Chapter 7: The Geneva Association (1973 – 2001)

3. Synthesis of the Various Types of Insurance
A first big change in insurance revealed itself and took place from the 1970s: the synthesis between various types or categories of insurance in relation to the level of vulnerability of businesses and eventually persons too.
Traditionally insurance had developed through the identification of a type (class) of risk (fire, theft, car accident, skiing accident, etc.) among which a certain homogeneity can be determined (a bicycle and a locomotive cannot be put in the same group), a certain scatter­ing of risks (it is not necessary that all the probabilities of loss be concentrated in the same place), a certain level of frequency of possible damages (thefts cannot be insured against if, for example, in a year there’s a loss for every two insured), a certain limit to the maximum possible damage (for example, the damage caused by a meteorite that destroys a city of a million inhabitants).
Actuaries will explain it better with technical terms such as seriousness, frequency, variance (an average can represent damages relatively close to this average or very great variations such as the cost of the destruction of a little sail boat or a cruise ship with 5,000 people on board).
The phenomenon of the growth of risks and vulnerability (and hence of their costs) led to the development of the risk managers to whom I have already referred. Taking a company’s vulnerability into consideration means that what counts is the cost of the losses independent of the origin or class of risk. If insurance always has to refer to specific classes of risk in order to manage them in a reasonable way, the insured has to identify his vulnerability whatever its cause.
That is how it is when a business suffers a fire breakout. It also risks losing clients if it cannot deliver its products. Some of those products could be badly made and cause harm to health or in some other way. If they are defective they must be withdrawn from the market.
All these aspects have obliged insurance to create well-prepared packages of insurance “products” which were originally developed separately. On the one hand, for example, fire (the cost of rebuilding a damaged house or factory), on the other the indirect losses caused by the fire (consequential losses) when the fire prevents one from fulfilling a delivery contract, and then all the consequences connected to various types of responsibility. Around thirty years ago at the Geneva Association we carried out the first study in Europe on the problem of withdrawal of defective products, a situation that brings into play all the obligations linked to responsibility. It was very amusing to read in our report that withdrawal of some products from the market was like trying to put toothpaste back into the tube.
In any event European industry, somewhat later than the United States, understood the interest of an open and transparent policy on the subject of withdrawal of defective products, and it is not unusual to read announcements in the press about the recall of that type of tyre or that other type of domestic appliance or car. Such incidents are rare but sometimes costly, and cannot be completely eliminated in our imperfect world. It is advisable to deal with them in the best way possible.
Here then is confirmation of an essential point. In economic practice, but not only there, vulnerability is a concern that has already caused important and very obvious changes in the business market.


4. Reflections on the Concept of Risk

Another strategic question that emerges together with the growing importance of vulnerability management concerns the idea that everyone, particularly economists, has of the concept of risk.
Well after the beginning of the 19th century risk was not taken into consideration by econo­mists. It was a subject for sociologists, from Weber to Sombart and others. Price balance excluded uncertainty on principle: in a society based on science it was thought that risks and uncertainty would one day be almost eliminated. This way of thinking lasted a long time and is still lurking in the opinions of many.
At the start of my work at the Geneva Association I met a certain number of top execu­tives resigned to the idea of an insurance condemned to a minor role and without a future. The CEO of an important insurance company said to me one day: “But Signor Giarini, you delude yourself. In today’s world based on science and technology, insurance is destined to disappear. If everything becomes increasingly foreseeable, there will be increasingly less need of insurance”. I thought exactly the opposite. This is why the role of insurance and economics cannot be understood without thoroughly studying their cultural premises and acquiring a real understanding of the scientific process.
At the Geneva Association therefore, we tried, with some success, to promote a discussion on this point of view, with publications, meetings, and conferences involving eminent scientists. The contribution of Nobel recipients such as Ilya Prigogine and scientists such as Karl Popper, Hermann Bondi and Walter Weisskopf, to mention a few, confirmed that this line of thought stood up well.
In particular, referring to one of our publications on The Limits to Certainty: Risk Management in a Service Economy*, Ephraim Katchalski-Katzir, President of the Weizmann Institute, wrote: “You have managed to bring the uncertainty of physics into economics thought, and have done so in a very clear and convincing manner: your analysis of the impor­tance of assuming risks in a modern economy and the study of the origins of uncertainty are particularly brilliant. You have produced a shrewd and exciting analysis of the risks run by people as individuals in many companies and by society as a whole, and you have shown how we have no other choice in the new era in which we find ourselves but to react in a suitable way to the various types of risk we face.”
Here was a judgement which went a long way to justifying the commitment to working for the Geneva Association.
As far as economists are more particularly concerned it was only in the 1920s that Frank Knight wrote a first book bringing out the fact that when it came to investing then the more dangerous the investment the greater was the interest required and vice versa. This meant that for the first time it was acknowledged that there was a certain autonomy in the notion of risk. All this seems obvious and simple, yet Knight’s name is not as well-known as the application of his ideas in every financial activity.
The risk of which Knight spoke and of which most economists, financiers, business people today speak, is none other than one of the two forms of risk of the service economy. On the one hand there is the risk on the part of the entrepreneur who depends on our actions and initiatives (we invest money, we marry, we go on a holiday, we buy a car, we study a given subject in order to qualify for a profession etc.).
Vulnerability on the other hand represents a pure risk. Insurers speak of “Act of God.” Any activity, including those “as entrepreneurs”, that we take on, is also subject to its own level of vulnerability.
Many economists, and often even other financial experts, do not acknowledge this distinc­tion. Over the last thirty years, these have monopolised the idea of risk management in order to define the evolution of money management this being in most cases, an “entrepreneur type” risk activity. While the term “risk management” came about initially in industry, especially in relation to the management of pure risks, dependent on the vulnerability implicit in every plan or situation. These two types of risks are complementary but very different. Pure risk lacks a university and cultural tradition, that of the economists and financiers. In fact it was expected that this vulnerability, which represented the imperfections of the present, would disappear with the development of technology.
Instead there was 11th September 2001, nuclear and biological risks, pollution, environmental risks, social welfare and the vulnerability of welfare and pensions systems. All pure risks are linked to technological and social evolution which to a great extent condition economic evolution of the service economy characterised by the need to obtain the best results controlling every kind of vulnerability.
Finally, there is an important lesson to be drawn from the study of industrial risks in many sectors: it is the one concerning the growing specialisation, complexity and concentration of vulnerability.
Imagine wanting to insure a satellite launch into space: such an occurrence can be counted in a few tens, even less each year. Compare this with a car insurer who has hundreds of thou­sands of customers. In the latter case the probability of accidents and future damage has to be shared by such a large number of cars that a forecast can be fairly close to reality. Instead for satellites a bad year could mean possible losses two, three, five, ten times greater that those reasonably forecast.
The logic of industrial specialisation and activity transforms some classes of risks into statistical units, often more limited in number. In these cases forecasts of accidents become increasingly uncertain. This kind of uncertainty is one of the elements behind the foundation of the Geneva Association. Uncertainty has increased even among insurers.
This was a challenge I did not manage to accept. I tried to tell the economists: you often put forward the concept of the economy of scale and specialisation. Why don’t you suggest an analysis that takes into account the cost of the increase in uncertainty due to specialisation? For their part, actuaries have been studying for a long time now what they call the credibility theory: faced with the increase in the classes of risk with increasingly limited frequency of damages, how does one aggregate – put together – various groups of classes of risks in order to find a better way of managing vulnerability. Economists and actuaries, get yourselves together to review the very concept of scale in economics.

* “The Limits to Uncertainty”, Kluwer Academics Publisher, Dordrecht, London, 1993

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