Navigating the turbulent waters of geopolitical hazards
Geopolitical risk is firmly back on the agenda for insurers.
If you asked any senior business leader a decade ago how they managed major geopolitical risks, they might have talked about horizon scanning but the feeling was always that these risks were just a distant dot on some far horizon.
Now, the subject is top of boardroom agendas across the globe. This is a new age of geopolitical instability, the likes of which we have not seen since the 1930s. For many, it started on 24 February 2022 when Russia launched its brutal, illegal assault on Ukraine but powerful currents were already running and buffeting the insurance market long before then.
A recent report from Airmic (Association of Insurance and Risk Managers in Industry & Commerce) and the Chartered Institute of Internal Auditors highlighted the broad sweep of the risks that need to be factored in: “We are at an inflection point in geopolitics. The spectre of war has returned to Europe. Decoupling between the economies of the US and China, the world’s two largest economic blocs, is reversing globalisation as we have known it. The International Monetary Fund’s (IMF) World Uncertainty Index readings have hit elevated levels in recent times.”
A decade ago much of the focus was still on terrorism, and the insurance market developed a range of products to meet that risk, especially after the attacks on the World Trade Center in 2001. In the UK, USA and elsewhere, many of these only came about because of government backing. Few are now called upon to pay out.
Insurance broker Howden says that since 2015 the insured losses from terrorism globally have plateaued with less than $1 billion paid out in the last eight years. Civil unrest and political violence have soared as terrorism losses have receded, topping $10 billion for the same period.
The war in Ukraine and the impact of sanctions is threatening to destabilize parts of the market, as it was ill-prepared for the consequences of such a conflict. The claims from airline leasing companies for the losses they have incurred on the hundreds of planes trapped in Russia are already approaching $20 billion and have led to a stand-off between underwriters and the leasing firms. These claims are already heading for the courts as liability and war risks insurers argue over who should be paying these enormous claims.
How should the insurance market address these challenges as it plays catch-up with our increasingly volatile world?
Héléne Galy, managing director of WTW Research Network, offered some insights at a Worshipful Company of Insurers’ webinar, saying a change in mindset was needed.
“There is always a human hand here, unlike with natural hazard risks for which insurance is very well developed. Risks driven by geopolitics are man-made. This has two consequences.
“It makes them very difficult to predict. Modelling is impossible. It also makes the risks more systemic and has implications for insurance availability and viability.
“The picture is made more complex because our world is increasingly connected”.
This complexity and unpredictability are making life hard for major buyers, says Airmic CEO Julia Graham. “It is harder for businesses to plan for disruption. Businesses are monitoring and navigating the short-term risk outlook, scenario planning for the longer view, but keeping an eye on strategic opportunities that can emerge from volatility. Building resilience is imperative. Businesses need to be prepared to deal with significant disruption caused by political incidents.”
AIRMIC’s 7 point plan for building geopolitical resilience
- Be agile in responding to the challenges of ‘once-in-a-generation events’ occurring with regular frequency
- Scenario planning and horizon scanning are the keys to preparing for geopolitical risk
- Stereotypical profiles of risk and internal audit professionals need to be reviewed to ensure they meet future needs
- Take a long-term view of geopolitics
- Stay true to the organisation’s purpose
- Geopolitics is not just all about downside risk
- Risk and internal audit need to operate as strategic enablers
This is about building resilience with a focus on risk reduction and mitigation as much as risk transfer. Implicit is an acknowledgment that many risks will not be insurable (see box). The ongoing debate about war and terrorism risks and cyber cover shows how easy it is to reach the boundaries of insurability.
Galy says “we are not entirely in the dark” as history and geography often lend a strong context to emerging geopolitical risks. She says maintaining a long-term view – both of the past and the future is essential to avoid “recentcy bias” – when risks are seen just through the lens of the current crises.
WTW’s own Winter 2023 political risk index focuses on a geographical analysis with the help of Oxford Analytica, looking at how global alignment has changed over the last five years (see map). It is a reminder of how powerfully and unpredictably geopolitical currents flow across the globe.
Alongside the Ukraine war and the constantly changing sanctions regimes, few will be surprised that the world’s largest businesses are anxiously watching China and its relationship with the United States in particular.
“These are the two most consequential countries in the world right now, with everything going on, and they have the remarkable ability to work together and to lead. But if we see a further degradation of that relationship, it also presents a significant risks, not just to the business community but also to global stability overall”, Bruce Andrews, corporate vice-president and chief government affairs officer at Intel told a recent McKinsey & Co. webinar.
China presents a major challenge, one that few businesses and insurers are addressing, at least openly. Xi Jinping’s New Era is making life uncomfortable for many Western businesses, with the latest draconian tightening of data protection laws at the end of April the latest shock.
Faced with a daunting range of challenges, many underwriters might be driven to despair.
During its annual gathering in Davos in January, the World Economic Forum propelled the term “polycrisis” into the vocabulary of political and economic analysis. It is a reminder of the multi-faceted challenges the world faces and the interconnectivity between political and economic issues.
This connection between economic pressures and political turmoil has been highlighted by London insurer Chaucer, which says the demand for political risks insurance has risen as governments face sharp falls in their foreign exchange reserves.
Sri Lanka’s collapse into political violence in 2022 started with its foreign reserves falling to unsustainable levels, leading to debt defaults and 50% inflation.
Over the last year 50 countries saw their foreign reserves fall by 10% or more, with the UK’s falling by 13.7%. Bolivia, New Zealand and the Republic of Congo experienced the fastest falls. When this happens the risks that massive public sector contracts might be delayed cancelled or simply unpaid increases, says Jonathan Bint, senior analyst and underwriter at Chaucer.
“When governments are short of foreign exchange then contracts with foreign suppliers can be a tempting target for cost-cutting. When the global economy stutters, cancelled government contracts and disputes over payments rise and they are by no means limited to emerging markets.
“In a period of rising global economic uncertainty, businesses that ignore the risk of contract cancellation, or an increase in reneging on bills, could be opening themselves up to significant financial loss.”
Economic risks are just another range of factors that need to be embraced, says Graham. “While understanding these dynamics will not solve anything, achieving greater clarity about risks and their potential effects will make it easier to create appropriate interventions and to build a more resilient business.”
With traditional modelling techniques not applicable to these new – for some businesses potentially existential – risks, scenario planning can provide answers. It is hardly a new analytical technique. Its lack of precision has not always made it an easy tool for insurers to apply but it can “help to develop effective risk prevention and mitigation strategies”, says Galy.