by Marcus Fletcher
In insurance the loss potential to natural catastrophes has traditionally been measured by catastrophe models. Catastrophe models are effective since they rely on past historic trends to predict possible financial loss to a natural catastrophe, however, emerging risks are harder to predict due to insufficient historic data. One of the key challenges to the insurance industry is identifying and designing products for emerging risks. These are five emerging risks that insurance companies are becoming increasingly concerned about:
Although hail is not a new risk to insurance companies the numbers of claims to hail have been rising in recent years. This is partly due to the development of roofing technologies, such as solar panels, and partly due to the concentration of assets in cities. Recent large hailstorms, such as the Central European hailstorm in the summer of 2013, have raised awareness in the insurance industry to losses from this type of event. This awareness will only increase if climate change alters the frequency and distribution of extreme weather in the future, according to an IPCC special report (2012).
2. Solar flares
Solar flares are ejections from the sun’s surface which can alter the earth’s magnetic field. They consist of large amounts of energy in the form of radiation and plasma. Solar flares are a concern for the insurance industry as they can cause widespread damage across a number of insurance classes. Space risks and damage to satellite components are the most obvious concern to insurers, however, solar flares can also create geomagnetically induced currents on the Earth’s surface which damage high voltage transformers. This could have secondary effects, such as blackouts, civil commotion, stock market disruption and bank closures due to ATMs not working.
One of the largest geomagnetic storms on record is the 1859 Carrington event which was estimated as having a 150 year return period. The insurance market Lloyd’s of London has calculated a repeat of this event in the US Atlantic corridor between Washington DC and New York, the most vulnerable area based on magnetic latitude, ground conductivity, distance to coast and population, could generate economic costs of between $0.6 – 2.6 trillion. This has led some to argue in the industry whether solar flares may be uninsurable. With the geomagnetic storm risk predicted to peak in early 2015 according to the 11-year solar cycle and an increased dependency on electricity, the risk of solar flares is being taken more seriously in the insurance industry.
3. Cyber risk
Cyber security incidents are multiplying in frequency and complexity and encompass anything from malware, administrative errors, malicious employee activity and internal hackers. 76 per cent of respondents to a survey conducted by Zurich Re stated that information security has become a significant area of concern in the past three years. The growing concern among private and public industries has led to the development of specialist cyber insurance policies. These insurance policies cover the cost of recovery to ‘business as usual’ after a cyber-attack.
The report conducted by the Harvard Business Review also found that there is a disparity between the concern about cyber security and the adoption of cyber insurance. Less than 20 per cent of participants in the survey have purchased insurance to cover cyber risk, leaving a lot of businesses exposed to the possibility of loss of business income and reputational damage. As cyber threats become more sophisticated the uptake of these cyber insurance policies is likely to rise and the insurance industry could play a key role in countering this new type of threat.
4. Global pandemic
In a recent survey by Tower Watson (2013), a global pandemic was voted by insurers as the most worrying extreme risk to the insurance industry. This has been exacerbated by recent infectious diseases such as avian influenza (2007), SARs (2003), H1N1 influenza (2009) and the Ebola outbreak in West Africa (2014). The ability of these infectious diseases to cross borders and threaten the regional economic stability of some countries demonstrated to insurers the danger of this emerging risk. The recent Ebola outbreak alone saw a lot of Ebola exclusions written into policies as insurers feared it may spread significantly to the UK and US. Whereas most of these epidemics and pandemics were relatively well contained insurers are alert to a much larger global pandemic.
The H1N1 influenza was the most deadly — killing over 18,000 people — according to an estimate from the World Health Organization. The 1918 influenza outbreak is used by the industry as a worst case scenario. This outbreak could have caused up to a reported 100 million deaths. A repeat of this event would severely damage the global economy, potentially instigating a global recession of 1 to 10 per cent global GDP. From an insurance perspective a global pandemic on this scale would not only impact insurers’ investments, but lead to a large number of claims across multiple classes of insurance.
During a global pandemic on the scale of the 1918 influenza outbreak, it is likely that liability claims would increase significantly. For instance, if an airline continues to operate it may face claims from passengers who contract an infectious disease while flying. Similarly travel insurance will be impacted if it has to cover medical expenses and costs of hotels while customers are placed in a quarantine zone. However, the 1918 influenza outbreak should not be considered a worst case scenario as it had a relatively low mortality rate (2.5 per cent). In addition increased global mobility and population growth since 1918 could lead to a more rapid and protracted spread of a disease. The ability of microbes to become resistant to the latest antiviral and antibacterial drugs and the historical recurrence rate of 30-50 years for pandemics, ensures it will remain a global threat to insurance for many years to come.
5. Water crisis
In the same Tower Watson Survey (2013) that placed global pandemic as the extreme risk that insurers are most concerned about, a food/water,/energy crisis placed third, just behind natural catastrophes. It is anticipated that almost half the population will live in high water stress areas by 2030. This threat is also not exclusive to less developed countries, as Spain and California (See Extreme drought in US threatens groundwater supply) have already experienced severe water shortages. The anticipated water scarcity for some regions in the near future is likely to threaten economic and regional stability, as well as food and energy production, the most water intensive industries.
Already 70 per cent of global water is used in agriculture, and population growth and concomitant demand for food will only put more pressure on food production. During a water crisis the insurance industry is likely to face claims from food insecurity and unsafe food. Likewise energy relies heavily on water, 39 per cent of all water in the US is used in energy production. Blackouts and supply chain disruption will lead to business interruption claims, claims that are made when a company is forced to stop operating. A water, food or energy crisis is likely to be a prominent geopolitical issue that the insurance industry needs to be alert to in the future.
Marcus Fletcher is a postgraduate student on the Risk Masters course in the Department of Geography and Institute of Hazard, Risk and Resilience at Durham University.