Covid-19 highlighted the need for governments and the private sector to work together to deliver solutions to meet systemic risk challenges. Our panel sat down to discuss the reasons behind the lack of progress in delivering these solutions and what can be done to bridge the gap between public and private to create better partnerships.
One of the many unanswered questions as the world learns to live with Covid-19 is how to finance the next major societal disruption.
The pandemic was a wake-up call for a generation of people who had never experienced a situation where the global economy was locked down.
The event has brought new understanding of the potential impact of systemic risks, at a time when the industry is becoming increasingly aware of other potential systemic threats such as climate change and cyber warfare.
“Most insurance risks are defined by geography and time,” explains Lloyd’s chairman Bruce Carnegie-Brown.
“They happen in a certain place, and they last for a particular length of time. Most systemic risks defy those characterisations.”
As a result of this, these risks move beyond the control of stakeholders to manage.
As Ian Branagan, chief risk officer at RenaissanceRe, notes, it is these risks that require a global, co-ordinated response from all counterparties, which includes engagement between the public and private sector.
Bridging the gap
Pool Re’s Julian Enoizi has extensive experience in bridging the gap between the industry and government, having served as CEO of the UK terrorism reinsurance backstop since 2013.
Enoizi believes the only way to solve many of the challenges we now face, from pandemic to cyber warfare, is through partnership between the public and private sector, but warns this remains challenging.
“If I had one observation of my time in my role, it is that there is an inherent distrust of the industry by the government and of the government by industry,” he explains. “I don’t think that has changed at all in the time I’ve been in the job despite my efforts and the efforts of many others.”
He believes part of the problem lies in the way the industry tends to approach the government.
“The problem with the insurance industry is that we always go to the government and ask them for what we need, in my own case an unlimited guarantee or whatever that happens to be.
“What we have to do is to start to show what the insurance industry can do for the government.”
While the industry is principally recognised for its risk transfer tools, in an event such as a pandemic costing trillions of dollars, it has been widely acknowledged that the industry balance sheet is not able to finance risk on this scale.
“But we can do a myriad of other things. We model risk, we understand risk, we price risk and we model the impact of losses,” Enoizi says.
“We plan for future losses, we incentivise the customer to behave in a certain way, we invest money in risk mitigation and we adjust claims. We understand and calculate claims and we have a distribution channel for the distribution of much of the money post event.”
All of these skills, while not directly financing risk, could bring huge advantages to governments. Enoizi believes it is a societal obligation for the industry to use these tools to help governments create more resilient societies for when – not if – a global economic and societal disruption next occurs.
Howard Kunreuther, co-director at the Wharton School of Risk Management, believes there is now a real opportunity for insurers to communicate about risk in a way that will grab people’s attention.
“When events are described as a 1-in-100-year risk, people will often think it is not going to happen to me. Framing the risk is important. We have carried out experiments that show that if you tell a person there is a 1-in-100 chance they will say it will not happen.
“But if you say there is a greater than one in four chance of a flood occurring over a 30 or 50 year period, people will pay attention. It is the same probability, but is being presented in a different way.”
Kunreuther highlights work he has undertaken with the Federal Emergency Management Agency to encourage flood insurance take-up in the US.
“They have now shifted their whole presentation to say that over the life of a mortgage, you will likely have at least one or more floods with a greater than one in four percent chance, to encourage people to buy flood insurance.”
Kunreuther also highlights changes to the risk landscape which have seen risks once considered 1-in-500-year events that could now have return periods of 50 years, and the importance of communicating these changes
“If you talk about the fact that these risks are increasing and focus on worst-case scenarios and talk about what happens if you are uninsured and unprotected and what you can do to mitigate, maybe we could get people to pay attention,” he says.
Isabelle Santenac, global insurance leader at EY, says the industry has a “unique opportunity” to stand up for its purpose to protect society and make it more resilient.
“Education is a key aspect of that,” she explains. “This is a unique opportunity for insurers to be perceived more as partners than just payers.”
Santenac believes the industry has a critical role to play in helping people and businesses become more resilient, through helping them understand what the risk is to empower them to make the right decisions.
Taking these steps will also enhance the industry’s reputation and image, she adds.
Lack of bandwidth
Enoizi believes there is a genuine lack of bandwidth at government level to address concerns about the next disruptive event given that the challenges presented by Covid-19 are still being navigated.
But he says work is taking place in government and in the House of Lords to improve resilience.
However, he believes it is unlikely a backstop or unlimited guarantee will be provided against this type of risk.
And behavioural challenges may emerge following the state support issued during the current pandemic.
“If you are a consumer you will look at what happened recently, and say why buy an insurance product if the government will bail me out?
“I’m seeing that in terrorism already with premium dropping as people decide that actually in the event of a catastrophic event, the government will bail me out.”
RenRe’s Branagan notes that similar behavioural challenges exist within governments and policymakers.
