Cyber awakening

Silver lining forecast

A return to rising inflation and interest rates will have repercussions for claims and investments, Swiss Re says

By Wendy Pugh

Economic impact: inflation is expected to feed further P&C rate hardening, says Swiss Re’s John Zhu The war in Ukraine and the pandemic have caused such head-spinning swings in economic expectations that even the Reserve Bank of Australia (RBA) has been embarrassed by guidance that missed the mark.

The RBA last month raised interest rates for the first time in more than a decade, after saying when vaccines were unavailable and dire covid scenarios possible that any increase may not happen until 2024. Instead, surging inflation and positive indicators have prompted a backflip.

“Australians have been resilient, they’ve adapted and interest rates are normalising much quicker than we thought was going to be the case, so from a forecasting perspective that’s embarrassing,” Governor Philip Lowe told a briefing.

“But what we did do in 2020 was make sure that we took every possible step that we could take to help the country in the full knowledge that if things turned out better, we’d have to reverse the policy stimulus more quickly.”

After years of inflation in the doldrums and falling interest rates reducing insurer investment earnings on premium income, the environment is changing in a hurry.

The rate hike came after the annual inflation rate hit a two-decade high of 5.1%, reflecting a shift in global economic trends examined in a Swiss Re Institute Sigma report. In the US, the consumer price index rose 8.5% in March, the most since 1981, and the Federal Reserve is also moving on rates.

“[This year] will be a challenging year for insurers with both sides of the balance sheet under pressure,” Swiss Re Group Chief Economist Jerome Haegeli says.

“The silver lining for insurers is that we are exiting the ‘low-for-longer’ and negative interest rate environment and this regime shift will benefit insurance companies over the medium and longer term. ‘Risk-free’ rates are finally not return-free anymore.”

For property and casualty (P&C) insurers, the changed scenario is a case of bad news and good news, with underwriters to see the impact of high inflation in claims and investments.

Swiss Re’s Sigma report, titled “Stagflation: the risk is back, but not 1970s style”, references a decade when economies were hit by the unexpected combination of high inflation on the one hand and weak growth on the other.

Drivers this time are shocks from the war in Ukraine and the reopening after covid, compounded by ongoing lockdowns in China. Swiss Re has adjusted inflation forecasts higher and growth lower, reflecting rising fuel and other costs and supply chain pressures.

The headwinds are blowing around the globe while differing by region, with Europe most exposed to the evolving repercussions from the Ukraine conflict.

For Australia, Swiss Re forecasts real gross domestic product growth will slow from 4.7% last year to 3.9% this year and then to 3% in 2023. Inflation may rise from 2.9% last year to 4.4% this year.

The Sigma report says P&C insurers are most exposed to an inflation shock, which will increase claims severity. Property and motor will likely be hit hardest, as construction and car part price rises outstrip those in the wider economy, while further ahead, longer tail business lines will be most exposed to sustained elevated inflation.

Impact of current inflation shock on global P&C claims by line of business

Line of business

Property Above-average Soaring construction prices

Motor, physical damage Above-average High car (part) prices and wage growth

Motor, bodily injury Average Wage growth in line with core CPI; medical cost inflation has remained below general CPI inflation so far

Liability Average Wage growth in line with core CPI; medical cost inflation has remained below general CPI inflation so far

Marine/Aviation/Transport Average In line with general CPI inflation

Source: Swiss Re Institute

Impact Reason

Swiss Re Chief Economist Asia John Zhu says floods and other natural catastrophes are an additional factor when looking at the Australian environment.

“The floods will in the short-term add to some specific and localised inflation, such as rents in affected regions. The impact on economic activity caused is likely to be temporary as growth will eventually rebound during the subsequent reconstruction, supported by the current strong job market and rising wages,” he tells Insurance News.

“Claims inflation is expected to feed through into further P&C rate hardening to catch up with rising loss costs. We also see the generally higher inflation macro environment to add the upward momentum in premium rates in many commercial and personal lines.”

P&C premium growth for Australia is expected to be 3.1% in real terms this year, driven by robust demand and rate hardening in commercial lines, with property a key driver, Swiss Re says.

On the investments side, interest rates have fallen since the global financial crisis more than a decade ago, while prudential and regulatory considerations constrain the ability of insurers to seek higher yields from potentially riskier assets.

The RBA cash rate declined from 7.25% in August 2008 to a record low 0.1% in November 2020, then remained mired at that pandemic-level low until the RBA made the move to 0.35% last month. The central bank has indicated a pathway back to 2.5%, with the pace depending on events.

“Investment income should improve, but gradually as rising interest rates feed into bond portfolio returns through short-term investments and reinvestments of maturing bonds,” Mr Zhu says. “This effect is gradual since it will take time for long-dated bond portfolios to roll over into higher yields.”

Globally, Swiss Re sees “headwinds to P&C profitability” this year before “tailwinds from further rate hardening and rising interest rates” next year.

The Sigma report warns that the macroeconomic outlook is” extremely uncertain” with risks skewed to the downside. Central banks must balance curbing inflation while avoiding slamming on the growth brakes and triggering a “hard-landing” recession. Even weaker growth in an inflationary environment presents challenges.

