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Insurers, know your war limits

08 November 2022 Gareth Stokes

Insurance brokers, insurers, reinsurers and risk managers have survived a terrible few years, learning hard lessons about the impact of systemic risks on their operations and profitability. The 2020-21 COVID-19 pandemic caught the entire non-life insurance sector off-guard, with global insurer and reinsurer exposures to business interruption (BI) losses far exceeding what had ever been envisaged. Natural catastrophes packed a punch too, with reinsurer Munich Re confirming that earthquakes, floods, storms, wildfires and other extreme weather events destroyed assets totalling US$280 billion in 2021!

South African insurers and reinsurers, meanwhile, endured multi-billion-rand ‘shocks’ that overlapped pandemic. First, widespread looting in areas of Gauteng and KwaZulu-Natal (KZN) in July 2021 cost the state-owned special risks insurer Sasria SOC Limited more than ZAR32 billion. And second, extreme flooding along the KZN coastline in April 2022 looked certain to cost traditional insurers and their reinsurer partners north of ZAR15 billion. These loss events have forced insurers and reinsurers to reconsider how they provide cover for risks that are, for all intents and purposes, uninsurable. There is also a growing awareness that climate change related extreme weather, coordinated cyberattacks, pandemic or war have the potential to bring the global insurance sector to its knees. 

Sharing systemic and other risk insights

And that, dear reader, is why the third edition of my book, ‘Everything you need to know about non-life insurance in South Africa’ contains a chapter titled ‘Insurance, the economy and systemic risk’ alongside chapters on insurance fundamentals, market statistics and regulation. The book offers a detailed overview of South Africa’s short-term insurance market and is an ideal companion for anyone working in the financial services sector, but especially in short-term insurance. So, if you’re searching for a distinctive year-end gift for your insurance clients, colleagues or friends then this could be the answer. You can order an individual copy here, or email for bulk deals. 

Aside from climate change and pandemic, 2022 has proven a testing ground for how the insurance industry responds to extreme geopolitical risk. On 24 February 2022 Russian forces entered Ukraine in what Russia described as a special military operation and most governments have since labelled as an act of outright aggression or war. At the time of writing, the Russia-Ukraine war had gone past 256 days in duration, inflicting terrible economic and social costs on both countries, and causing varying levels of hardship for citizens and firms operating in countries around the globe. 

How war impacts the global insurance industry

One of the most comprehensive explainers of how war impacts economies and the global insurance and risk environments comes courtesy a 62-page study published by London-based insurance market Lloyd’s and Aon, titled ‘Ukraine: A conflict that changed the world’. The study considers five ‘plausible scenarios’ for the war in the context of broad themes like economic impact, geopolitics, inflation and social transformation… It then further explores the main factors driving insurance and risk decision making, defined alphabetically as climate transition, cyber, energy security, ESG, food security, public sentiment and supply chain. 

Early on, the report concedes that the potential impacts of war are far-reaching. “The prominent theme throughout our analysis is that these risks are incredibly interrelated,” they wrote. “As with COVID-19, first order impacts have the potential to trigger second- and third-order impacts in different risk categories”. This phenomenon is easily illustrated by how heightened supply chain risks, which appear under the list of market factors, also contribute to the global rising inflation theme. From an FAnews perspective, we thought readers would be interested in a brief overview of the four main themes, with some concluding comment on how insurers and risk managers might respond. 

Self-sufficiency comes at a cost

Starting with geopolitics, the report observed that the Russia-Ukraine crisis “has exposed the vulnerabilities associated with globalisation in an international system in which a powerful state asserts self-interest and breaches international norms and laws”. Many countries responded to Russia’s actions by imposing heavy sanctions against Russia, with the result that international firms and leading Western brands have exited that market in their droves. These responses came in addition to the pandemic-linked move by many countries to restore self-sufficiency to critical supply chains, in a trend that the report reckons will “reverse decades of trade and specialisation” and “make goods and services more expensive in the long term”. 

The inflation theme needs little introduction, with the local and global news wires full of reports of central banks hiking interest rates in response to four-decades-long inflation highs. Over the past 12-months, the Bank of England has hiked interest rates a staggering eight times, taking its benchmark rate to the highest level seen since November 2008, at 3%. And in early November 2022, the US Federal Reserve pushed through a fourth consecutive ‘jumbo’ or 75 basis point rate hike, taking the federal funds rate to between 3.75% and 4%. US rates are expected to peak next year, at around 4.75%. According to the report “many businesses are likely to adjust their budgets for risk management solutions and reduce discretionary spend to account for inflationary pressures from supply shocks”. 

An energy and commodity squeeze

As for economic impact, Lloyd’s explains: “Owing to its position as a leading energy and commodity exporter in global supply chains across various industries, Russia’s exclusion from international trade will have significant economic ramifications, particularly for businesses in Europe and in goods-producing industries like food and energy”. The UK is already processing the economic fallout of this conflict, with economists warning of a two-year-long recession on the back of soaring energy prices. Energy prices push inflation, and inflation pushes interest rates, with both phenomena adding thousands of pounds to households’ annual expenses. The UK government, having spent billions of pounds to keep businesses and households ‘afloat’ through pandemic, has little in reserve. 

Finally, social transformation deals with the impact on communities as a consequence of war. “This conflict has brought with it the fastest refugee flow in Europe since World War II, surpassing the flow of asylum seekers at the height of the Syrian refugee crisis,” the report noted. “Around three million people fled Ukraine in the first three weeks of the crisis [with the displacements continuing] as the conflict continues”. The resulting social transformation will introduce myriad constraints to Europe-focused organisations, not least of which labour shortages and constraints in critical logistics and transport functions. 

As the Russia-Ukraine conflict pushes into 2023, multinational firms will have to elevate many of the above risks on their corporate risk registers. According to Aon and Lloyds, businesses will have to “take a broad, informed approach to assessing, mitigating and managing risk within their organisations, while building resilience through activities such as supply chain simplification, workforce upskilling and implementing a robust cyber security framework”. Insurance brokers, working with the risk management teams at large corporates, will have their work cut out for them too. 

Findings for all risk stakeholders

The report suggests that brokers and their clients ‘lean’ on insurers to “take a pragmatic and innovative approach to providing risk management solutions and deploying their capital to help customers and society recover and build resilience, accounting for the changed geopolitical environment and macroeconomic conditions that invalidate our previous models and methods”. It is also more important than ever for “academics, governments and regulators to invest in understanding the overlapping risks present in all sectors and societies”. 

Writer’s thoughts:
With more than 8000 kilometres between South Africa and Ukraine, our country has managed to avoid most of the social fallout from this conflict; but we are not insulated from the global economic consequences, most notably in energy and food prices. And there are plenty of local companies that will have suffered financial losses due to the conflict too. Have any of your commercial insurance clients been directly impacted by the Russia-Ukraine conflict? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts

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