tianjin and the loss accumulation can be found in "sigma No 1 2016: Natural catastrophes and man-made disasters in 2015" (starting on p. 13) and on 2016 disaster and natural catastrophe loss estimates here: news release.
[(1) the total insured loss is estimated to be between USD 2.5 and 3.5bn, estimate as of March 30 2016, sigma No 1 2016]