War on Five Fronts
Russia’s invasion of Ukraine on Feb. 24 was a turning point in the long-simmering hostilities between the two countries.
For global insurers, it’s largely too early to tell what the ultimate cost will be, but they are pinpointing certain lines as more troubling than others. Cyber, aviation, political risk, trade credit, and marine are the lines worth watching, and some claims have begun to trickle in.
Cyber, aviation, political risk, trade credit, and marine are the lines being watched most closely.
Due to the unfolding nature of the war, the full extent of cyber warfare is difficult to pin down.
The economic impact of the war could pressure insurers’ earnings and claims reserves
Cyber War Exclusion Tested
Back in December 2015, a Russian-backed threat group known as Sandworm allegedly hacked Ukraine’s power grid, compromising the information systems of energy distribution companies in the country and disrupting the electricity supplied to businesses and consumers. In 2017, Ukrainian and U.S. intelligence agencies blamed Russian-based threat actors for the series of cyber attacks using the Petya malware that took down the websites of Ukrainian banks, government ministries, newspapers and utilities.
Fast-forward to late April 2022: Microsoft released a sobering report describing “relentless and destructive” cyber attacks launched by six separate Russia-aligned nation-state actors against Ukraine, more than 237 “operations” in all. Major broadcasting companies were attacked, crucial operating data from nuclear power plants were stolen, and civilian access to critical life services and reliable information was disrupted. The cyber attacks targeted “hundreds of systems,” the report states.
A few weeks later, in mid-May, the U.K. government reported that a cyber attack in the run-up to the war in February that struck communications company Viasat in Ukraine was launched “almost certainly” by Russian military intelligence. The attack disrupted wind farms, satellite operations and internet users throughout Central Europe.
Due to the unfolding nature of the crisis, the full extent of cyber warfare is difficult to pin down. The Rand Corporation suggests the possibility that Russia may increase the barrage of cyber attacks against a widening array of institutions, including those in the United States and its allies. In response, cyber-security experts in the United States and Western Europe have mobilized to help Ukraine defend against the potential onslaught.
From an insurance industry standpoint, the question is whether Ukrainian companies or other businesses operating in the embattled country purchased cyber insurance contracts absorbing business interruption losses caused by lack of internet access or inoperable computers and networks.
Although the policies’ contract language typically excludes coverage for “war” and “hostile acts,” a recent ruling involving pharmaceutical giant Merck casts doubt on the applicability of the exclusion. In June 2017, more than 40,000 Merck computers reportedly were infected with the NotPetya malware, causing a $1.4 billion loss. Merck filed a claim on its all-risks insurance policy, which included coverage for data loss events.
The insurer denied the claim, attributing the malware attack to Russia’s military intelligence, deployed during the conflict with Ukraine. Merck’s all-risks insurance policy expressly excluded coverage for acts of war. Merck subsequently filed a lawsuit against the insurer. In February 2022, a New Jersey Superior Court judge concluded that the war exclusion clause did not apply because the contract language implied armed conflict.
To clear up any confusion, Lloyd’s Market Association published four new war exclusion clauses in November 2021 that specifically exclude coverage for losses caused by “cyber operations,” defined to mean computer systems used “by or on behalf of a state to disrupt, deny, degrade, manipulate or destroy information in a computer system, of or in another state.”
In April, Munich Re told Reuters it was developing new war exclusion language in its cyber policies based on the clauses developed by Lloyd’s. Legal experts have commented publicly that none of the new war exclusions are friendly to insureds but are designed specifically to reduce insurance carrier losses.
Other insurers and reinsurers are expected to insert variations of the new war exclusion clause in their cyber insurance contracts at renewal. However, insureds with cyber policies yet to renew are likely to have the previous war exclusion clause in their contracts. If this is the case, they may be covered for losses caused by cyber attacks attributed to the war in Ukraine.
“Cyber policies have always had war exclusions, but generally they were very difficult to enforce due to the difficulties associated with proving the involvement of state-sponsored actors,” says Catherine Thomas, senior director of analytics at A.M. Best Co.
Lloyd’s new war exclusion clauses also rely on the ability of an insurer to prove that a cyber attack was sponsored by a nation-state, according to a recent report by credit rating agency S&P Global. Minus this attribution, it would be difficult for an insurer to exclude coverage for a cyber attack that could have been perpetrated by a non-state-sponsored actor.
“Attribution is notoriously difficult to prove,” the S&P report states. “Brokers and clients might argue that an attack is covered when there is no clear attribution. … The insurance industry is preparing for a potential surge in cyberattack claims if the Russia-Ukraine war continues to escalate.”
