Dr. Thomas Sepp, Chief Claims Officer, Allianz Global Corporate & Specialty (AGCS)
One of the world’s largest container ships runs aground in the Suez Canal bringing mass disruption, a tragic airplane crash results in a number of fatalities, the operator of an oil pipeline is blackmailed by hackers. Sometimes it seems hardly a day goes by without industrial insurance claims making the headlines.
Such loss events regularly occupy the attention of insurers today, but what about tomorrow? What are some of the most important claims trends we can expect to see in the future? In addition, to what extent are prevention and risk mitigation possible?
As the Chief Claims Officer of AGCS, I am primarily concerned with four future loss trends: the impact of cyber risks and new technology; the growth of social inflation and collective redress; increasing environmental, social and governance (ESG) risks; and, of course, climate change.
1. Three factors driving cyber and technology risk
Cyber risk is already very much on the loss agenda of companies and insurers, as the incident of hackers blackmailing the operator of the oil pipeline shows.
At AGCS, we saw cyber claims reach their highest level to date last year with just under 1,000 reported claims involving us and other insurers – around 10 times more than four years ago. We expect the cyber risk dynamic to continue to grow strongly, driven by three factors:
Firstly, rapidly advancing digitalization is increasing the exposure – for example, the pandemic-driven shift to remote working has caused cybercrime to explode. Interconnectedness of supply chains, production networks and business models, the rapid growth of data volumes, the use of cloud technologies, artificial intelligence or cryptocurrencies – all these developments will make companies even more vulnerable to hacker attacks and internal IT mishaps.
Secondly, it is difficult to contain cybercrime. The main cause for concern here is the globally active hacker syndicates, which have long offered crime-as-a-service. In addition, geopolitical tensions are increasing – which plays into the hands of gangs in Russia or China. Without better-equipped cyber-investigation agencies and stronger regulation of cryptocurrency trading, it will be almost impossible to put a stop to the criminals in the Wild West of the Dark Net.
Thirdly, prevention is expensive and demanding. Companies have to invest continuously in cyber security at increasingly higher levels. Many also find it difficult to select effective services and vendors in the ‘market for lemons’ of cybersecurity solutions. In case of a cyber-incident or an emergency, which can happen to any company at any time, it is important to have secure backups and a robust, well-tested crisis plan. This can not only help companies to limit losses but also to get operations back up and running quickly. It can also be the best safeguard against potential lawsuits against company management if they are perceived to have neglected the board duty of cybersecurity.
2. Social inflation and collective redress bring a tougher legal and liability environment
Social inflation refers to a trend toward higher settlement amounts for injured parties resulting in more frequent and costly liability claims for insurers and companies. Originally, a US phenomenon, it is increasingly globally.
Commercial and product liability policies, as well as automobile, professional, health, workers’ compensation and directors’ and officers’ (D&O) policies, may be affected. A study by VerdictSearch shows that the frequency of court-awarded indemnities of $20 million or more in 2019 had increased by more than 300% compared to the annual average from 2001 to 2010.
The target is primarily large corporations – such as we have seen in cases of glyphosate or opiate lawsuits – but increasingly also smaller companies from the logistics or retail industry, for example, when it comes to the question of organizational culpability in accidents. Social inflation is driven by many causes, among them social developments such as shifting perceptions and attitudes – including the different values of the “Millennial” generation, general criticism against – and distrust of – corporations, and the increasing influence of social media sentiment. Added to this is a customer-friendly interpretation of contracts in court and, last but not least, the increasing professionalization and sophistication of the plaintiffs’ side.
Of course, the liability environment in the UK, Europe, Asia or Africa is not as ‘toxic’ as in the US and the pandemic also contributed to a slowdown in court activity in the US. However, it would be premature to sound the all clear. Further, dismissing social inflation as a purely American phenomenon that at best affects national companies active in the US market, means also misjudging the situation, as potential drivers of social inflation are thriving around the world.
Following many national initiatives, a recently adopted EU directive will now create uniform requirements for collective actions in Europe so that consumers can better assert their rights against large companies. Meanwhile, the UK litigation market has seen an increase in claims for collective redress across a variety of sectors. Outside of Europe, Australia has seen consistently high activity while activity has stepped up in Canada.
