Dynamic Risk

What Does Dynamic Risk Mean?

Dynamic risk refers to a risk caused by sudden and unpredictable changes in the economy. This can manifest through fluctuations in pricing, income, brand preference, or technology, potentially leading to significant personal and business financial losses for those affected.

Insurance companies are particularly susceptible to dynamic risks stemming from government policy changes and political pressures within the industry. While government policies can impact all sectors, insurance companies face heightened risks due to strict regulations governing their operations. Additionally, dynamic risks can arise from cultural shifts, but insurers may also be triggered by fluctuations in underlying investments during economic crises.

The unpredictable nature of dynamic risk can have severe consequences for both insurance companies and consumers. When an insurance company faces dynamic risk, it often finds itself with limited options to mitigate the threat. This situation can lead to substantial increases in premiums or costs associated with purchasing insurance products. For consumers, this is evident when the overall basic cost of insurance rises for all policyholders, regardless of their risk rating or claims history. Such increases are frequently a result of dynamic risks encountered by the insurance company.

Insuranceopedia Explains Dynamic Risk

In the insurance industry, dynamic risk is assessed using planning tools that measure and predict potential risks. However, this can be challenging, as dynamic risks often stem from cultural changes influenced by numerous factors, and some of these factors may emerge without historical data for comparison.

The fundamental premise of insurance is the transfer of risk. Policyholders exchange potentially large, unpredictable costs for a known, smaller premium paid to an insurance company. The insurer then pools these risks and seeks to forecast, manage, and pay claims.

A clear example of dynamic risk is the COVID-19 pandemic. Its multifaceted impact has had drastic effects on various lines of insurance coverage, including business interruption, trade credit insurance, travel, cyber liability, and event cancellation.

For instance, some businesses filed claims due to disruptions in supply chains and the inability to operate normally because of government lockdown measures. Others sought coverage for lost income when customers delayed payments or could not pay at all. Events such as Wimbledon, the world’s oldest tennis championship, were canceled, leading to an estimated $155 million in event cancellation payments.

An even more extreme example is the estimated $2 billion in claims resulting from the postponement of the Tokyo Olympic Games. In all these scenarios, the impact of large claims across multiple lines of business was both unpredictable and potentially catastrophic for many insurance companies.

While many insurers had considered and priced pandemic risk into their models, an unexpected event of this magnitude is challenging to plan for due to the lack of relevant historical data. Furthermore, the pandemic has led to a significant number of premature deaths, which has immediate and obvious implications for life insurance companies. This situation, combined with volatility in financial markets, may have various effects on life insurance assets, balance sheets, and future premiums.