Partner Hermès Marangos notes that the crisis in Sri Lanka has wider implications in the wake of the pandemic, the war in Ukraine and the global energy crisis, which the insurance industry must manage, in Insurance Day.
Hermès’ article was published in Insurance Day, 7 June 2022, and can be found here.
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 long-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 of the Russian invasion of Ukraine may not be war losses related, but rather from other societal risks that can have devastating effects due to a wider destabilisation of numerous countries and the losses accumulation problems resulting 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.
Seen in the above 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 United Nations 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 the present events in Sri Lanka to the civil unrest in Haiti, Indonesia, Pakistan, Thailand, Brazil and Turkey, to name but a few hotspots in the world. 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 (not just developing ones) suggest that 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 does not necessarily have to be the biggest one.
In predicting the more vulnerable geographical areas that may require assistance to prevent political upheavals, the crisis that hit Latin America in the 1980s may be a useful guide. The inability to deal with oil prices and pay back national debts led to the collapse of economies in that part of the world one after the other.
As with Sri Lanka, many countries are finding it hard to borrow sufficient money to deal with their debts. Post-pandemic, the energy crisis, the war in Ukraine (increasing further the cost of food and fuel) and the increased cost of borrowing impact on crucial areas that affect the insurance industry. Leading 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 counties (in addition to the World Bank warning even prior to the war in Ukraine that there was a looming worldwide debt crisis) facing unsustainable sovereign debts are threefold: rising food prices, energy costs and tougher financial conditions. The United Nations 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 the issues are immediately addressed, as Russia and Ukraine supply wheat, countries such as Egypt potentially face societal unrest given that they only have three months of supplies of wheat. Tunisia’s economy is also overheating. Foreign debt accounts for 100% of its GDP. Petrol prices at record high. Experts agree that the situation can lead to civil unrest. Lebanon continues to be on the verge of collapse; the huge explosion at the port in Beirut having destroyed its grain supplies. The currency lost 90% of its value with food prices having gone up by eleven times. Historically Lebanon imported 80% of its wheat from Ukraine. It now relies on the World Bank for food security.
On the American continent, even a strong economy that always bounced back, like Argentina, is now facing a tenth time defaulting on its debts. It wants to renegotiate with the IMF to refinance a $45 billion loan.
El Salvador and Peru also face hyperinflation in commodities, food shortages and mass unemployment. Again, the relevant indices suggest a very similar situation to Sri Lanka.
In sub-Saharan Africa the countries that need to be considered in anyone’s risk management, with similar issues profile to Sri Lanka include Ghana (debt levels soaring with interest payments choking the economy with a debt crisis imminent) and Kenya (unmanageable debt and relying on emergency help from the IMF). There is an eighty percent debt of its GDP in South Africa, with a danger of collapse of government institutions, and more civil unrest as experienced in 2021. In fact, the civil unrest related losses to the insurance industry from South Africa are indicative of the extent of riot exposure to the industry.
Another country that may experience problems is Turkey. Powerful states with huge populations and economies, at least from an insurance industry risk management perspective, can be even more problematic. Turkey’s currency is sliding, and its debt is soaring, with inflation touching 70%. It is also facing food shortages.
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 leading economists that there is a 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, with creditors providing contingency plans to borrowers, and mechanisms being introduced to prevent low-income countries from collapsing under the present strains and restructuring debts better, insurers must continue to monitor how much of this burden they consider is for the insurance industry, so as to develop their societal risks 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. After all, 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 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.
Admittedly 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/terrorist 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.
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28 November 2023
28 November 2023