“In a stagflation-like scenario consumers’ disposable income and savings will come under pressure and demand for insurance falls as more of household budgets are taken up by other costs of living,” Mr Zhu says.

A positive is that insurers can mitigate the risks of the economic situation through strong capital and risk management, repricing insurance risks to account for higher claims costs, reinsurance transactions, asset reallocation in investment portfolios and hedging against inflation, Swiss Re says.

At the RBA, Dr Lowe says the rise in rates, in contrast to earlier expectations, is “basically a positive story”. Responses to get through the pandemic have worked and curbing inflation will “require a further lift in interest rates over the period ahead” as policy returns to more normal settings.

Recent experience shows nothing is certain, but insurers may have something to look forward to from an investment perspective while they first deal with difficulties caused by rising inflation and a volatile global economic environment. 0

Cyber awakening

Insurers are demanding businesses switch from being sitting ransomware ducks, to peacocks proudly displaying their digital credentials to attract optimum cover

By Miranda Maxwell

Password, according to research by IT experts, is still the most commonly used password in business across all industries.

This is a telling example of a complacent blind spot towards cyber “hygiene” that insurers are cracking down hard on, no longer willing to provide cover for firms that leave themselves so wantonly exposed to ever more frequent and severe ransomware attacks.

The past year has seen cyber attacks evolve from just encryption of data to “triple extortion”, where the attackers extract money from customers and other third parties.

Cyber insurers have imposed significant rate increases accordingly, and introduced higher self-insurance retention levels, co-insurance, coverage restrictions and language as they scramble to limit indemnity for losses arising from ransomware and systemic cyber events.

In the past, cyber underwriters were content with short renewal applications and limited checks on exposure to issue formal terms. Today, cyber insurers are more deeply investigating controls, with a laser focus on resilience to a ransomware attack.

In something of a meeting in the middle, executives must now jump through a series of hoops to extract the best cyber cover, with lengthy questionnaires and stringent requirements the new norm. Insurers are insisting on protections such as multi factor authentication, phishing training, offline backups, endpoint detection, segmentation and privileged access management before they are prepared to quote.

WTW’s local Cyber and Technology Risk Specialist Benjamin Di Marco says for a long time, carriers “did not really ask great questions,” and just a handful of checks regarding privacy policies, response plans, data amount estimates and provider lists was “all it took for a $100 million company” to secure a cyber cover quote. “The industry really hurt itself because the view was that it was a profit class and everyone wanted to do it. We weren’t actually thinking about what were the good risks and wanting minimum requirements before you are insurable.

“It has absolutely flipped on its head, it’s a really big focus,” Mr Di Marco tells Insurance News.

Some cover providers were “skating by on the easy market – the people who hadn’t tried to understand the risk and couldn’t work through the proposal and didn’t understand what the clients were doing, and that is both on the insurance and broker side,” he said.

“Those people are screaming from the rooftops now because if you don’t know what is going on, you have no chance in the world of managing this, particularly for complex risks.”

Today, there are set controls to meet, without which most carriers will not even quote, and the “ones that will quote will give you incredibly curtailed cover to a point where the cost benefit becomes much more questionable”.

“The underwriting process is much harder, the information that we get together is much harder.”

The new, tougher underwriting attitudes are starkly reflected in the numbers: S&P Global Market Intelligence calculates a drop in the average US property and casualty direct loss (plus defence and cost containment) ratio for standalone cyber insurance to 65% last year, from 72% in 2020, though still well above the 42% average loss ratio for 2015-2019.

That was even as those insurers significantly grew cyber direct written premium to $US3.15 billion, from $US1.64 billion a year earlier, illustrating new discipline and caution when underwriting cyber.

Cyber insurance is the fastest-growing segment for US P&C insurers, where there has been a doubling of reported claims for each of the past three years, with closed claim payments up 200% annually over the same period.

At Axa US, direct written premium in cyber jumped 44% to $US421 million last year, while at Zurich US it was up 138% to $US136.6 million, at Tokio Marine it was up 334% and Arch Capital wrote $US143.6 million after almost none a year earlier.

Ratings agency Fitch says 8100 claims were paid in 2021, and premium rates for cyber coverage skyrocketed in response to the expanded claims activity and cyber incidents, at a pace considerably higher than other commercial business lines.

Cyber product performance is not broken out and published separately in Australia, though the Australian Prudential Regulation Authority (APRA) recently required general insurers to report on certain data regarding standalone cyber insurance policies.

Mr Di Marco says this year will remain tough but there is light at the end of the tunnel for cyber cover market conditions.

“This year is going to be bad – anyone who tells you it is going to get better this year is just lying to you – but there are enough green shoots to think things will start improving next year,” he said.

“This is probably the new norm for rates but I think we can get a little bit better in terms of both the underwriting and the industries and the classes that are really distressed and are really difficult to get insurance for. I think they become viable.”

WTW urges businesses to focus on preparing adequately for a cyber event to occur, simulate board-level cyber exercises to “cut through decision paralysis”, reduce supply chain dependency, and take out appropriate cyber insurance cover.

Close attention will be paid by insurers to vulnerabilities concerning a work-from-home environment as high levels of claims force underwriters to reject risky business.

Mr Di Marco says the mechanics of data and operational restoration is becoming “so much more onerous” as malicious actor variants become more destructive, and and business interruption (BI) effects