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Editor’s letter – The one-in-a-billion scenario

Less than 24 hours later, his company’s New York office, occupying some of the highest floors in the World Trade Center’s North Tower, was dust; the fate of several hundred of his colleagues, unknown. Terrorism had created a void in a city, a nation, an economy – and in all our hearts and souls.

Days later, this executive’s preference for the phrase risk management began to move away from pedantry towards genuine validity: it is about measuring the probability and magnitude of events, and selecting from a range of options, of which insurance is but one.

The simple mathematics tell you that if any outcome is twice as likely but half as large as another outcome, then they are, in risk management terms, essentially equivalent (the art is in assessing what the relevant risks are and estimating the numbers correctly in the first place). This sort of mathematical reasoning provides a firm foundation for the management and judgement of risk.

But the conventional calculations start to break down under the weight of what can be called “reciprocity failure” when one attempts to evaluate the infinitesimally small likelihood of an almost infinitely huge catastrophe.

When what one trader described as “your one-in-a-billion scenario” becomes a 100% reality, then perceptions of risk – all risks – will be altered dramatically, at least for a period of time. Fate has grabbed the ragged end of the risk-reward curve and given it an almighty shake. Previously unimaginable dangers will torment us like demons. Perceived potential losses will swell to nightmarish proportions. The phrase “That will never happen” will vanish from our lexicon.

If all of this makes us value what we already have a little bit more, then some small good thing will have come out of the American disaster.

But if we are all made more timid and suspicious then this tragedy will truly impoverish us all.

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