In a new survey by the Swiss Re Institute of the emerging risks and trends for the (re)insurance industry, respondents rated climate change risks, large-scale cyber-attacks and corporate sector vulnerabilities as the top three business threats for insurers.
Although the COVID-19 crisis was the most talked about danger this past year, professionals from the insurance industry and large corporations as well as academics rated climate change as the No. 1 emerging risk. Climate change risks are losses from primary perils, such as tropical cyclones, and secondary perils, which include heatwaves or intense rain, based on estimated financial impact and likelihood to materialise.
Large-scale cyber-attacks ranked second. In third place were corporate sector vulnerabilities, which develop through debt build-up due to favourable credit conditions. Other top emerging risks include risks in transitioning to a net-zero emissions economy, "black box" concerns with AI and machine learning, and mental health.
The survey listed 12 emerging risks and included a question on the financial impact of COVID-19. Roughly half of the respondents found the pandemic's impact as likely but moderate over the next 10 years.
1. Climate change risks
"The risk of rising sea levels, greater wildfire prevalence, and greater storm intensity will continue and will shape third world development, global preparedness and a greater commitment of corporate profits to fit this preparedness." - Survey respondent.
2. Large-scale cyber-attacks
"The increasing volume of data and use of digital connectivity means potential entry points are also increasing. That said, protection tools are also increasing in sophistication. Companies that are diligent and intentional in protecting all aspects will fare better but could still be impacted." - Survey respondent.
3. Corporate sector vulnerabilities
"This is already happening. There is a growing need to go back to the basics on the financial behaviour of corporations. If this does not happen, the crisis will be global and systemic again." - Survey respondent.
Overview of top 10 surveyed risks
The risk map below shows that seven out of 10 risks surveyed have the potential to significantly impact insurance companies. While the risks were rated separately, interaction and accumulation are likely. Climate change, for example, may move the geographic range of some diseases globally and increase the probability of a severe disease outbreak. The severe disease outbreak threat is already impacted by insufficient drug deployment.
1. Emerging physical climate change risks
Climate change, in combination with economic growth and rising urbanisation, is most likely contributing to an increasing number of small- to medium-sized losses stemming from secondary perils. This could impact the profitability of certain lines of business if not monitored and priced accurately.
The rise of so-called secondary perils, such as heatwaves, droughts, water scarcity, wildfire as well as intense precipitation events, in contrast to primary perils, such as tropical cyclones and European winter storms, has been observable already.
The climate change impact on physical risks can occur at various levels of severity over a long time period. Increased temperature variability and the resulting heatwaves can not only affect agriculture, productivity, water resources, health and mortality, but can also increase the risk of conflicts in certain regions.
Physical climate change risks in combination with the economic value concentration in exposed areas may potentially lead to:
- an increase in frequency and severity of relevant secondary perils
- higher severity but lower frequency for capital intense NatCat events
The following area in the (re)insurance industry could be affected:
- annual insured losses could rise if they become increasingly affected by secondary
- perils, which are usually smaller in scale but occur with a relatively high frequency
2. Large-scale cyber-attacks
As companies' cloud computing and infrastructure systems are increasingly connected to the internet, their exposure and vulnerabilities to cyber-attacks are growing. State-related actors can play a role in the background, giving attacks a new quality in respect to impact and frequency. The volume and sophistication of malicious internet activity has increased substantially.
There is a growing potential for large cyber-attacks to affect many companies at the same time through common internet infrastructure or the use of a major cloud provider. The resulting potential for critical infrastructure breakdown in areas like power, gas, water and strategic industrial sectors – e.g. telecommunications – poses a growing accumulation risk.
Large-scale cyber-attacks can lead to:
- property damage (e.g. fires, explosions, flooding if pumps don’t work, etc.)
- business interruption in all areas from production and health to the general services industries
- Life & Health losses if water supplies and sanitation are affected
- a disruption of financial markets which rely on communication
- a disruption of financial services operations because transactions are not possible
The following areas in the (re)insurance industry could be affected:
- property/specialty covers
- cyber insurance
- liability/casualty lines
- Life & Health lines
- financial insurance lines (e.g. credit risk if production is interrupted for a long time)
- insurance assets
- insurance industry operations
3. Corporate sector vulnerabilities
Corporate friendly financial conditions have extended the corporate credit cycle. This has led to further financial risk-taking by some firms with continued build up of debt. The rising debt has led to an increase in the vulnerabilities of the corporate sector.
The International Monetary Fund (IMF) estimates that in a material economic downturn half as severe as the global financial crisis, corporate debt owed by firms that are unable to cover their interest expenses with their earnings could rise to the levels seen during the global financial crisis. This could result in losses at financial institutions with significant exposures to highly indebted nonfinancial firms — a development that could amplify macroeconomic shocks.
Monetary authorities might try to support but there is little leeway left for traditional rate cuts. Thus, they may also adopt more innovative approaches such as "helicopter money". While such policies might be effective at supporting asset prices for a time, their efficacy in stemming a downturn is untested. Furthermore, they will also lead to higher uncertainty and could lead to the buildup of financial imbalances.
Re/insurers' investment portfolios would suffer from credit spread widening, higher defaults and lower equity valuations in a correction phase. If continued monetary/fiscal expansion is successful in extending the economic and corporate credit cycle, the current low interest rate environment may last for many more years to come, thereby depressing re/insurers' investment income.
Survey methodology
The SONAR team surveyed 309 professionals at insurers and large corporations as well as experts in academia globally in fall 2020. Participants filled out an anonymous online questionnaire. More than two thirds of the respondents were experts at primary insurers, brokers, and reinsurers (Swiss Re employees were excluded from the survey). Not all areas that are affected are captured or enumerated. Risk areas vary from company to company.
