These are the external risks you need to fret over…

The cost-of-living crisis; erosion of social cohesion; public infrastructure and state collapse; and supply chain issues are among the ‘big bubbles’ on a graphic representation of the risks facing insurers and reinsurers circa 2023. These were also among the risks explored during a recent Insurance Institute of Gauteng (IIG) Insights 2023 session presentation by Carolyn Thompson, Executive Head of Product, Underwriting and Pricing at Old Mutual Insure. Among the first statements put to the mostly South African audience was that the short-listed external risks were global and interconnected.

Eskom drives cost-of-living higher

South African citizens should be quite familiar with the interconnection between the cost-of-living and the collapse of public infrastructure risks as they frantically free up capital to buy generators or solar installations and the cash to operate same. Thompson further observed that the cost-of-living and infrastructure challenges are common worldwide, as are some of the risks that were illustrated in smaller ‘bubbles’ such as extreme weather, natural disasters and interstate conflicts. “A term that I came across while researching these risks is poly-crisis, defined as a cluster of related global risks with compounding effects, such that the overall impact exceeds the sum of each part,” she said. And it turns out poly-crisis is an apt description for the economic, political and social environment that brokers, insurers and reinsurers are trading in today. 

The remainder of the presentation explored how external risks filtered into the world of risk mitigation and risk transfer, specifically in the non-life / short-term insurance sector. “There are a lot of changes happening at the moment with various insurers sending out communications about how they are managing these risks,” said Thompson. FAnews readers who advise clients on their short-term insurance contracts are already quite familiar with insurers’ responses to poly-crisis under headings such as cover, exclusions and premium… But we need to gain a deeper understanding of the main risks that insurers and reinsurers are exposed to before we go into more detail around their responses. 

The rising frequency and severity conundrum

First up for discussion was the (by now) familiar increase in frequency and severity of natural catastrophe events. Thompson used multi-year natural catastrophe statistics published by Munich Re to support the ‘rising frequency and severity’ claim. Simply put, there are more extreme weather-related loss events each year with each of these events causing greater economic and insured losses. And the damage caused by outlier events is staggering too. For example, Hurricane Ian which tore through the United States (US) last year cost the insurance industry more than any storm since Hurricane Katrina in 2005. It is easy to dismiss rising damages as a consequence of more infrastructure or more people being insured, but the actual loss events are getting bigger too, explained Thompson. 

Reinsurers took strain indemnifying against unprecedented flood losses last year, with the April 2022 KwaZulu-Natal flood in South Africa; flooding in the New South Wales and Queensland regions in Australia; and extensive flooding in Pakistan to name a few. To make matters worse, the poly-crisis means that climate-related loss events are magnified. “The recent Pakistan floods were exaggerated by global warming which has accelerated the rate at which ice caps are melting,” Thompson said, before unpacking South Africa’s weather risks in the context of La Niña, a weather phenomenon that contributes to higher-than-average rainfall and below normal temperatures. Although the country has experienced this weather phenomenon before, in 2010 and 2017, it is uncommon for it to persist for as long as the current cycle, being three-years beginning 2021. 

It does not take much imagination to translate the rising frequency and severity of natural catastrophe events into insurer and reinsurer operating models. “We are sitting with a completely different experience to what we priced on [with the result that both insurers and reinsurers] need to put rates up,” Thompson said. “The accumulation of the extreme weather events over the last two years has been catastrophic to the local industry”. Unfortunately, insurers and reinsurers with South African risk exposures must also accommodate the risk multipliers that go hand-in-hand with natural catastrophe. Consider the state of municipal infrastructure: the insured loss potential due to a summer cloudburst and flash flooding event goes up exponentially when storm water drains are not functioning optimally, and motorists face countless potholes. 

Freddy’s back! Loadshedding stage VI and higher

Then we have everyone’s favourite nightmare: loadshedding. Thompson used ‘claims paid’ statistics for power surge going back to 2014 to illustrate the significant increase in insurers’ exposures as loadshedding entered the equation, from 2018. “The power surge peril was designed to cover for surges coming from lightning strikes [and] was never intended for what insurers are covering on that peril today; electronic devices are not meant to be turned on and off repeatedly,” Thompson said, eliciting an assumed chuckle from the virtual audience by saying there was a reason parents screamed at their kids when they toggled a light switch on and off. 

The presentation delved into various other factors that are driving domestic insured losses higher, including crime; inflation; skills shortages; and supply disruptions. Local insurers have to consider each of the aforementioned claims drivers when determining an appropriate short-term insurance premium; but they also have to absorb the re-risking practices of the reinsurance market. 

As Thompson explained, the accumulation of catastrophe events seen globally since 2020 has really hit reinsurers hard. “The prices that reinsurers were offering insurers was in line with their historic CAT experience; they need to reprice as if today’s [level of loss] is the new normal, because it is,” she said. In other words, reinsurers are approaching their cover and premium decision making on the basis that today’s extreme weather experience will continue or worsen. The consequence for brokers and their clients is obvious: the new normal is going to affect your insurance premium heavily, as your insurer’s reinsurance pricing goes up! 

The challenge to insurers is to remain relevant to customers without going under; to trade sustainably, local insurers must respond to both external risks and their reinsurer’s repricing. “We cannot offer cover on everything that the customer wants because we risk not being able to pay for anything in three years’ time … the challenge is to offer sustainable, responsible cover,” Thompson said. Customer choice is critical, as is the matching of premium to risk. Future conversations between broker and client will therefore proceed on the lines of: “Yes, you can have this cover, but it is going to cost more and will come with more conditions attached”. This conversation will go hand-in-hand with flexible product design. 

Tough cover exclusions explained

Today’s newsletter hopefully offers some insight into the cover exclusions that insurers have communicated to brokers and their clients recently. Exclusions and limitations on business interruption covers announced post-pandemic; the power surge exclusions announced during 2022; and grid failure exclusions announced early 2023 are all measures to ensure the long-term sustainability of the short-term insurance industry. Communication between broker and insurer and broker and client will be critical in navigating this evolving cover landscape. “We must be clear with customers about what is covered and what is not covered so that they do not have surprises at claims stage,” Thompson concluded. This is particularly relevant in the context of a national grid failure. 

Writer’s thoughts:
South Africa’s short-term insurers have come in for a lot of criticism for recent decisions on grid failure and power surge exclusions. Do you think the criticism is deserved, or are you among the handful of realists who appreciate that a short-term insurer cannot cost effectively cover against property losses arising from a single, national event like grid failure? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za.