“My experience of working with governments for a number of years on climate resilience is that they are often used to responding to situations, but not used to strategically thinking about what will happen in the future,” he says.
“For climate resilience, it took six years before the concept of premium financing became accepted around a year ago. That is now an accepted concept of the way donor countries provide funding to the inter-governmental sector to do their work.”
Santenac believes the biggest risk is nothing happening in the short term and a similar systemic risk event occurring.
“This would mean the insurance industry will again be on the hook because of not being able to protect people.
“A lot can be done but it’s true that governments are more focused today on how to fund all the recovery of the Covid-19 costs.”
She believes parametric solutions may address part of the problem and enable a more rapid response in a more affordable way for a lot of people.
Carnegie-Brown also believes objectively tested parametric solutions could help build trust between governments and private enterprises.
“We’ve just participated in helping the UK government reopen event cancellation insurance and that was a successful new public-private partnership (PPP),” he says.
“Most of the risk is being taken by the government but one of the key issues is what is the trigger for an event in terms of it being cancelled? If it’s the government calling the event, clearly the industry isn’t happy about that.
“So if you can move to objective tests around these things, I think it can help enormously to build confidence in the value of these products.
“That’s certainly where I would advocate that we go on these things as a way of working, with different responses for different markets.”
Clearer definitions of perils are also required, with one example being war risk in the cyber market.
“War risk is excluded from cyber cover but wars are currently being fought in the cyber space and war has not been declared,” Carnegie-Brown says.
“So if a big war event or a malicious cyber attack took down the grid system in the UK, I’m sure insurers would say that it feels like a war event if it was traced back to a rogue state. And yet war would not have been declared between the parties.
“There are issues of definition where we need to be as clear as we can be so that we know where the risk exists when an event happens.”
Kunreuther says long-term thinking is critical, particularly for challenges such as climate change.
Most importantly, there is a need to link insurance to mitigation efforts so that policyholders can reduce premiums by taking steps to reduce any potential losses.
“If they say they cannot afford to do this then provide a long-term loan. People must think long-term and protect themselves before an event occurs.”
With the COP26 climate talks approaching, Santenac suggests a tax on carbon-intensive industries could help fund a reinsurance backstop-type mechanism to help protect against climate risk.
Enoizi says it is important to look at the type of economic structure that is right for today, and consider PPPs.
“I’m a red-blooded free marketer so for me PPP is the way to go. But it has to go hand-in-hand with incentivisation of behaviour towards risk mitigation.
“A PPP wasn’t in place at the start of the pandemic as it wasn’t thought of as something we were going to need.”
As Enoizi acknowledges, herein lies the key challenge for the sector – encouraging government investment for risks that may not happen.
To do this the sector will also have to overcome the short-term thinking of many politicians, who often fail to look beyond their own term of office when investing.
Achieving engagement on these issues will be critical if the industry and governments are to come together to create a joined-up approach to manage the systemic risks which will likely disrupt society in the future.
Carnegie-Brown: “Clarity has enormous value to both parties”
Lloyd’s chairman Bruce Carnegie-Brown has called for the industry to “take a good look at its policy documentation” following the disputes which marred the claims response to the Covid-19 pandemic.
Speaking during The Insurer’s #ReinsuranceMonth panel discussion on systemic risk, Carnegie-Brown acknowledged it was always difficult to create precise wordings for the unknown, but said the industry did not do as good a job as it could have done during the pandemic.
“The scale of the issues here were always going to be too large for the industry, irrespective of the wordings in policies,” he said.
“The global non-life insurance industry has about $2trn of assets available to pay its claims, and the IMF report for 2020 alone shows governments have injected more than $15trn into their economies, and we know the pandemic has continued well into 2021.
“The industry was never going to be able to cover this, nor did the industry try to cover this.
“Unlike specific events, this was a multiple-peril event for the insurance industry. There were numerous lines of business in the insurance industry where claims arose.”
Carnegie-Brown said this presented aggregation challenges for the industry, with Lloyd’s continuing to estimate insurable losses for the industry from the event at in excess of $100bn.
“The industry needs to look at the appropriateness of its wordings and in many cases, wordings have become quite sloppy as the market got more and more competitive over a 20-year period,” he continued.
“Not only did prices fall in the market but people started messing around with terminology and definitions and what was included and what was not, creating some confusion in the minds of customers as to what was covered and what was not.”
While business interruption was always intended to be adjunct to a physical damage policy, Carnegie-Brown said some “pretty inclusive wording” suggested claims should be paid.
“A number of participants in the industry got some of those definitions wrong and the issue has caused reputational risk and damage to the industry,” he said.
“It’s almost certainly true that the industry did not do as good a job as it should and as we think about either the issue of pandemic recurring or risks such as cyber and climate, the industry should take a good look at its policy documentation.
“The worst outcome is uncertainty, either the underwriter has the risk and they didn’t intend to have the risk, or the customer has a claim that is not paid. Clarity has enormous value to both parties.”