Risk Management Reports

January, 1999
Volume 26, No. 1
Issues for 1999

Each January I suggest some issues that should require the attention of risk managers in the coming twelve months. It is an exercise of personal chutzpah. For 1998 I warned of the growing importance of and reliance on information technology, from intranets and the Internet to the Y2K problem. The forecast Leonid meteor shower in November had little effect on satellites but the Microsoft litigation and the AOL/Netscape merger easily focused our attention on the latent uncertainty in this arena. I also suggested financial market instability. The forecast breaking of the equity market "bubble" happened, but the insurance market, equally unstable, continued on its reckless under- priced path. The enlarged responsibility of employers to employees remained high on the organizational agenda. As forecast the Middle East replaced Hong Kong in political news, with Saddam Husseinís posturings and the dramatic Wye River accords. I missed Kosovo. Finally, I raised three general issues: the "millennium fever," greater interest in crisis management and a continuing movement toward naming a "Chief Risk Officer" in some organizations.

If I could bottle and sell Uncertainty in 1999, Iíd be a millionaire! The crystal ball is all smoke and clouds: political turmoil, economic questions, Y2K coming ever closer, and the potential for legal mass hysteria. Add to these some developing issues that will affect us over the longer term, such as health pandemics, the corrosive effect of gambling, the growth of the geriatric society, a new role for risk management, and 1999 will indeed be "exciting times."

Issue number one is economic instability. In May 1998 I echoed warnings that the equity market "bubble" in the United States would burst. It did, only to be reinflated by a new bubble of "irrational exuberance" flying in the face of continued Asian financial difficulties, a South American growth rate projected at 0%, a shaky Brazil, and shrinking corporate profits in the US. The Economist called it a "dead cat bounce." Charles Clough, the chief investment strategist for Merrill Lynch, argued that the Federal Reserve Boardís cut of interest rates "reflated" the market. Eric Kobren, in Fidelity Insight, suggested that "too few people are talking about earnings," and Peter Bernstein, the observer whose judgment I trust, warned that a "rebirth in euphoria is premature." Some say that the current lift is fueled by baby- boomer optimism that canít be dampened, becoming a self-fulfilling prophecy. Three possible outcomes of this second bubble, according to The Economist, are "an overheated economy with rising inflation," "an external shock," or a "financial crash when a speculative bubble bursts." Its conclusion: the US expansion "will enter the history books with a less happy ending." For risk managers, the spillover from this possibility will mean a reduction in market liquidity, fewer counterparties for risk-bearing deals in the capital markets, and an increase in prices in the insurance market. The so-called "hard" market will return at last! Paraphrasing Macbethís witches: "Double bubble, toil and trouble, Fire burn and cauldron bubble." It wonít be an easy year.

The second issue is political turmoil. Beginning with the almost incredible scenario playing out in the United States, where a President faces an impeachment trial in the US Senate, and current and possible upheavals in the Middle East, Balkans, Iraq, Central Africa, India-Pakistan, Indonesia, North Korea, Russia and, yes, even Canada. Will more local eruptions occur while the US is busy cleaning its own sordid laundry? All of this while Europe wrestles with the introduction of the Euro, its single currency. The world will be a less tidy place in 1999. Surprise will be the order of the day.

Legal mass hysteria is my third issue, a pernicious disease spreading rapidly in the US. It has been exacerbated by the enormous tobacco settlement, one that threatens to stimulate similar suits in other countries. In particular, the outrageous agreement by an arbitration board to award some $8 billion in fees to lawyers who helped three states win $34.4 billion in their cases could easily precipitate a rush by other plaintiffís counsel (and I use that term advisedly!) to cash in on other class actions. Just consider what the legal fee awards may be on the larger $206 billion multi-state tobacco settlement! The legal system in the US is running amok! Hysteria also seems to have provoked the $3.2 billion settlement offer of Dow Corning to women alleging injury and systemic diseases from exposure to silicon in breast implants, despite the latest court-appointed scientific studies that show no causal connection. Granted that studies continue and we may yet learn of problems connected with silicone, but the initial reaction is clearly hysterical. Hysteria may yet create enormous payments for alleged exposure to EMF (electromagnetic force). Peanuts have been removed from the menus of many airlines and schools in response to a small group of hysterical parents whose children are allergic to this vegetable. Americans eat three pounds of peanut butter per person each year. In seventeen years, the Center for Disease Control reported only 88 deaths from food allergies, including peanut butter. Compare this to the deaths of 2,880 children in automobile accidents and 2,944 in other accidents in 1995. Misperception of risk, the power of the few to intimidate the many with the threat of legal action, and a legal system out of control permit an irrationality that threatens our entire economic system. Managing the risk of hysteria over a product or service will be a major role for risk managers.

The computer is my fourth major issue. Foremost is the Y2K problem, which will be resolved, one way or another, on January 1, 2000. No matter how well prepared we think we are, we will all be gripped by caution as we cross this millennium threshold. Forget the fact that, historically, the 2000th year following the birth of Jesus Christ almost certainly occurred six years ago: the computers are wedded to our mistake, as are we to them. I trust we will breathe a collective sigh or relief on January 2 next year, but who knows? Whatever happens, however, I suspect weíll see a continuing round of claims, and the inevitable lawsuits, against insurance companies for whatever does happen to go wrong, and an equal number of requests to the courts for relief by insurers. This preoccupation with Y2K could have a salutary side effect. It could force a thorough review of dependencies on hardware, software and data, a corollary investigation of data security and privacy, and consideration of the promises and perils of the new digital economy. The "Digital Economy" was the title of a group of thoughtful articles in the Autumn 1998 issue of The Wilson Quarterly. Bradford De Long described the economy, its "sheer speed" and the implausible idea that "you make money by selling goods for less than they cost - relying on the learning curve to lower your costs next year." Shades of the fabled Armenian rug merchant: Iíll sell it to you for less than it costs me, but make up the difference on volume! Edward Tenner outlined the five "most ominous threats" of Y2K: "second-order effects, malicious codes, interdependencies, litigation, and embedded processors," abbreviated as SMILE. He recognized the possibility of a "late 1999 panic that might be comical but also potentially deadly." He concluded, " . . . technology is not just a radiant future but a messy present . . . ." Leslie Simon cited real concerns about privacy, security, objectionable content, access, taxation and infrastructure, noting that "cyberspace is borderless" and that "trying to draw up laws and regulations in a national vacuum is increasingly an exercise in futility." We are just beginning to live with the computer and the new age of information.

Copyright 1999, by H. Felix Kloman and Seawrack Press, Inc.

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