Even before the conflict began, the cyber insurance market was in the doldrums, with several carriers no longer offering coverage and those that continued to provide insurance tightening up contract terms and conditions, reducing limits of financial protection and hiking premiums.
“Cyber is a very immature product, with barely a decade of data for insurers to base their coverage and pricing on,” explains Edward Chanda, national sector leader for insurance at audit and advisory firm KPMG. “There’s growing demand for higher limits than the industry is prepared to provide. The conflict will make that even more onerous.”
Aviation Losses Significant
Experts are also focused on the aviation market, though it’s not the airlines themselves but the jet leasing companies that are facing losses. Approximately half of Russia’s fleet of about 1,000 jets are leased from companies outside the country. Shortly after the invasion began, the European Union ordered lessors to retrieve their planes. About 30 planes were recovered outside the country; another 400 to 500 leased jets remain stranded on Russian tarmacs, creating the potential for substantial insured losses.
Some Western-made planes reportedly have left the tarmac to fly within Russian territory, despite the suspension of spare parts shipments by Boeing and Airbus. On June 14, the European Union’s top safety regulator said he is “very worried” about the safety of passenger and cargo aircraft flying without proper maintenance and correct parts replacement, citing reports that Russia may be cannibalizing some airplanes to keep others operating.
“What we are hearing is that the aviation insurance market is under the most duress” from the war’s impact, says Michel Léonard, chief economist and data scientist at the Insurance Information Institute. “We estimate potential insurance losses due to the loss of use of planes to be between $8 billion and $12 billion.” No more than 50% of that amount, Léonard adds, will come from U.S. carriers.
According to Léonard, war-related claims against aviation insurers have been filed, including an estimated $3.5 billion claim filed by AerCap Holdings, the largest jet leasing firm, to cover losses on 113 planes stuck in Russia. Another leasing firm, Air Lease Corp., plans to write down more than $800 million in losses caused by 27 jets stranded in the country, while BOC Aviation, which has 17 planes valued at nearly $600 million in Russia, was said to be pursuing insurers for the losses.
Léonard explains the crux of the issue. “When a plane is immobilized and cannot be monitored, it doesn’t have a complete log—the records involving its condition, dates of inspection, maintenance and significant events that occur to the aircraft,” he says. “Without a full log, under international aviation treaties, it cannot be certified to fly in regulated countries. … Assuming a standard aviation insurance policy that is written with force majeure, the insurer must pay for the loss of use of the plane.” Force majeure refers to unforeseeable circumstances that prevent the fulfillment of a contract.
“It’s a hugely complicated situation,” says A.M. Best’s Thomas. “The countries that had registered the planes suspended their safety certifications following the invasion of Ukraine. This would usually mean aircraft must be grounded, but a law was signed in Russia allowing the Russian air carriers to continue operating without foreign licenses.”
Robert Hartwig, a professor of finance and insurance and the director of the Risk and Uncertainty Management Center at the University of South Carolina, concurs on these varied complexities, noting that, even if the planes are returned intact to the lessors, the lack of verifiable maintenance logs makes them potentially worthless, as the aircraft would not be considered flightworthy.
“What we don’t know is if Russian airlines are continuing to pay their lease payments, although I can’t imagine that aviation insurers will continue to insure aircraft that are effectively expropriated by Russia,” Hartwig says. “They have no ability to monitor whether the planes are properly maintained and inspected according to very rigid safety protocols.”
Another area of uncertainty is the loss trigger in the all-risks insurance policies sold in the contingent aviation insurance market to aircraft leasing companies. The policies, which provide coverage in the event of war-related losses, have a seven-day cancellation clause. Insurers likely canceled the war coverage the minute Russia invaded Ukraine, on Feb. 24. The trigger date for the loss was possibly the date that Russia confiscated the leased aircraft, on March 14. If this is the case, then the war coverage might not apply, given the seven-day cancellation.
These are just hypotheses, leading Thomas to suggest the possibility of disputes over when the loss was triggered. “Was the coverage canceled before the loss was triggered?” she says. “We just don’t know at this point.”
A report by Fitch Ratings affirms the likelihood of legal challenges. “There may be disputes over whether certain coverage automatically expired once sanctions were imposed or was cancelled in time by the carrier before the actual claims event—the expropriation of planes,” the credit ratings agency states.
Fitch estimates that the residual value of the stranded aircraft is $13 billion, adding that, in a “worst-case scenario,” claim losses could total $10 billion.
