Innovate… it’s time

In 2015, Bill Gates warned of the possibility of a pandemic and that the world would be unprepared to deal with it from a health, commercial and economic perspective. Five years later, with the spread of Covid-19, we stare one of history's most devastating recessions in the face. Saleem Firfirey, candidate attorney at Webber Wentzel, shared some of ideas around commercial risk management and the fact that it has to be more strategic than ever before in dealing with current threats to the business environment.

(Firfirey was supervised by Justin Malherbe in writing this article.)

Risk management
Risk management - the identification and analysis of threats or risks that affect organisations and solutions to deal with them - dovetails with the need for insurance. However, certain insurance policies are inadequately equipped to deal with the Covid-19 pandemic.

Many businesses are suffering significant losses. In his address to the nation on 9 April 2020, President Cyril Ramaphosa asked businesses not to rely on invoking force majeure clauses in contracts. As a result, on public policy grounds, this may no longer be a line of defence for businesses. Also, most business interruption insurance policies require underlying material damage to insured property to trigger cover. Although some policies do extend cover for infectious or contagious diseases, this is often limited in the event of a pandemic.

Naturally, questions of public policy arise. Is enforcing a force majeure clause or exclusionary clause fair in the circumstances? To whom is it fair? The answer to this is unfortunately uncertain. Our courts have at times demonstrated a lack of appreciation for the notion of fairness. In a life or death scenario, protracted court battles serve little purpose.

Since the SARS outbreak of 2003, there has been an increase in multiple influenza pandemics. The effect of globalisation, 17 years later, has increased the propensity for diseases to spread rapidly around the globe. Current losses have to be managed using salary cuts, temporary layoffs and other liquidity-based strategies. In future, insurance products must be reconsidered in the South African market.

Parametric insurance

Parametric insurance can be seen as an attractive enhancement or alternative to traditional policies. It is unique in that it covers the probability of a predefined event occurring, instead of indemnifying the actual loss incurred.

Practically, it involves an agreement to pay out a pre-agreed amount when a triggering event occurs, if predefined parameters are met. An insurable trigger is one which is fortuitous and can be modelled. From a transfer of risk perspective, this is very attractive.

Although it is quite a new concept, international markets have adopted parametric insurance in cases of natural disasters. For example, the event could be the occurrence of a flood or earthquake and the respective parameter would be the water level or Richter scale score. In the case of pandemics, there would be a need to access big data and complex modelling capabilities.

A possible shortcoming
A shortcoming of parametric insurance is that it does not cover the actual loss suffered as a result of the trigger event. Instead, predetermined approximate loss is covered. This gives rise to basis risk, an occurrence where an insured will not be fully indemnified if the approximation was incorrect. However, the insurance industry can overcome this phenomenon using enhanced parameters and improved modelling. Current trends in international markets have shown that insurance providers can easily factor complexities into parametric models.

Not much is known about parametric insurance in the South African market. Its proposed implementation brings about important questions. How will it be regulated? Is there sufficient data available for implementation?  Is there demand for it?

Considerations
The benefit of parametric insurance is that the claims procedure is transparent, predictable and allows for speedy settlement, all of which has been emphasised in the most recent Financial Sector Conduct Authority circular. For businesses, this is highly beneficial from a liquidity perspective, and can be critical to its recovery.

Covid-19 is a trigger event for fundamental change in the South African insurance market. Parametric insurance provides an attractive alternative or enhancement to traditional commercial insurance policies that are ill-equipped to deal with events such as the current global health crisis and resultant economic slowdown.

Writer’s thoughts:
In a matter of three months we as an industry have learnt how innovative and adaptable we can be. The one moment we were still wondering how we are going to get through 21 days of lockdown, and the next moment we are launching new products while in survival mode… Risk management is now more important than ever; can this be a solution for one of our challenges going forward? Please comment below, interact with us on Twitter at @fanews_online or email me us your thoughts  editor@fanews.co.za.

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