--> Gill Blog: March 2004

Gill Blog

Monday, March 29, 2004

Linking Petroleum Uncertainty to Teleworking

Perhaps the most visible byproduct of lingering uncertainty in the Middle East is the soaring price of petroleum. A year ago there were some who speculated that a quick war in Iraq might stabilize gas prices, but over the past few months nothing could be further from the reality as prices continue to rise. So far, there are no signs of stability in the near term. These circumstances are starting to bear an eerie resemblance to the energy crisis of the 1970's when there were long lineups for gas and even if one made it to the pump there was no assurance any gas would remain. There was perhaps no event since the Great Depression that has caused such consternation for policy makers than the Energy Crisis which was marked by the rise in oil prices during the 1970's. This began October 17, 1973 when OPEC first flexed its monopoly muscles and quadrupled the price of oil. In the months that followed, people across North America and Europe literally shivered through the winter. The effects of this single event reverberate today, and affected policy making in areas one would never associate with fuel. (Ever wonder why adjustable rate mortgages came into being? You can thank the '73 oil embargo--we'll save that discussion for another day.)

Given the current state of uncertainty (especially during an election year in the U.S.), there are many ways to analyze and react to these circumstances. For one, despite consumer fears of prices going north of two bucks a gallon, this should be put into a broader global context. As it turns out, the sky isn't entirely falling for those in North America, whose fuel prices are among the cheapest in the world. Says John Wada of Rochester, Wisconsin-based Runzheimer International in an article comparing global fuel costs:
"When you view the U.S., and even Canada, from a global perspective, North American fuel prices are still relatively inexpensive"
In fact, there are some who even make the argument that the prices we have paid for petroleum in North America over the past two decades have been artificially low, and this has actually created more chaos. In an article written in the Los Angeles Times in 2000, Edward Luttwak explained this paradoxical truth:
"Almost two decades of cheap petroleum have had devastating effects on both the demand and the supply side of the world's energy balance. The great conservation efforts, originally launched in the aftermath of the 1973 Arab oil embargo and the resulting explosion in oil prices, have been abandoned. By 1975... the smallest cars on the market were the ones most in demand...In recent years, with gasoline prices already low and still falling...the market for the smallest and most efficient cars virtually came to an end. More than 60% of American car buyers were not content even with full-sized eight-cylinder cars, choosing instead sports utility vehicles--in fact powerful four-by-four trucks, which have been getting bigger and bigger."
Regardless of the well-reasoned arguments put forth by pundits such as those cited above, the fact remains that oil prices are determined by an intricate web of competing factors, which range from Iraq, to political instability in Venezuela to the emergence of China as a munufacturing superpower. More than ever, we must make tactical changes to our lifestyles in order to adapt to this period of uncertainty. Might we be angling toward a familiar theme?

Despite the long gas lines of '73, motorists had to make due because the lack of alternatives. Today we have a greater degree of flexibility, and can make lifestyle changes without without making significant changes to our routines. Last week AAA suggested several strategies that Americans might consider to mitigate problems associated with petroleum price uncertainty. AAA recommended familiar standards such as clean fuel policies and more fuel-efficient cars, but they also mentioned an option we have promoted on this forum: telecommuting. Although technology allows many organizations to effortlessly establish telecommuting arrangements with their employees, providing them the tools to be as productive in a decentralized setting as they would be in an office, I was suprised by not only the simplistic way in which telecommuting is presented - for example this quote from an information guide from Canada:
"If you work in an industry or service whereby the work that you provide can be provided by telecommuting then ask your boss if this is possible. Saving even one or two days out of five depending up how far you usually commute will save lots of gas, money and time over one year. Telecommuting or working from home is the growing trend. With the advent of company chat rooms, even conferencing or meetings are possible without using gas."
But I was unsettled by the take of some southern media outlets that not only fail to understand the global roots of petroleum price uncertainty (they seem to blame those in the north for using too much energy if you can believe it), but also seem to cast telecommuting in a negative light, as demonstrated by this quote:
"We might hit a threshold price where you see dramatic changes, and you might see more people trying to find carpooling options or more companies being pressured to have telecommuting options"
More than anything, this seems to suggest that public and private agencies have to engage in a fundamental reworking of efforts to promote teleworking. Thus far, most institutional initiatives are targeted toward the end-user, i.e. the worker. To provide greater context and urgency. policy makers should also be formulating comprehensive teleworking business cases targeted toward the organizations that are backed by sellable statistics, such as detailed cost-benefit analyses, as well as standards of business continuity. By doing this, subject companies will be greatly incentivized to step up there efforts - thereby making gas lines a curious relic of a bygone era.

