Dynamic Risk

What Does Dynamic Risk Mean?

A Dynamic risk is a risk brought on by sudden and unpredictable changes in the economy. As an example, this can occur through changes in pricing, income, brand preference or technology. These changes can bring about sudden personal and business financial losses to those affected.

Insurance companies are often affected by dynamic risks related to government policy changes and political pressures on the industry. While government policy can affect all industries, insurance companies have a greater risk due to the strict governance and regulations the government has on how these companies operate. Often, dynamic risks are brought on by cultural changes, but in the case of insurance companies, it can also be brought on by fluctuations in the underlying investments during an economic crisis.

The unpredictable nature of this type of risk can often have drastic consequences for both insurance companies and consumers. When an insurance company is exposed to a dynamic risk, they are often left with few options as to how to overcome the risk. This in turn results in large increases in premiums or costs related to purchasing insurance products. An example of where a consumer would see this is when the overall basic cost of insurance increases for all consumers regardless of rating or claims history. This is often a result of a dynamic risk the insurance company has encountered.

Insuranceopedia Explains Dynamic Risk

In the insurance industry, dynamic risk is assessed using planning tools that measure and predict the potential for these risks. This is not always possible given that dynamic risk is typically a cultural change that can be influenced by many factors. But, as we have recently seen, some factors often appear with no historic data to compare.

Consider that the underlying premise of insurance is a transfer of risk. Policyholders are swapping potentially large outgoing costs for a known, smaller premium paid with an insurance company. The insurance company then pools all the risks and seeks to forecast, manage and pay claims.

An obvious example of a dynamic risk is the COVID-19 pandemic. The multi-faceted nature of this has caused drastic effects on many lines of insurance coverage. Some of the affected lines include business interruption, trade credit insurance, travel, cyber liability and event cancellation.

For example, some businesses made claims due to a disruption to supply chains and the inability to operate as normal due to government lockdown measures. Others needed to claim coverage for income lost when customers who owe money for products or services delay payment or could not pay at all. Events like Wimbledon, the world’s oldest tennis championship, were cancelled. This alone will result in an estimated $155 million owed in event cancellation payments due to the cancellation of the tournament.

An even more extreme example of an insurance payment due to event disruption is the estimated $2 billion that will be due to the postponement of the Olympic Games in Tokyo. In all these scenarios, the effect of these large claims on so many lines of business was both unpredictable and potentially catastrophic for some insurance companies.

While many insurers had considered and priced pandemic risk into their pricing, an unexpected event of this magnitude is very difficult to plan for due to the lack of relevant historical data. In addition, the pandemic has resulted in a significant number of premature deaths, causing an immediate and obvious insurance implication for life insurance companies. This together with the volatility in financial markets, may have various implications to the life insurance assets, balance sheets and future premiums.