Reduced market access, regulatory fragmentation, the return of inflation, cloud risk accumulation and emerging liability legislation for artificial intelligence, are some of the key risks identified in this year's Swiss Re SONAR "New emerging risk insights" report.
The publication is based on the SONAR process, a crowdsourcing tool drawing on Swiss Re's unique internal risk management expertise to pick up early signals of what lies beyond the horizon.
Potential impact on insurance industry
The report offers insights into emerging risks and highlights a number of unique trends. According to Swiss Re, emerging risks are newly developing or evolving risks that are difficult to quantify and sometimes not fully understood, but potentially have an impact on the insurance industry and society.
Swiss Re's 2017 report on new emerging risks helps shape the debate around emerging risks and how they can best be tackled.
"Ignoring emerging risks is not an option, either for political decision-makers, the insurance industry or society as a whole," according to Patrick Raaflaub, Swiss Re's Group Chief Risk Officer. "The earlier we adapt to these changes, the better prepared we'll be. Sharing knowledge through a proactive risk dialogue across stakeholders can help the insurance industry create a pro-active and pre-emptive risk management culture that enables disciplined risk-taking. That is an important step to help society as a whole to become more resilient."
Here are 18 of the emerging risks that Swiss Re says could have the biggest impact on the insurance industry and our global society:
1. Reduced market access.
Western countries that have historically promoted free trade and financial globalization have recently experienced upturns in politically motivated nationalism and protectionism. Such developments may eventually lead to trade barriers and market access issues around the globe. The ultimate result could be a slowdown in economic growth and in the international expansion of multinational corporations, including large insurance companies.
- In a world where nationalistic tendencies are strengthening, market access will become more difficult for all industries, including re/insurance. Consequently, there will be a negative impact on global trade and economic growth.
- In the long-run, diminished diversification effects will make insurance products more expensive, which will dampen insurance growth and hinder the industry’s efforts at bridging the protection gap.
2. Hijacked money: Political risk of forced investments.
Global re/insurance companies held assets of $32 trillion in 2015, 75% of which were invested in fixed income assets, according to the Swiss Re report. Many European governments try to kick-start economic growth in their countries while being confronted with high levels of public sector debt, rising entitlements, and enormous future liabilities. Pools of large, managed assets are attracting their attention.
Privately-held assets have also come under scrutiny of governments in order to spur growth and funding preferred industries. Many populist parties favor such programs.
Such policies would amount to a partial confiscation of insurers’ assets. If more widespread, they would put the industry under threat. Limitation to “only small” percentages of total assets could erode over time, and an ever larger part of assets could then be sequestered. From an operational perspective, it would pose grievous problems to asset-liability management.
Insurance companies may resort to capital flight if such policies become more commonplace. Also, demand for insurance in countries affected by such policies may be reduced, as the trust placed in insurers’ ability to pay in the case of claims may be weakened.
- Insurers could face significant balance sheet uncertainties over whether they can meet their liabilities, which would in turn undermine the trust in the industry.
- Insurance multinationals will see fungibility of capital reduced.
- Politically selected industries for investments could be exposed to asset bubble risks.
3. Cash repression: The paper money squeeze.
There is growing criticism of paper money and coins, and a small but increasing number of companies and service providers no longer allow for cash payment.
The insurance industry is investigating scenarios of cash repression, ranging from writing business digitally, to an entirely cashless economy. Cash repression poses a significant risk for insurers, because it deprives them of the option to store cash physically, and allows for even more pronounced negative interest rates.
- An end of paper money could pave the way for even lower negative interest rates, with severe assets risks for insurers.
- The withdrawal of paper money from circulation could lead to a further erosion of trust in governments and institutions in general, that could transiently also affect the insurance industry.
- Digital payment networks are highly dependent on security and stability, as they are more susceptible to cyberattack, identity fraud, etc.
4. Cloud services risk accumulation.
Cloud services have become widespread, for businesses and consumers alike. The increase in data volumes and the mobility of data access have been driving the adoption of cloud computing as well as lower costs. The cloud allows different users to access and share data. Clouds-of-clouds — integrated distributed cloud services — or super clouds, promise cloud services regardless of where you are and where the data you want to process is hosted.
But as the cloud of cloud (super cloud) accumulates datasets and services on an ever-increasing scale, it also generates a variety of risks that may accumulate to a “perfect storm”. Should an event bring down or severely impair a super cloud, whether through a technical failure, a cyberattack or a power blackout — possibly caused by a natural disaster — and last a couple of days, the financial loss could be immense.