Tuesday, March 23, 2004

PSEP: More than Window Dressing

I received some preliminary feedback on the newsletter published last week from a few readers who thought it was a little presumptuous on my part to compare Canada's new Minstry of Public Safety and Emergency Preparedness (PSEP) to the U.S. Department of Homeland Security. Some commented that this was nothing more than Canada's attempt to show they are just as important as their neighbors to the south, and creating this Ministry was, as one reader put it, "a cry for attention."

Given the fact the budget for Homeland Security exceeds $38 billion, and PSEP's is $5 billion (Canadian), one might see a basis for initiating such an argument, but when the deeper reasons for PSEP's formation are better understood, it becomes clear that PSEP is much more than window dressing. A tidy summary of the differences and basis for the two organizations is summarized in this excellent presentation that was recently put together by a consortium of three law firms - two American, and one Canadian. After reviewing the document, it becomes abundantly clear that the driving factors for PSEP's formation were: creating a set of uniform standards applicable on both sides of the border; and more importantly, preservating the unique trading relationship that exists between the two countries. As the U.S. and Canada are by far each others largest trading partners, it is vital that both countries better align security protocols so disruption to the flow of trade is minimized.

One of the segments that was particularly well done was by Sarah Diamond at McMillan Binch LLP. Ms. Diamond points out how the funtional structure of PSEP actually existed under two different ministries prior to its formation last December. Therefore, it was vital that in order for all interconnected functions to operate efficiently, these functions all be brought together under one umbrella. The current and prior structures are illustrated in the presentation.

The most important channels for trade are road, rail and sea, therefore, measures had to be put in place to better coordinate security standards at border crossings, while not disrupting the efficiency and free flow of trade. Indeed, over the past two years, there have been incidents that have occurred that have created delays at border crossings, but for the most part, both sides are doing there part in enhancing the infrastructure and taking a unified approach.

Wednesday, March 17, 2004

Q1 2004 Newsletter Published Today

Click here to read our latest newsletter summarizing events over the past quarter.

Sunday, March 14, 2004

Global Government Reinsurance Programs for Terrorist Risks

A couple of posts back we discussed how the clock was ticking down on the Terrorism Risk Insurance Act (TRIA) in the United States (to get the complete picture on this legislation, we recommend the following book available from the International Risk Management Institute). In it we stressed that in the absence of a government-backed program that reinsured risks from terrorism for losses to commercial property and business interruption, the insurance industry could face severe challenges (an inability to reconcile this issue in the long-run could in fact be a major catalyst that drives a movement toward new and innovative workplaces – we’ll leave that discussion to another day). Since posting that piece, we thought it would be useful to get an idea how other countries are handling this complex issue.

The following document provides a review of disaster insurance programs in Japan, the U.K. and New Zealand. It is encouraging to hear most European countries have established, or plan to create government reinsurance programs for terrorist risks, but this will certainly not come without a few headaches along the way, as country to country alignment of policy can indeed prove to be complex (even more so in the aftermath of the horrific terrorist attacks in Madrid). The primary stumbling blocks have to do with a few key areas. For one, the subsidies under such programs discourage risk mitigation (e.g. companies who spend more money on security or facility redundancy were not able to share in lowered risk through reduced premiums); secondly, the risk classifications are often inadequate and vague (e.g. in Japan, the government distinguishes between only two types of dwellings in four rate zones and fail to adjust for building age, structural integrity and underlying soil conditions – factors we have previously cited in this forum); finally the setup of these types of programs do not offer total risk diversification, as they tend to retain all terrorism risk within a specific country, instead of through a global reinsurance pool. Despite the challenges, programs such as Pool Re demonstrate that with a little commitment, all things are possible.

