The key to managing systemic risks…

Thirty years ago this month, UK mutual Pool Re was established as a partnership between British property insurers and Downing Street to address the issue of limited insurance availability for terrorism cover.

This was in response to a specific geographic risk posed by Irish Republican terrorists. A decade on, however, and the West was confronting a new global threat: terrorism motivated by Islamic ideology.

After 9/11, global property insurers threatened to withdraw terrorism cover for the very simple reason that they did not have the capital to underwrite a systemic risk threat so difficult to model. A flurry of new public-private initiatives swiftly emerged including TRIA (US), GAREAT (France) and ARPC (Australia).

All had different structures, but the common thread was facility for governments and (re)insurers to work swiftly to devise a solution in the face of real and immediate threat.

Sadly, in the 20 years hence, the world has clearly become an even riskier place. In the Middle East, the atrocities in Israel and Palestine have again turned the region into a febrile tinderbox, while there is little sign of resolution from Russia’s brutal invasion of Ukraine. Despotic states such as Iran and North Korea appear emboldened, while the Chinese dragon continues to menace Taiwan. It is a depressing state of affairs.

Technology, digitalisation and innovation have brought prosperity to many – but they have also brought the threat of cyber attacks damaging companies, infrastructure and even national economies at a time of geopolitical unrest. Covid-19 was also a visible reminder of the impact pandemics can have on both society and the global economy. Likewise, no one in the (re)insurance sector is immune from the impact of climate change on natural catastrophes.

(Re)insurers are in the risk business – but the above all pose systemic threats to the global economy which the industry cannot tackle on its own. To give a topical example – global cyber premiums are around $10bn, yet recent research by Lloyd’s estimates a major attack on a financial services platform could generate economic losses of $3.5trn. That is not so much a protection gap as a chasm.

Industry academic Professor Paula Jarzabkowski coined a useful term for these reinsurance public-private partnerships: PGEs (protection gap entities). Unfortunately, there has been more talk than action in the 20 years since the flurry of post-9/11 terrorism PGEs. Is this a failure on behalf of the industry?

“Lloyd’s estimates a major attack on a financial services platform could generate economic losses of $3.5trn”

The Insurer doesn’t believe so. After all, one has only to look at the tremendous work Marsh McLennan, sponsor of Professor Jarzabowski’s book, and others have undertaken with governments – including in Ukraine – to examine options around both the eventual rebuild of the Ukrainian economy and the provision of insurance for the export of grain.

However, it is a shame that there has not been more progress in tackling all of these threats with governments through the development of more PGEs. After all, (re)insurers may not have the collective balance sheet to cover all of these potential threats, but they still have a lot to offer in providing some risk financing, as well as modelling, risk mitigation/adaptation and loss prevention, among other services.

One of the themes of Jarzabkowski’s recent book – Disaster Insurance Reimagined, published last week by Oxford University Press – is that there is no such thing as the perfect PGE, but a key component is to introduce flexibility. This enables PGEs to evolve, just as threats and our understanding of them continue to evolve.

Pool Re is a good example of this – it is a much-changed entity over 30 years, having established a £7bn ($8.5bn) reserve, buying £2.5bn of reinsurance limit from the private market while judiciously expanding coverage capabilities. It has done this by sponsoring invaluable research into the terror threat, enabling the private sector to expand while also paying the UK government for its backstop in the event of a catastrophic loss.

“[Pool Re] has paid £2bn to the UK Treasury in return for a guarantee that it has never had to use in 30 years”

Since 2015, it has paid £2bn to the UK Treasury in return for a guarantee that it has never had to use in 30 years.

So, as the European industry gathers in Baden-Baden today for the start of the annual conference, the focus among cedants, underwriters and intermediaries will naturally be on the 1.1 renewals. But back at the head offices, we would urge the industry’s leaders to continue talking to governments and international organisations about developing new PGEs to tackle the world’s most pressing threats. By doing so, the industry remains not just relevant, but also an essential partner for policymakers and their clients in navigating these risky times…