Systemic Risks Require Cooperation
Half-year economic projections recently released by the Organization for Economic Cooperation and Development (OECD) painted a gloomy picture of where the global economy stands and where it is heading.
“After collapsing in the first half of the year, output recovered swiftly following the easing of measures to contain the COVID-19 pandemic and the initial re-opening. Policymakers reacted rapidly and massively to buffer the initial blow to incomes and jobs. But the pace of recovery has lost momentum over the summer,” OECD observes. Its estimates suggest the world economy will rebound by 5% next year, but first it will take a 4.5% dip in 2020.
As a result of these massive economic shocks, insurance carriers have found themselves in an alarming predicament where their investment assets are deteriorating while access to capital is curtailed. The incredible cost of a single global event—like the COVID-19 pandemic—has forced both the private sector and governments to revisit their prior discussions about systemic risks and start seeking solutions in earnest.
The pandemic has, in fact, revealed a significant protection gap for non-damage business interruption (NDBI) insurance due to the lack of historical data on global pandemics of this magnitude, governments’ lock-down procedures, and proper risk modeling tools.
According to the Artemis June COVID-19 Market Survey, which includes responses from hundreds of insurance and reinsurance industry executives, (re)insurers expect the majority of underwriting losses to emerge from the non-life portfolio, with 47.3% of the respondents expecting between $80 billion and $150 billion in non-life insurance losses due to the coronavirus pandemic. PeriStat currently estimates COVID-related losses at $24.8 billion in the first quarter. But claims will continue to come in, with major uncertainty around how indirect claims in casualty and credit lines will play out in the coming months.
Worldwide, there is a growing understanding that pandemic risk requires a coordinated response at many different levels. Almost 93% of the respondents in Artemis’ survey agreed that industry/government-supported reinsurance schemes will be helpful to mitigate pandemic risks, and authorities in the U.K., U.S., France, Germany, India, and other countries are looking into them now. However, when asked what kind of pandemic backstop respondents would prefer to see enacted, no clear solution emerged, with the largest segment (34.8%) of respondents preferring a backstop “like PRIA, but with capital markets hedging capacity for peak pandemic risk in ILS form.”
At the regional level, the European Commission is examining the merits of a future public-private pandemic (re)insurance solution that could operate on a pan-Europe basis. In fact, within the next few weeks, the European Commission’s Financial Stability, Financial Services and Capital Markets Union (FISMA) will propose “…shared resilience solutions, where the private sector offers a (possibly limited) first layer of protection, complemented by public intervention when claims exceed certain predefined levels (second layer) and possibly by reinsurance mechanisms (third layer). [In addition, due to] the interdependencies of our economies and of the single market for insurance, some experts and stakeholders support coordinated approaches and promote some form of EU-wide coordination of national initiatives or EU (direct) layer of intervention (fourth layer).”
Some European countries have begun to implement individual pandemic risk solutions to counter the effects of the crisis, singling out specific activities or sectors ranging from film and entertainment to hospitality to trade credit. To that end, European countries and Canada have introduced government-backed trade credit. However, we continue to see individual governments struggling with incremental steps to stave off further market hardening and reduced capacity. Realizing the full potential of comprehensive recovery strategies has yet to occur.
In response to the coronavirus pandemic, companies are speeding up digital transformation to relocate their businesses and employees to a remote working environment. In fact, the number of full-time work-from-home employees has expanded at a rate of about 2.86% per year from 2005 to 2020; by contrast, since the beginning of the pandemic, the growth rate has skyrocketed to about 493%.
Consequently, the sudden growth in technology dependency has increased companies’ vulnerabilities to cyber attacks. In addition, cyber risks are not limited by geography and can easily spread across the globe in a matter of seconds, exposing companies and insurers to high financial losses due to accumulation risk.
According to S&P Global, market penetration for cyber insurance products has remained relatively low despite cyber security being among the largest risks for organizations globally. The estimated yearly economic costs of cybercrime already exceed $700 billion, but insureds’ global cyber coverage remains below $5 billion annually. Both S&P Global and Munich Re expect the global cyber insurance market to increase 20-30% per year on average in the next three years. “We think that [cyber insurance] is really going to move from that luxury, optional purchase to a must-have because businesses have had to shift operations online to cope with the pandemic,” said Anthony Cordonnier, head of cyber product management at Swiss Re, in an S&P article.
