RIDING OUT THE STORM
Insurance risks have become a whole lot bigger
Proper risk management is essential for insurance companies and helps keep premiums down for their clients
The combined effects of climate change and poor maintenance of infrastructure mean that the risks insurance companies are expected to cover have become a whole lot bigger.
The recent storm in Cape Town is an indication of the possible size and scale of severe weather events that might become the new normal in the future, says Christo Rautenbach, a coastal modeller at the University of the Western Cape and honorary research associate at the University of Cape Town.
Models indicate that the frequency of one storm event every 30 years is likely to change to one storm event every three years, he says.
As early estimates suggest the Cape fires and storms could cost the industry as much as R4bn, considerably more than previous disasters, insurance companies are likely to post a strained set of underwriting results this year.
Unsurprisingly, the share prices of Santam and Rand Merchant Investment Holdings, which owns Outsurance, have still not recovered to the levels they were at before news of the Cape Town storm broke.
Industry insiders warn that premiums will harden for the first time in years.
Intense competition and abundant reinsurance capacity have meant that the domestic insurance industry hasn’t had much of an underwriting cycle over the past five to seven years, says Hollard CEO Nic Kohler. "We’re heading into a harder rates cycle for the first time in a long time."
Broadly speaking, an insurance underwriting cycle works like this: fierce competition keeps premiums soft, tempting insurers to underprice risks to grow their books. Losses from underpricing then lead to a hardening of rates, which eventually soften again under the weight of competitive pressure.
But premium increases arising from the Cape fires and storms are unlikely to be extreme, says John Melville, executive head of risk services at Santam.
"As far as pricing is concerned, SA has largely followed the global reinsurance market," he says.
Low interest rates globally and an excess of capital, including alternative capital such as catastrophe bonds, have kept reinsurance rates low. An absence of large natural catastrophes globally in recent years, such as huge hurricanes in the US, has also helped, says Melville.
Insurers have in turn been able to pass reinsurance premium savings on to their customers.
Catastrophes also make up a small portion of clients’ premiums, which will limit the effect of any increases, says Soul Abraham, head of commercial lines at Old Mutual Insure.
According to software company Risk Management Solutions, catastrophe bonds enable insurance risk to be transferred to the capital markets. Institutional investors such as pension funds invest in these “cat bonds” at healthy interest rates.
In the event that none of the designated insurance events occurs over the lifetime of the bond, a coupon is paid for that period, with the principal amount returned at maturity. In the event that a specified event does occur, the principal amount is transferred to the insurance company, coupon payments stop or are reduced, and at maturity either nothing or a reduced amount of principal is repaid.
Still, as insurers and reinsurers take pain from claims arising from severe weather events — as well as an unusually high number of industrial fires in SA — insurance premiums, particularly on property, are likely to move higher.
Fortunately, insurers renew pricing and conditions on their policies annually, which goes some way towards protecting profits, Melville says.
Increased risk from extreme weather events could lead to some areas being uninsurable, but it is more likely to drive greater engagement between insurers, policyholders, local authorities and brokers to mitigate risk proactively, he says.
Kohler agrees, saying that pricing will mirror stricter risk management standards. In other words, if a company institutes sound risk management practices it will get a better deal on its insurance.
Better risk management by a municipality can be as straightforward as getting rid of alien plants, which are more flammable than indigenous varieties.
Similarly, a well-situated and responsive fire station can be the difference between a R5m and a R500m loss.
This was demonstrated in the St Francis Bay fire of 2012, in which dozens of homes were burnt to the ground in a matter of hours. In 2010 the seaside town’s fire station had been moved 20km away to neighbouring Humansdorp. Fire fighters were not on the scene quickly enough to stop the blaze. Needless to say, the station was moved back to St Francis Bay after the fire at the behest of insurers.
As the nature and scale of insurance risk changes, those insurance companies with a sophisticated risk management function are likely to come out on top.