Pool Re was a vehicle created in 1993 by the British Government in response to terrorism risk associated with the IRA, and was established as a reinsurer of last resort, as private insurers reduced their coverage for terrorism. It provided a mechanism that effectively allowed participating insurers to reinsure the risks that arose from terrorism. Obviously, a great deal can change in ten plus years, thus continual tweaks have needed to be made to these mechanisms in order to maintain their relevance. For example, in the wake of the terrorist attacks of 2001, industry representatives in the U.K. began expressing their concerns about the widening gap between Pool Re coverage and that provided by reinsurers. It became obvious that some of the terms specified in the original document had become severely outdated. For instance, earlier versions of Pool Re covered commercial property damage and business interruption costs that arose from an act of terrorism which results in “fire or explosion.” This wording would therefore not cover event terrorism that caused other kinds of damage.

Accordingly, changes have been made and it would seem that the working group that oversees this process is continually working to ensure the nuances of this initiative remain robust. Some of the more significant changes that have been made to this document include an amendment that caps the amount of losses an insurer can incur, as well as reversing a former exclusion which had existed under the scheme for damage caused by nuclear devices. A tidy summary of some of the changes has been listed in this document by AON, in that also presents some of the challenges that lie ahead:
The deletion of the nuclear exclusion is also to be welcomed. It was not a realistic possibility that the war risks exclusion would be deleted, but it is notable that all forms of ‘cyber’ attack will excluded and in general there is still a requirement for physical damage to be caused. The use of contaminant chemical or biological agents primarily intended to cause injury to persons would not necessarily be construed as ‘damage’. The onus would be on the insured to show that actual physical damage to property, with resulting business interruption if applicable, has occurred.”
More than anything, this demonstrates how the nimbleness and flexibility of policy makers, can overcome extremely complex circumstances. Both public and private sector policy makers in the U.S. who are currently wrestling with how to reconcile the pending expiration of TRIA can look across the pond to see that logical change is certainly achievable – all it takes is getting everyone on the same page.

Monday, March 08, 2004

A Great Canadian Tool

First there were mountains. Then there was snow. Then there was skiing, which was of course soon followed by après ski. Around this point, some forward looking real estate developers keyed into the fact that ski resorts weren't just places where people braved the elements to get from top to bottom, but they were actually places where people socialized, stayed a few days and had fun. Enter the era of the modern North American ski resort, and with it, Intrawest, a real estate development company (notice I didn’t say ski resort operator) that has done much more than clear some trees to create skiable mountain terrain. Intrawest has used its magic touch to transform the surrounding areas close to the areas where people actually ski into economically invigorated zones that has been repositioned to offer residents and visitors a generous mixture of amenities including ample retail and restaurants. The result is often likened to a place with the charm of a classic European ski village with the pizzazz of Vegas. In turn, this has substantially increased the value of surrounding real estate, and transformed small ski villages into vibrant places that do much more than provide great skiing - they provide a great atmosphere to conduct business.

I mention this after spending several days at British Columbia’s splendid Whistler-Blackcomb ski resort - Intrawest's signature project. After marveling at how much the ski experience had evolved (from years ago when the idea of post-skiing entertainment was grabbing a luke-warm cup of hot chocolate on a big wooden picnic bench), I realized that this place was very business-friendly. There were major conference centers that seamlessly handled a steady flow of large-scale industry get-togethers, as well as office centers nestled in the heart of the village. I got into the spirit of things and used the trip as a chance to not only to reconnect with parts of my body I was acquainted with when I did ski, but also to catch up good friends and colleagues who had gathered from all over North America. It was the perfect opportunity to exchange new ideas, get updated on new technologies and pave a path for business development on the near horizon. In the midst of all this, it occurred to me at some point that a place like this very much aligned with the broader themes of what we discuss in this blog.

