Marc Beckers considers the impact of the financial turmoil on second order risks

Analyse the economic capital of European insurers and you’ll see that, on average, credit risk only represents about 5 to 10% of the total required capital.

The bulk is linked investment risk (especially for life insurers) and biometric insurance risk. This is where the average company should focus most of their risk management attention as it is where the strong will be separated from the weak in terms of enterprise risk management.

The importance of credit risk has increased significantly during the current financial crisis. Just like in mathematics, the second order risks tend to gain in importance as sophistication improves. Moreover, once you take correlation into account, the risk might not be minimal anymore.

How correlated is the reinsurance market? And how concentrated is it? It is hard to assess in what way the reinsurance market contains a systemic risk such as we’ve seen in the recent banking crisis. Clearly the asset and liability side are less intertwined and liquidity risk is much smaller.

However, a huge catastrophe event in today’s market could certainly have severe implications as the asset side of the balance sheet is already impaired and paying claims at short notice could be very painful.

It is not surprising that stochastic tools to analyse the credit risk of insurers are suddenly becoming popular. Companies have offered such tools for many years, but second order risks tend to surface quicker when the water reaches the chin – and are certainly demand driven.

Marc Beckers is head of Aon Benfield Analytics EMEA.