Political Risk Exposure for U.K., European Insurers
Unlike other property and casualty insurance policies that specifically exclude coverage for losses resulting from acts of war, political risk insurance is expressly designed to protect foreign businesses against the loss of assets and profits due to political upheaval. Insurable risks include war and civil war, political violence, strikes, riots and civil commotion, as well as asset expropriation and government breach of contract.
“Since Russia’s invasion of Crimea [in 2014], there has been a significant decrease in U.S. companies doing business in Ukraine,” Léonard says, which means that exposure for U.S.-based political risk insurers was also significantly reduced in Ukraine.
Alternatively, U.K. and Continental Europe-based insurers, Léonard says, “likely kept higher exposures than their American counterparts, given trade flows between Ukraine and the rest of Europe.”
Léonard estimates the private political risk insurance market (minus policies involving aircraft) has a $10 billion exposure, of which no more than $2 billion to $5 billion is insured by U.S.-based carriers, “well within their ability to perform on their obligations,” he says.
Claims are in process, and more are expected. “We’re fielding many ‘notices of circumstance’ in the here and now involving the conflict in Ukraine,” says Laura Burns, a U.S. political risk product leader at WTW (formerly Willis Towers Watson). A notice of circumstance is a contract provision directing insureds to inform an insurer of circumstances that are reasonably expected to give rise to a claim.
“Two covers are in sharp focus—the political violence peril, which covers property damage caused by political violence, and forced abandonment, which permits the insured to abandon a damaged property and receive full payment for damage losses,” Burns says.
Burns says she is concerned about potential asset expropriations by Russia. “The government has signaled they will mirror the sanctions imposed by the U.S. and Europe, laying the groundwork to potentially expropriate the assets of the many foreign companies that have signaled their intent to leave the country,” she says. “Unless companies write off the assets they leave in Russia, there could possibly be a significant number of claims.”
She adds, “It’s a bit premature to ascertain the number of losses and their magnitude at this point because everything is so fluid, but we’re keenly watching things as they unfold.”
Trade Credit Concerns
Trade credit insurance, which protects businesses against the nonpayment of commercial debt, is also under the microscope. These policies also have war exclusion clauses, but as Hartwig points out, they don’t always define what constitutes an “order of a government, public or local authority.”
“As such, there is some uncertainty as to whether these exclusionary clauses will apply in a given case,” he says.
A recent commentary from credit ratings agency DBRS Morningstar states, “Trade credit insurers should expect to deal with an inflow of credit default claims by insured entities, once their business counterparts in Russia and Ukraine start missing payments for the goods or services rendered to them on short-term credit.”
Although war exclusions may limit insurers’ loss exposures in Ukraine, the exclusions are not likely to apply to business in Russia, since the conflict is not within its borders. “The barrage of financial sanctions on Russia has elevated the risk of payment defaults, which could be borne by insurers and reinsurers alike,” the rating agency states.
If Russia imposed reciprocal sanctions on U.S. and Western countries that resulted in the nonpayment of debt, Thomas says, trade credit insurers would absorb these losses and follow it up with a sharp pullback. “Insurers can respond quickly to these trends and correspondingly reduce coverage,” she says. “We haven’t seen losses flow in yet, although we’ve seen a bit of an increase in credit default rates in Russia. We do expect losses, but compared to potential aviation losses, they’re lower down on the list.”
Hartwig shares this view. “There’s no question that the war between Ukraine and Russia will strain the trade credit market, given the pressures already in the market from the supply chain disruptions arising from the pandemic,” he says. “Receivables may be delayed, or payers may become insolvent because of the war. But the U.S. is a very minor trading partner with both countries, limiting the exposure.”
Marine Coverage Pullback
Ukraine transports 70% of its exports and 99% of corn exports via ship. According to a report by Allianz, Russia’s naval blockade of Ukraine and the closure of Ukraine’s major ports in the Black Sea, including the port of Odessa, have caused widespread disruption to global shipping, exacerbating the ongoing supply chain debacle. “Hundreds of vessels were trapped in ports or at anchor,” the report states.
With Russian vessels banned from entering U.K. and EU ports, as well as being detained for possible sanctions breaches, the war affects shipping beyond the zone of conflict. “Many Western companies have voluntarily opted to cease trade with Russia, creating a complex and uncertain legal situation for contracts, including insurance,” Allianz states.
Although marine insurance policies typically exclude the seizure of ships and physical damage losses caused by war or hostile actions—and Allianz concedes that some claims will be denied under these exclusions—many ship owners often purchase temporary war insurance coverage for an added premium, Allianz notes.