If a huge data storage provider like Amazon Web Services is disabled for 24 hours, it is going to cause business interruption for countless sub-providers and their clients. If web pages and business applications are not running and business data not accessible, business processes will discontinue, and the accumulated loss could be considerable. Since operations and supply chains will be inevitably affected, the longer the interruption persists, the wide-ranging the effects will be. And the indirect consequences for a third party can also be generated by a region geographically remote. The accumulative property of the super cloud consequently makes it a preferred target for hackers and cyber war strikes.
- High severity of a single event due to the inherent accumulation potential.
- Business Interruption (BI) and Contingent Business Interruption (CBI).
- Liability for data loss and privacy issues.
- Loss scenario depends on location, concentration and redundancies of clouds-of-clouds service.
- Regulatory complexities and uncertainties abound, affecting operations of global players.
5. Growing water stress.
The World Resources Institute ranked future water stress (ratio of withdrawals to supply) in 167 countries and found that 33 countries will likely face extremely high water stress by 2040. Climate change is expected to play an increasing role.
Water scarcity, drought and wildfires already lead to significant economic losses today. As population and economic values continue to grow in affected areas, loss potentials will increase as well.
Regarding water consumption, the industries in strongest competition for decreasing water resources are the agricultural and beverage sectors as well as the energy and mining industries. Severe water stress in these areas could impact global food production and related commodity prices.
As a side effect of increased drought, forests generate less yield and at the same time contain more fuel for large scale wildfires. In some regions of the world, food security is the dominant risk factor and has just recently increased the famine risks for parts of Africa. If combined with conflict areas such situations can lead to humanitarian crisis and migration.
- Losses in agricultural, energy and forestry sectors due to drought conditions will likely increase. At the same time, this is a chance to enhance water-efficient practices and to provide parametric insurance solutions.
- The risk of large-scale wildfires affecting wide areas remains a considerable long-term risk that is likely to increase.
- Drought-induced soil subsidence can create property damage from cracks in buildings and other infrastructure.
- Water pollution events in the energy, mining and agricultural sectors could lead to environmental liability exposures, including clean-up costs.
- Many water basins cross country borders which can lead to regional or even larger scale conflicts between nations.
6. Artificial intelligence legislation.
The rising importance and capability of robotics, artificial intelligence (AI) and self-learning machines pose questions about the changing status of intelligent machines.
Discussions about future liability regimes and financial security instruments tailored to respond to the liability risks associated with autonomous systems in general, and with robotics/AI/machine learning in particular, have gained momentum.
- Discussions on future liability regimes gain importance with the take-off of autonomous systems and robotics in general, and with artificial intelligence and machine learning in particular.
- Shifts from the current liability regimes could leave consumers with more vulnerability.
- Implementation of mandatory financial security requirements may negatively impact the development of voluntary insurance solutions.
7. Sensors as weapons (Internet of Things invites cyberattacks).
The proliferation of the Internet of Things (IoT) continues unabated and is leading to an explosive spread of digitally enabled devices in public, home, manufacturing and commercial use. As early as 2018, it's expected there will be 22 billion IoT-enabled devices (sensors, chips etc.), way in excess of the 7 billion mobile handhelds. But security with many of these devices is generally poor and malware targeting the IoT has become sophisticated.
With the IoT becoming the ‘new normal’, the predictions are that the short-term benefits of digital investment will soon be outweighed by the costs for cybersecurity. That being said, the cumulative effects of cybersecurity investment over the years will still be worthwhile in the long term. But the IoT as an attack multiplier may eventually undermine the culture of trust that (still) pervades the internet and could eventually dull the promise of beneficial digitization.
The sheer proliferation of devices amplifies the risks significantly. For the insurance industry, this means that constant monitoring of the cyber risk landscape is a matter of some urgency.
- Manipulated IoT may not only lead to property loss and business interruption, but could also cause fatalities.
- Cyber risk exposure for the industry is likely to increase with the exponential growth of the IoT and will require adjustments in risk identification, assessment and measurement.
- The lack, or insufficient level of protection and updates for IoT devices, could increase the likelihood of liability claims against software producers and distributors as well as hardware providers.
- A massive hijacking of the IoT for cyber-attack purposes can raise fundamental issues around the insurability of cyber risks and could provoke public-private partnerships to provide insurance capacity through pool solutions.
8. The return of inflation.
Inflation affects insurers in various ways: it influences investment returns, asset valuations and, particularly, future, longer-term insurance liabilities. For insurance liabilities, medical and social cost escalation are of particular importance.
The impact is strongest with P&C insurers, as inflation directly increases claims costs of long-tail legacy business.
- Inflation will add to pressure on insurers’ profitability, already under stress from competition and regulatory requirements.
- While insurers can protect themselves through a number of measures against the potential effects of inflation (e.g., diversifying assets into commodities or real estate, premium increases to manage claims costs, contract clauses), circumstances warrant careful management and may not always be permissive to such measures.
