Sri Lanka unrest highlights type of losses industry should expect next

Hermès Marangos examines the wider implications of the crisis in Sri Lanka for the international (re)insurance sector in the wake of the Covid-19 pandemic, the ongoing energy crisis and Russia’s invasion of Ukraine.

It is not easy in our industry to bring all the threads of global events together to predict the future, especially with the prospect of a drawn-out war in Europe, but this is exactly what is required to implement proper risk management. 

The London market is very well placed to lead the way, given its leading role as an international market, its experience with war and other political violence risks and industry practices regarding political risks. 

As with previous wars, the longer-term impact on the industry from Russia’s invasion of Ukraine may not be related to war losses, but rather other societal risks that can have devastating effects due to a wider destabilisation of numerous countries and the loss accumulation problems arising from that. 

Potential ramifications are severe, as there are converging factors that include severe economic hardship due to the pandemic and the energy crisis and, of course, the war. 

In this context, the social unrest in Sri Lanka may be an indication of the type of losses the international insurance market should be readying itself for next. 

While it is correct that Sri Lanka has been mired by corrupt politics and mismanagement of the economy, reports from the UN and the World Bank show that the pressures that forced it into defaulting on its debt could equally lead to other countries defaulting. 

The pattern is predictable. Collapsing societies invariably lead to civil disturbances that involve riots and civil commotion, with losses that in the context of typical insurance policies are covered. 

Inevitably there are similarities in Sri Lanka to the civil unrest in Haiti, Indonesia, Pakistan, Thailand, Brazil and Turkey, to name a few. From an accumulation perspective, riots, in general, have a greater impact on the insurance bottom line than isolated acts of other types of political violence, such as terrorism or war. 

The indicators in various countries suggest there is no room for further economic shocks. This historically translates to a higher probability of instability and violence. A minimal change in food supplies, interest rates or energy costs may be the straw that breaks the camel’s back, even if that last straw is not the heaviest one. 

Like Sri Lanka, many countries are finding it hard to borrow sufficient money to deal with their debts. The energy crisis, the war in Ukraine (increasing further the cost of food and fuel) and the increased cost of borrowing all impact on crucial areas that affect the insurance industry. 

Economists are now identifying various countries where converging factors will likely lead to social unrest or collapse of parts of their economy. Non-democratic regimes are more likely to see societal risk losses. 

Key indicators of further problems in developing countries facing unsustainable sovereign debts (in addition to the World Bank warning even prior to the war in Ukraine that there was a looming worldwide debt crisis) are threefold: rising food prices, energy costs and tougher financial conditions. 

The UN reports that at least 107 countries face at least one of the three risks, with 69 countries facing all three risks, which for the insurance industry represents potentially extensive losses to their political risk covers. Unless these issues are immediately addressed, these countries could face a similar situation to Sri Lanka. 

If the World Bank is right that many developing economies will not be able to service their debts, then unless one heeds the warnings by economists of the need for new and drastic economic policies and risk management across all economies, debt to GDP will reach breaking point for many nations and households. 

This means better economic management must be implemented to assist a world facing debt distress and borrowing to stay afloat.  

While the world has to learn to manage debt and borrowing properly, insurers must continue to monitor how much of this burden they consider is for the insurance industry, so as to develop their societal risk covers accordingly. 

If done properly, this allows the insurance industry to identify what geopolitical confrontations can impact on societal risks. We now see how terms imposed by borrowers in developing countries correlate to social unrest. 

Debt crisis is a security issue and therefore the insurance industry is entitled to contain its losses to whatever it is prepared to sustain for losses that flow from resulting instability in numerous parts of the world. China, for example, may play a controlling role as a creditor to Sri Lanka.  

In terms of general principles applied to these losses, risk managers should recall that there are standard scenarios to be considered. 

Although the triggers may be very different, we are seeing worldwide (and not just in economically challenged countries) that the expressions of discontent are accompanied by riots, malicious damage and looting, whether the riots are capable of being described as political, economic or indeterminable.

As all such risks are covered, the international market must decide to what extent it wants to be exposed to them, and at what premium. Much will depend on the willingness of the reinsurance market to provide support.

There are new wordings being put forward to differentiate between riot “types”, but it still remains to be seen how the international market can contain or restrict coverage of all-risk policies to strictly economic riots (the argument being anything “political” should not be the responsibility of the all-risks market, but rather the specialist political violence/war/terrorism market).

Whether and when a specific riot becomes a civil commotion or a popular uprising, and whether a related loss may be excluded from cover, may be a question of “degree” and ultimately turn on the factual matrix surrounding the event. 

For example, while a civil commotion may ordinarily be covered in a typical all-risks policy, if that civil commotion assumes the proportions of or amounts to an uprising, it may be excluded. The issue then becomes whether there is a link between the actual losses and any uprising.

What is clear is that the factors that are now converging in numerous countries will likely fuel social discontent and will therefore need to be managed by the insurance industry.

Hermès Marangos is a partner at Signature Litigation LLP and has been representing entities on complex cross-border issues, including international (re)insurance and underlying commercial litigation, for 30 years.