Black Swans on the Horizon: Expecting the Unexpected
Elise Farnham | April 1, 2011
Insurance and claims professionals tend to focus on the past when analyzing future exposures. They analyze and evaluate past losses to prepare themselves for handling future losses. While this backward focus provides a systematic, logical process for anticipating future needs, it does little to prepare claim professionals for "Black Swans" that come out of nowhere and completely change what we thought we knew.
Unfortunately, looking in the rearview mirror does not prepare claim professionals or their organizations for "Black Swans" that explode on the scene and entirely change many long-held beliefs about risk and loss exposures, claiming behavior, and allegations made by plaintiffs or insureds when presenting their claims.
The Black Swan Theory
Author Nassim Nicholas Taleb wrote The Black Swan and developed the Black Swan Theory, defined as any event that is unpredictable and an outlier, has tremendous impact on what the world thought it knew, and can be rationalized in hindsight. Black Swans, by definition, are entirely unpredictable. They can and do occur on a regular basis and can be used to explain every major upheaval in the world's knowledge.
Despite the inevitability of Black Swans, claims professionals must continue to analyze past occurrences to prepare themselves for the future. They must continue to review case histories to determine precedents set by prior court decisions. Concurrently, they must also look to the future. The Black Swan Theory points to the fallibility of known information about claims and analysis of losses and coverage. Because claims professionals can never know what is unknown, they must develop tools that will help them prepare for the totally unexpected.
The first thing to understand is that the Black Swan Theory acknowledges the unpredictability of future events with large impact. There is another aspect of Black Swans that is also important to remember. Following a Black Swan event, we attempt to rationalize the occurrence, thinking that we should have known it could and would occur. In reality, we could not have known the timing of the occurrence, the impact of the event, or the changes that the world would make because of the event.
Black Swans include events such as occurred on September 11, 2001, at the World Trade Center, the devastation caused by Hurricane Katrina, and the nuclear disaster unleashed as a result of the March 2011 tsunami set off by the Japanese earthquake. Each of these events was unpredictable, but individuals have said, "We knew this would happen." And yet, they couldn't possibly have known, for if they had known, government officials, property owners, and insurance professionals would have changed their processes and procedures prior to the events occurring.
Prepare for the Unexpected
Just because Black Swans exist and are unpredictable does not mean we cannot be prepared for them. In fact, the concept of insurance is to provide financial assistance when the unexpected occurs. So, how do claims professionals prepare for the unexpected?
Scenario Planning
Because every event has consequences, an appropriate goal would be to make sure there are more positive than negative outcomes when the unexpected occurs. One tool to consider is scenario planning. Scenario planning that takes into account both positive and negative outcomes serves to prepare the claims professional for a range of possible outcomes—which, obviously, aren't predictable anyway! Scenario planning has its own weaknesses, of course. Because Black Swans are unpredictable, the scenarios that are developed will most likely never occur. However, studies have shown that individuals who practice their creative and critical thinking skills by analyzing and working through scenarios are much better prepared to handle unexpected events. Consider scenario planning as practice for the real thing.
Be Aware of World Happenings
It's also important to simply pay attention to the world around us. While no one predicted the financial collapse, once it occurred, certain downstream behaviors could be anticipated. Claiming behavior changed dramatically following the financial downturn. Fraud increased dramatically, personal lines claims volume decreased, policy limits were reduced, and insureds purchased more limited coverage or requested higher deductibles. Foreclosures resulted in mortgagees getting involved in property ownership, claim processing, and claims settlement activities that had previously been done by the insured as mortgagor.
Global warming will most likely result in numerous Black Swans. And, while more severe weather has been predicted for the future, where will it strike? How much property will be damaged? How many insurers will be able to withstand the financial impact of multiple catastrophes? Will there be sufficient claim professionals to handle the loss adjustment duties? What if predictable catastrophes result in unpredictable consequences? What new technologies will be developed to assist claim professionals in handling the loss adjustment activities?
Continuous Education
Continuous education is another tool that claims professionals should employ. It is a common practice today for many claim practitioners to focus on a single line of coverage or type of claim. An effort should be made to broaden knowledge and increase its depth. Attending seminars and conferences is one method of broadening knowledge. Most conferences offer numerous seminars on a wide range of topics that might suggest a learning opportunity that the claims practitioner had not previously considered. Utilizing the resources available from defense counsel with a particular specialty is another. Law firms are particularly helpful in providing information as to current court findings and trends.
By following current trends, claims professionals can better anticipate future outcomes. Certainly attaining a credential will help assure that the claim professional is prepared for any event that might occur.
Conclusion
The rearview mirror is great for analyzing past losses, but to effectively manage future losses, claims professionals and their organizations must also consider "what if?" In this way, they will successfully meet the challenges of the next Black Swan.
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