9. Regulatory fragmentation.
After a prolonged period of coordination, local regulators have started to show a declining appetite for globally-aligned policy reforms. With recent political changes and protectionist trends, the chances of global standards being agreed and implemented have decreased, while territorial approaches to supervision are on the rise. For the re/insurance industry, this could threaten global diversification of risk pools and the efficient management of capital. This regulatory fragmentation is exacerbated by a trend towards
For the re/insurance industry, this could threaten global diversification of risk pools and the efficient management of capital. This regulatory fragmentation is exacerbated by a trend towards extraterritorial application of domestic rules.
Rising popular discontent with the current economic and political order in the world’s developed economies, which supply not only most of the insurer’s sector premium income but also most of the financial assets, could lead governments to withdraw from international regulatory standard-setting efforts, and more generally adopt key tenets of economic nationalism. Since it may potentially impede insurers’ ability to engage in cross-border capital management, regulatory fragmentation is a particular concern for international insurers who seek to support the benefits of diversification by pooling capital centrally.
- In a fragmented regulatory world, there's much less opportunity to efficiently pool risks. It, therefore, increases the operational costs due to two main factors: (a) reduced diversification possibilities, and (b) operational costs to implement local, regional and global regulatory rules.
- Uncoordinated regulatory approaches will be less effective in promoting financial stability and could undermine re/insurers’ ability to support economic activity and closing the protection gap.
10. Eroding rationality.
The foundation of the re/insurance business model is based on the one hand on rationality, i.e., a common and mutually intelligible understanding and assessment of risks, and on the other hand on trust, i.e., the trust of the customer that the insurers will pay in future in case of a legitimate claim.
The advent of digitization and the spread of social media have multiplied and “democratized” the supply of information. So have the quality standards of many of these new information sources and suppliers. It has also provided a platform for conspiracy theories and the spread of fake news, alternative facts and blatant lies.
This can have significant impact on the insurance industry. If customers don't trust insurance to behave fairly, and assuming that customers don't only rely on facts and rationality, the insurance industry could very well lose business. At the same time, it becomes increasingly difficult for re/insurers to know which data sources they can tap into are reliable. So new information asymmetries are emerging which could influence the relationship between insurers and insureds.
- Growing distrust in established political institutions is spreading to corporate players, many of which are already held in low esteem by important sections of the population. This will have a particular impact on the insurance industry whose business model is highly dependent on clients’ trust.
- Social media are an ever more important channel to spread stories, rumors and false information. Simultaneously, the service of bulk social media are increasingly sold not only for commercial, but also for illegal purposes.
- The rapid spread of overly biased and fake news poses a major reputational risk and communication challenge to insurance companies in high-profile claims situations.
11. Shifting land use.
Recent decades in the developed markets have witnessed rising real estate values in the centers of prosperous cities. So-called flagship stores have been willing to pay ever higher rents to front downtown properties, in locations characterized by service industry offices and urban infrastructure hubs.
The trend among insurance companies to invest in central urban real estate is ongoing. It's reinforced by the low-interest rate environment, but also reflects expectations that real estate in urban cores will continue to be in high demand with both commercial and residential users, thereby resulting in continued positive price development in the long term. However, demand for certain types of real estate may moderate over time.
The recent trend towards sharing cars and apartments may result in lower demand for parking and residential space. This trend could be further reinforced by autonomous vehicles being able to park themselves in confined spaces when not needed in the connected ride-sharing service network. Additionally, there would be the impact of drone deliveries, teleworking and virtual business meetings.
These combined shifts could result in lower demand for commercial real estate, therefore putting downward pressure on land values. Finally, if online shopping continues to gain market share, certain the flagship stores may no longer maintain a presence in the traditional city-center.
These multidirectional trends result in uncertainty around the valuation trends for investment in real estate in the long run.
- Real estate investment portfolios may be subject to increased volatility going forward. Therefore, when managing these investments, future trends need to be carefully monitored, particularly in inner cities where the property use might change over time.
- In the context of the low-interest rate environment, insurance companies are attracted to investing into centrally located urban property, with expectations of rising rent revenues and asset values being widely maintained globally. Nevertheless, longer-term demand for retail space, offices and particularly for parking and storage units could experience a decline.
12. Underestimated infectious diseases.
The question isn’t whether another deadly infectious disease will appear, but when and how well society is prepared to cope with it.
- In an extreme scenario, a major epidemic or pandemic has significant relevance for property & casualty-related lines and the financial markets.
13. Opioid medication.
Opioid addiction is a serious problem in parts of the U.S. Almost 100 Americans die every day from an opioid overdose, according to Swiss Re. Numerous factors are influencing the steep upturn in opioid addiction, and there is no real consensus among the experts as to the causes.