U.S. brokerage Woodruff Sawyer issued a report on the invasion with further detail on the marine market. The report states, “We have been notified that some cargo insurance carriers have invoked their right to issue a Notice of Cancelation (NOC) specific to War, Strikes, Riots, and Civil Commotion risks in, to, and from Russia, Ukraine, Black Sea, and Sea of Azov within territorial waters. These NOCs are subject to the Notice of Cancelation period which can range from 48 hours to 7 days. Carriers are then reinstating coverage, and putting geographical stipulations in place for war, strikes, riots, and civil commotion going forward.”
According to a report issued by CBIZ, the coverage reinstatements, where available, come with a high price for merchant shipping vessels in the region. “Insurers are either refusing coverage for vessels sailing in the Black Sea or demanding enormous premiums,” CBIZ states.
Hartwig says a “key exposure” for marine insurers going forward is physical damage to cargo. “With so many ships stuck in the Black Sea and unable to reach their destinations because of the war, there is a high risk of cargo like grain and corn spoiling and becoming worthless,” he says, adding that, as both cargo policies and standard hull and machinery coverages expire, “new policies likely won’t be written until the conflict concludes.”
The Allianz report came to a similar conclusion: “Renewals could…prove complicated for vessels affected by the conflict.”
Regarding oil tankers and LNG (liquefied natural gas) carriers stranded in the Black Sea, Léonard says their owners tend not to buy cargo insurance or political risk insurance because of the energy-related nature of the commodity. “They don’t get targeted (for sinking), because they’re considered spoils of war to a large extent,” he explains.
Marine hull and cargo losses were low at press time. As of mid-June, six commercial ships had been hit by missiles, with two of them sinking. (Russia and Ukraine offered conflicting reports on casualties.) The prior month, PCS, a risk modeling company, projected that industrywide marine insurance losses could range between $3 billion and $6 billion.
Exacerbating Economic Conditions
Certainly, the war has exacerbated challenging economic conditions globally. Moody’s forecast the slowing of GDP growth in the G20 economies to 3.6% in 2022, down from the rating agency’s initial 4.3% projection. Moody’s attributed the decline to potential reductions in European imports of Russian oil and gas, a liquidity squeeze, and a widespread recession.
“The Ukraine conflict has triggered a sharp rise in energy and commodity prices, which is feeding through into higher inflation,” Moody’s reported. “Protracted inflation would add to property and casualty insurers’ claims costs, putting pressure on earnings and possibly also on claims reserves. … More widespread inflationary pressure…would expose insurers to higher liability loss costs and would also push up their own payroll expenses.”
A.M. Best’s most recent report on the economic impact of the war on the insurance sector arrived at a similar assessment. The credit rating agency cautions that the economic effect of sanctions may spur higher commodity prices, adding to inflationary pressures at a time when the U.S. Federal Reserve and global central banks are trying to contain inflation. Further sanctions against Russia may affect the ability of global insurers and reinsurers to underwrite Russian risks or to service claims on existing policies, with possible worse news in store.
“The impact of an escalating global conflict may increase the risk of a systemic cyber attack and cause substantial economic and insured losses,” the A.M. Best report states. “Heightened risk perception could lead to higher prices in an already hardening market.”
Several projections have been published on the aggregate losses from the war for the global insurance and reinsurance industries in the first quarter of 2022, ranging between $16 billion and as much as $36 billion, the worst-case scenario provided by S&P Global Ratings. However, many experts cite a considerable amount of uncertainty regarding final numbers due to claims incurred but not yet reported.
Swiss Re CFO John Dacey cited a very high degree of uncertainty over potential impacts on insurers and reinsurers from the war and related events. “So far, we have hardly seen any actual claims,” he said on a media call discussing first-quarter results. The reinsurer reported a first-quarter net loss and booked a reported $283 million in reserves related to the war.
Other early numbers related to the invasion include approximately $57 million in estimated losses disclosed in late April by specialty insurer and reinsurer Arch Capital and a first-quarter net loss that included €85 million (US$89.45 million) due to the conflict reported by French reinsurance giant SCOR.
Having evaluated first-quarter losses attributed to the war, Catherine Thomas, senior director of analytics at A.M. Best, says, “It is clear so far that very few claims have been paid and the vast majority of them are IBNR, creating a huge amount of uncertainty what the ultimate losses will be.”
IBNR, an acronym for “incurred but not reported,” refers to the reserves for claim-generating incidents that have not yet been reported to the insurer.