Legal tech – specialized software solutions and automation of legal activities – will ensure that class actions can be handled ever more efficiently in law firms in future. The assumption of litigation risk is another driver: The number of litigation funding companies, which advance court and legal fees, is growing steadily in many countries globally, as widespread as in Saudi Arabia and South Africa. This increases the willingness of plaintiffs to take legal action. Companies and their insurers must expect more lawsuits and proceedings and prepare for a tougher liability environment and rising reputational risks.
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3. ESG topics no longer voluntary
In recent years, we have witnessed a paradigm shift: The ethical standards that are placed on companies in the area of ESG have increased massively. Whether it is global warming, diversity, biodiversity, or even executive pay, CEOs and boards can be accountable and regularly face campaigns from activists and non-governmental organizations (NGOs). Capital markets are also demanding more robust commitments to a climate-friendly economy or specific audits on inclusion.
The social and media pressure is accompanied by a regulatory wave of new laws, standards and obligations for companies. Between 2018 and the end of last year, law firm Herbert Smith Freehills counted more than 170 new ESG regulations worldwide – more than in the previous six years combined. A recent example is a Supply Chain Act which now holds German companies accountable for their suppliers’ human rights compliance.
Companies must apply these regulations as well as fulfill comprehensive reporting obligations – and this is of course only right and desirable, but often complex and not without pitfalls in practice. Those who fail to implement them, or implement them carelessly, face the threat of fines or official proceedings. For financial institutions in particular, compliance violations are already one of the biggest drivers of insurance claims, as an AGCS analysis shows.
In short, in the ESG spectrum, companies and their insurers must expect new liability scenarios, changes in legal interpretation, and increasing potential for lawsuit and litigation risks. In D&O insurance, we are already seeing the first claims around reporting obligations or greenwashing allegations. Conversely, companies that actively integrate ESG issues into their risk management, manage them systematically, and communicate them properly tend to have fewer claims, as a scientific study by the Value Group has shown. At AGCS we consciously use ESG indicators for forward-looking models in D&O underwriting.
4. Higher property damage, compliance and litigation risks from climate change
Climate change is resulting in more extreme weather events in many parts of the world, leading to significantly higher property damage risks, especially near coastlines, flood plains and in areas prone to forest fires, given these are areas that more and more people and companies have settled in. Recent research by the Allianz Center of Competence for Natural Catastrophes at Allianz Re shows that the frequency of major hurricanes has increased by 15% over the past 40 years – in each decade. The hotter and longer dry spells of recent years also lead to a higher risk of wildfires, as seen for example in Australia and California in particular. Meanwhile, the Earth’s warmer atmosphere means it can absorb more water, so we can also expect heavier rainfall in some areas. In the UK, for example, seven of the 11 years with the highest rainfall to date – since 1862, when weather records began – have been in the years since 1998.
In addition to property damage caused by climate-related weather extremes, new liability scenarios are also looming: More than 1,500 climate lawsuits in 37 countries have been filed to date, largely against “carbon majors.” The issue of climate compliance should also by no means be underestimated in view of the number of existing and planned regulations on the way to a climate-friendly economy. The flood catastrophe in parts of Germany and the Benelux countries has impressively demonstrated the devastating damage that heavy rain and flash floods can cause.
Responding to existing and emerging exposures
The loss scenarios in today’s digital and globalized world are diverse and interconnected. The coronavirus pandemic has shown us the limits of previous approaches and processes that were considered robust and the climate crisis and technological change will most certainly present us with further challenges.
It is therefore more important than ever for companies to identify risks and loss scenarios at an early stage through systematic monitoring and early warning systems, to learn the right lessons from events, and to agree on effective prevention and risk mitigation, risk transfer, and business continuity measures for the future.
Insurance companies must proactively address these loss trends. We need forward-looking risk assessment and underwriting processes and further product innovations – especially with a view to the protection gap for exposed tangible assets, but also for intangible assets such as data or intellectual property that have so far been inadequately protected. At the same time, for insurers, pricing discipline and adequate margins, systematic capacity and portfolio management, and robust reinsurance are needed to cope with the increase in both the number of loss events and the average cost per loss. Only with a focus on profitability are insurers long-term partners.
In addition, services in both loss prevention and claims handling continue to gain in importance. As an insurer, we will only retain our relevance as a risk transfer partner for companies if we find answers to the emerging exposures of the future – and provide reliable and competent assistance in the costly accidents, devastating natural catastrophes and tragic accidents of the present.
Published in Versicherungsmonitor on July 27, 2021