Whatever the actual causes of the epidemic, the potential impact for the insurance industry could be serious, not only within the U.S., but also in Canada, faced with a similar opioid epidemic.
The rising cost of opioid use adds to workers’ compensation medical claim costs. Moreover, opioids can heighten risks for users at their workplace and behind the wheel. And there have been recent lawsuits against distributors by states and other municipalities seeking damages for the economic impact these drugs have had in their jurisdictions.
- With opioids as a major cost driver, worker’s compensation in the U.S. may face a serious medical claims inflation.
- Liability lawsuits may also be launched against the manufacturers and distributors of opioids, including pharmacies, resulting in bigger claims exposure of pharmaceutical and related companies.
14. Stress and fatigue in safety-relevant jobs.
High-profile accidents such as Deepwater Horizon highlighted the role of the human factor in high-risk system vulnerability.8
Research points to the fact that humans do not fail but their working environments do – by creating conditions where timely and appropriate reaction is impossible should an emergency arise.
The following list of important human factor elements should be considered in identifying working environments that can lead to failure are the following:
- Lack of communication.
- Lack of resources.
- Lack of teamwork.
- Lack of awareness.
- Lack of knowledge.
- Lack of assertiveness.
- Large-scale reorganization.
- Studies show that the human factor plays a crucial role in insured large scale industrial losses, both in terms of likelihood and impact.
- As an example, some airlines have pushed for pilot payment according to actual flight hours. Compensation based on actual flight hours may lead to situations where pilots go to work even if they are not fit enough for flying an aircraft (e.g. due to illness).
15. Antimicrobial overuse in animal farming.
Apart from the abuse and overuse of antimicrobials in the treatment of human illnesses and infections, the proliferation of antimicrobials in the production of livestock and in aquaculture is a key factor in the spread of global antimicrobial resistance (AMR).
Contamination of meat with antibiotic-resistant bacteria can produce a range of liability claims including product recalls in the food sector. Bacteria intentionally added during the processing of food (starter cultures, probiotics) or contamination during the food production may also be a cause of the problem.
- The development of AMR in livestock and aquaculture may result in higher than expected losses from new animal diseases.
- Contamination of meat with antibiotic-resistant bacteria increases the liability risk for the food industry and can produce a whole array of liability claims including product recalls in the food sector.
16. Carcinogens in artificial turf.
Artificial turf in sports arenas has seen steady growth since the 1960s, as a cost-efficient and allegedly ecological alternative to natural turf.
Some of the artificial turfs are manufactured using crumb rubber from recycled car tires that some scientists say could cause cancer. If there is a provable link between artificial turf and cancer, it's likely there will be a casualty claims wave against manufacturers.
Currently, however, the scientific community appears to be divided over whether there is a provable correlation between incidences of cancer and exposure to artificial playing surfaces.
The establishment of a causal link between crumb rubber and carcinogenic particles could pose a significant liability risk for producers of artificial turf, for schools, universities and municipalities providing artificial turf fields, as well as sports clubs, which have their athletes train and play on them.
- If a causal link can be established between exposure to artificial turf and incidence of cancer, a casualty claims wave against artificial turf manufacturers, schools/universities and sports clubs/municipalities seems likely.
17. Pros and cons of work in the gig economy.
Increasingly, people are deriving their entire income from several smaller jobs, money which together may amount to that formerly provided by just one source of employment. The result is that some people have become increasingly dependent on juggling different jobs, with the employee of the past becoming more of the entrepreneur of the future.
Increasing flexibility of work has been welcomed both by employees who can decide more freely over their schedule and by companies which can ease market and shareholder pressures by relying on a contingent workforce. The use of robots, and automation in general, will likely further accelerate this trend.
If precarious working arrangements abound with negative effects on household incomes, frustration will grow among the workers and can manifest in distrust of corporations and political pressure for respective regulations.
- Insurance coverage for people switching between regular employment and self-employment on a daily or hourly basis may become more demanding, creating protection gaps and also increasing the risk for fraud.
- Employee loyalty might decline in such an environment.
18. Dangerous games: Risks of e-sports.
E-sports — basically hardcore video gaming — sees the number of fans and amateur players increasing steadily. The biggest e-sports markets are the U.S. and China with major tournaments attracting both online and live audiences in the hundreds of thousands.
Another feature of the sport is the growing numbers of gamers suffering injuries. Health insurers may have to deal with injuries and mental disorders among younger people involved with the sport.
- Companies sponsoring e-sports events may face reputational risk issues if e-sports are increasingly perceived as socially harmful leading to addiction or mental problems among young people.
- Health insurers may be faced with a growing number of smaller injuries and mental disorders among younger people resulting in long-term adverse effects. Other impacts on health can be through either sleep deprivation or abnormal sleep behavior patterns resulting in various diseases.