Environmental And Social Risks Weigh On Insurer Sustainability
Story/photo by Africa Ahead
The fact that environmental and social loss events often fall within the universe of practically uninsurable ‘systemic risks’ means that these constructs pose a major threat to insurers’ and reinsurers’ long-term sustainability. Of greater concern, the World Economic Forum (WEF) Global Risks Perception Survey 2021-22 lists five environmental and three social risks in its top eight, with debt crises (an economic concern) and geopolitical confrontations in positions nine and 10.
On the environmental slate, it mentions climate action failure; extreme weather; biodiversity loss; human environmental change; and natural resource crises, while social issues include social cohesion erosion; livelihood crises; and infectious disease. This survey is just one among hundreds of international studies that elevate environmental, social and governance (ESG) factors – or at least two of the three – as the biggest issue facing insurers and reinsurers today. This ranking of global risks provided an excellent backdrop for a presentation titled ‘ESG challenges and opportunities facing the insurance industry’ delivered by Francois Theron, deputy CEO of South African general insurer Discovery Insure to the 2022 Financial Intermediaries Association of Southern Africa (FIA) Advice Summit.
Theron grabbed the audience’s attention early on, reinforcing both environmental and social risk perceptions with an excellent video montage of deforestation; glaciers melting; plastic contamination of the oceans; and footage of loss and damage following natural catastrophes such as drought, flood, storm and wildfires, to name a few.
“You may feel that some of these risks are not relevant to us today, and that we can leave them for the next generation to deal with; but ignoring ESG risks has had and will continue to have a dramatic impact on society, and by extension the insurance sector,” he said. Nothing illustrates this reality better than the increasing frequency and severity of extreme weather events, which more and more insurance and reinsurance experts acknowledge as a consequence of climate change.
South Africa, which has for decades presented a relatively benign risk profile insofar as natural catastrophes, has experienced first-hand how devastating such events can be following the April 2022 KwaZulu-Natal (KZN) floods. It is estimated that insurers and reinsurers will pay out around ZAR17bn to insureds following this disaster, with the total economic cost exceeding ZAR50bn. And the trend is set to get worse. According to Theron, there were more than 16 severe weather events per month in South Africa in the first nine months of 2022 compared to just nine events per month in 2021, illustrating just how volatile weather risk is becoming.
On the social front, global life and non-life insurers paid out billions of dollars to settle claims during the Covid-19 pandemic, with the former settling unprecedented values/volumes of death claims, and the latter making good on millions of business interruption (BI) claims. But although insurers and reinsurers tend to focus on the economic costs caused by the perils that they cover, there are long-term social considerations too. “The human impact of pandemic has been dramatic; and we are seeing [more evidence of this coming through] in the health data now, with incidences of mental illnesses higher than ever before,” says Theron.
Why should insurers and reinsurers care about ESG? Well, the short answer is that insurer resilience and sustainability hinges on being able to cover risk exposures through sensible underwriting. Insurers must collect sufficient premium from their insured bases to settle claims, cover operating costs and provide a reasonable level of return to shareholders. Shifts in the environmental and social risk landscape have immediate and significant impacts on the level of risk that insurers are exposed to. Using the earlier statistics, a South African general insurer would have had to factor in and price for just nine extreme weather events per month in 2021, versus 16 in 2022, with each event costing more, on average, in the latter year. If the insurer fails to address this issue by raising premiums, renegotiating reinsurance treaties and/or stricter underwriting, it will eventually go under.
Extreme weather has huge implications for traditional short-term insurers, exacerbated by rising repair and replacement costs, and poor risk mitigation. Discovery Insure offered an excellent piece of analysis based on the so-called La Niña weather phenomenon, which is defined by a two- or three-year period of excessive rainfalls. They estimate that the occurrence of this weather phenomenon can erode an insurer’s loss ration by between 1.3% and 6.1%, which is significant given many traditional insurers aim for an underwriting margin of around 7%. Another interesting insight was the impact that apparently innocuous municipal shortcomings in firefighting services and road maintenance can have on a traditional insurer, with Discovery Insure paying out 31% more for pothole-related damages and 115% more for fire claims in 2022 compared to 2021.
All the time, the cost of servicing claims is rising. Supply chain issues that developed during the Covid-19 pandemic persisted through 2021 and into 2022, with upwards of 350,000 containers standing idle in 2021, and the cost of shipping a container from China to South Africa up by 500%. “These issues have had a ripple effect through the motor industry, specifically around the inflation impact and shortage of car parts,” said Theron. Average inflation was four times higher in 2021 than it was in 2020 across both vehicles and vehicle parts. Also, local insurers faced long delays to repair vehicles due to spare parts shortages and have seen the value of their second-hand motor insured book rising sharply, with consequent underinsurance risks.
Shifting focus to social issues, and more specifically social cohesion erosion, Theron pointed out that pandemic had shown up severe income disparities in society, globally. Nothing better illustrates this disparity than the fact that only 6% of the populations in the 52 poorest global economies had been vaccinated against Covid-19, despite a global push to achieve universal coverage.
“The top 20% of the world’s population recovered half of their pandemic losses by the end of 2021 whereas the poorest 20% had lost a further 5% of their income, being in an even worse position than they were before,” said Theron. “And by 2030, about 51 million more people are projected to be in extreme poverty.” In South Africa, a single loss event triggered by inequality and poverty cost the insurance industry more than ZAR32bn, with reference to widespread looting that took place in July 2021 in areas of KZN and Gauteng.
The insurance and reinsurance industries are at a tipping point insofar as their responses to major systemic risks posed by climate change, cybercrime and the ongoing erosion of social cohesion. These challenges, says Theron, should be viewed as opportunities for both insurance broker and insurer to come up with new insurance products that meet shifting consumer needs.
Future-fit products must accommodate the evolving risks landscape and meet consumer demands for flexibility through pay-as-you-use offerings and other innovations. And solutions will have to be sought for future systemic risks, whether by the industry or through collaboration between governments and the private sector. As for monitoring environmental and social progress, Theron suggests benchmarking against the UN’s 17 Sustainable Development Goals (SDGs), with the caveat that achieving these goals is too big for any single player acting in isolation.
Source: https://afahpublishing.com/