In an era of shrinking distances, cheap airfares, and connectivity (wireless connectivity everywhere - can’t tell you how many folks I saw on chairlifts or rest stops working away on their blackberries, or treos), places like Whistler can indeed provide a window into the future that lies ahead. Communities such as this compellingly prove that large urban centers are not the only places where business can thrive. In fact, they can thrive in places that just a few years ago were inconceivable - a chairlift, the lobby of a well-appointed ski lodge, or adjacent to a granite facing of a peak 8,000 feet up in the air. A great Canadian tool indeed.

Thursday, March 04, 2004

TRIA Update: The Clock is Ticking

In October, we published an abstract and multimedia overview of one of our white papers “The Rippling Effects of Insurance Uncertainty on Commercial Real Estate”, which discussed how the terrorist attacks could have caused chaos in the insurance industry had it not been for a key piece of federal legislation. The Terrorism Risk Insurance Act, or TRIA came into effect in November of 2002 after it became apparent that the new reality of risk could potentially render the insurance industry insolvent without a federal reinsurance backstop. This legislation was of particular interest to large owners of centrally-located real estate, as conventional thinking suggests a heightened risk of terrorism in more densely populated nodes. There were strings attached, however, as TRIA was put into effect for a period of only three years until a better solution could be crafted. Almost sixteen months after the passage of TRIA, it seems the industry is no closer to a solution than it was prior to the legislation. Not good news - the clock is ticking and unless a new initiative is put together, TRIA will expire on December 31, 2005.

This emerging problem was highlighted in a public hearing conducted by The National Commission on Terrorist Attacks upon the United States on November 19th of 2003. The transcript of this hearing is quite lengthy, so we have isolated the portion where TRIA's future was discussed. The following assessment of emerging challenges was made by John Degnan, the vice chairman of Chubb Corporation. Chubb was one of the largest insurers at the World Trade Center and expected to pay $3.2 billion in gross losses arising out of the September 11 attack.

Mr. Degnan not only described the intricate relationship that exists between the insurance industry and reinsurers, but also how the dynamics of insurance have changed since the terrorist attacks.
“Before September 11…when an insurer looked at a workers' compensation risk for a financial services provider, as many of the companies in the World Trade Center were, the maximum probable loss of such a firm was relatively low compared to often other more dangerous lines of work. White collar workers generally don't experience the same incidence of claims or severity of claims that manufacturing workers experience, and we underwrote to that risk. But after September 11, even a moderate sized financial services company can face a maximum risk of more than half a billion dollars. So even under TRIA, each individual risk that we write has a probably maximum loss of up to the per company deductible, and insurers continued to be faced with staggering potential losses.”
It seems the emerging problem here is a uniquely American one vis-à-vis other developed countries, who have put strong public-private insurance partnerships into place and enacted legislation to mitigate the risks associated with catastrophic loss. An example of this is Pool Re in the United Kingdom. This reinsurance device mandates that all organizations take out terrorism insurance. Degnan points out that TRIA is voluntary, thereby creating a market condition described as Adverse Selection that forces only those people with the greatest exposure to terrorist events to take out terrorism insurance:
“Those who, for example, work in signature buildings, such as the Empire State Building in New York or the Sears Tower in Chicago, generally are buying the terrorist insurance. But if you live in a low -- or you work in a low-rise office building outside Des Moines, Iowa, you're less likely to buy terrorism insurance. And the only way insurance really works as a mechanism is if the fortunate many take care of the misfortunate few by allowing their money to be pooled to deal with catastrophic risk. But because terrorism presents such unique risk management issues and concerns, policyholder participation in a terrorism insurance arrangement should be compulsory.”
Degnan suggests that even those in Des Moines are not in the clear:
"However, our attention cannot be limited to those exposures. Terrorists, as we know, most often strike at soft targets in an attempt to disrupt everyday life. An effective federal terrorism insurance program, therefore, has to address the exposures presented by high profile, and to a terrorist, highly desirable targets, like sports arenas, universities, shopping malls, daycare facilities, and even hospitals
Regardless of the ongoing discussions and the national forums that have been established, one thing remains crystal clear: a new public-private initiative is required that constructively deals with the reinsurance backstop issue over the long term. In the absence of such an initiative, the burden of the terrorism insurance problem squarely rests on the shoulders of the private sector, and this could indeed prove too hard to handle alone.