A “black swan” event is the kind of event that almost no one ever predicted or expected would happen–and then it happens. And, no, COVID-19 does not apply; many experts warned of a global pandemic for years, and the world has experienced such pandemics many times before. The subprime mortgage crisis of 2008, however, would probably qualify even more. At the time almost no one was aware or, or quantifying the risk of, risky derivatives in the U.S. housing market obliterating the global economy virtually overnight. That is a true black swan.
Black swan events are part of the so-called “long tail” of probability distributions, and they are the kinds of things that insurance as a concept is perfectly positioned for. As a rare event that can cause havoc to one person, that person can protect herself by asking an insurance intermediary to protect her from loss, and the intermediary can make bets with other people to limit their own exposure to the black swan event. We do this all the time with all sorts of things, from car accidents to home burglaries, so why not do it with a global economic meltdown, too?
This is why a booming industry of long-tail insurance in the form of financial derivatives has become a growing part of portfolios around the world. To structure such products, one must use a very complex set of mathematical calculations in addition to a profound understanding of financial markets and probable risks to the system.
The mathematics of black swan insurance is intimidating, but there’s more to it than that. The creativity involved in thinking of potential black swan events and the emotional intelligence required to identify the market for insurance and sell that insurance mean that this niche in the financial industry requires people of all sorts of talents and skill sets.
Black swan insurance will most likely continue to be a popular and profitable business, and it is a sector of finance that should not go unnoticed. At least, until the next black swan comes around–maybe that one will chance the black swan insurance market forever, too.