The future of cyber insurance will lead to a continued and more widespread offering of products beyond compensation solely for financial losses. Insurers have the ability to provide additional value through assistance services as well as helping policyholders better handle cyber risks. These key services would provide additional benefits to the policyholder, enabling insurers to differentiate themselves from competitors, and helping to reduce the frequency and severity of cyber claims through loss mitigation.
Climate Change Risk
Despite the increased focus on the pandemic, the severity of this year’s extreme weather-related events—from wildfires in the United States and Australia to record heat waves in Europe to floods in Japan—keep a spotlight on climate-related risks for insurers. It’s understood that climate change alters the probability of extreme weather-related events, often increasing the frequency and intensity of such events. According to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC), human-induced climate change trends will continue to have a major influence on weather-related risks.
The number of natural disasters causing $1 billion or more in damages has been on a steady rise for more than a decade; in addition, insurance payouts for natural catastrophe events in 2017 and 2018 stood at $219 billion, the highest ever for a consecutive two-year period, according to Swiss Re. This year’s losses from natural disasters in the U.S. alone are also expected to put a dent in insurance companies’ bottom lines. Although the hurricane season has not yet peaked, insured losses from Hurricanes Isaias and Laura are estimated in the vicinity of $5 billion and $13 billion respectively. California’s wildfire may eclipse losses from two years ago, when they were around $11 billion. “A billion here, 11 billion there – pretty soon we’re talking about ‘real money,’ against available reserves that are far smaller than they at first appear,” warns Jeff Dunsavage of the Insurance Information Institute.
As the severity of weather-related events is forecasted to intensify, the industry is focused on efforts to build and promote more sustainable behaviors. Carriers have been both issuers and investors in green bonds, which help shape governments’ and companies’ behavior and promote a low-carbon economy. In addition, Swiss Re Institute has recently launched the Biodiversity and Ecosystems Services Index to guide insurance product development and decision-making in underwriting and asset management. The Index, which assesses countries’ food and water security and air quality regulation, reinforces the connection between preservation actions and economic impact. As an example, ecosystem restoration in coastal Louisiana can reduce expected flood costs by $5.3 billion a year, while saving coral reefs can lower flood damages from 100-year storm events that would otherwise increase by 91% worldwide.
State participation remains instrumental in flood, crop, and fire risk management. Similar to the U.S. National Flood Insurance Program, the United Kingdom’s Flood Re acts as a reinsurer against flood losses to secure the availability and affordability of flood insurance in high-risk areas. The reinsurer can provide up to $2.7 billion of cover through the global reinsurance market. Thailand, one of the world’s top rice producers, launched the Government Disaster Relief Program, offering financial assistance to farmers whose crops have been damaged by destructive weather conditions. Laos and Myanmar also have a catastrophe risk pool through the Southeast Asia Disaster Risk Insurance Facility (SEADRIF); this provides the governments with immediate post-disaster liquidity for natural disaster recovery.
Recent public-private partnerships in weather-related risk management also build on forward-looking initiatives in infrastructure development and sustainable growth. Specifically, insurers have worked with government agencies on low carbon benchmarks and standards for sustainable insurance, but they have also developed useful risk models of much value to the public sector. For example, some countries within the EU have tied funding for pandemic recovery to investments and reforms in environmental sustainability, education, and employment initiatives in order to comply with the EU’s green and digital transition. As always, broader data exchange between the public and private sector would improve risk models, but it is a distant goal.
Stephen Weinstein, COO of RenaissanceRe, recently noted: “There are only two things that [the private insurance sector] can do to reduce the cost [of systemic risk events]. One is to invest in mitigation, and the other is to diversify the financing as much as possible. The best way to diversify the financing is to make [systemic risks] global.” With the rise of insurtech, the private sector has drastically increased the amount and quality of risk mitigation tools. Overall, diversification of systemic risks remains tricky. Global solutions are yet not attainable, but governments are poised to make good progress to address systemic risks in their own jurisdictions once they put out immediate pandemic fires.
Andrea De Bono is The Council’s 2020 Market Intelligence & Insights intern.