Double Black Swan Looms Over Insurance Industry

As the insurance industry emerges from the pandemic, the threat of a double Black Swan — climate change and cyber security — looms over the industry. Climate change and cyber security are real and fast-increasing threats that are expected to accelerate further post pandemic. But in order to tackle these pressing issues, the insurance industry needs a fresh approach to address the multi-dimensional disruptions that these threats can potentially cause.

The COVID-19 pandemic has been referred to many as the “Black Swan”, a term coined by Nassim Nicholas Taleb to describe a rare, unforeseen event that has extreme consequences. But just as September 11 had forever changed air travel, COVID-19 has radically transformed every aspect of the global business landscape far into the future. This has caused many of us to ask, “What’s next?”

The threats of climate change have become strikingly apparent in recent years. 2016 was the hottest year in recorded history. The Greenland ice sheet lost a record amount of ice in 2019, which was equivalent to a million tonnes per minute throughout the year. The years 2019 and 2020 broke all sorts of unwelcome weather records and natural disasters from hurricanes, earthquakes and massive floods to devastating fires in the Amazon forest as well as the Australian bushfires.

The threats of climate change “Black Swan” on the global economy have reached new heights and ushered in a new urgency. Hurricane Harvey caused an estimated $125 billion in economic damages whilst the Australian bushfires not only killed more than a billion animals but resulted in damages worth more than $4.4 billions. However, the economic costs of climate change losses are likely to be far higher due to its systemic effects.

With future economic costs of climate change amounting to about 5 to 10% of the world’s GDP, as estimated by the World Bank, insurers can no longer avoid or postpone addressing the impact of future systemic ‘Black Swan’ climate catastrophes on their underwriting, pricing, investment decisions as well as their bottom lines. Against this background, the insurance industry needs to become more resilient against climate change through better risk awareness and innovative risk mitigation tools that can help to build a more sustainable industry, and ultimately a more climateresilient society. The industry should also incorporate environmental factors in insurance pricing in addition to traditional insurance pricing factors. For instance, scenario-based analysis can be used to project future claim experience under multiple climate conditions.

COVID-19 has also shone the spotlight on the potential catastrophic effect of cyber incidents ‘Black Swan’. The acceleration of digitalisation during and post pandemic has heavily increased the threat of business interruptions due to ransomware attacks, technical failure or via the supply chain as well as the severity of consequences from data breaches, phishing and hacking.

Although it may not possible to predict all plausible Black Swan type cybersecurity incidents, it is critical for insurers to have a crisis management approach to effectively manage the situation. This involves adopting a strong cyber security discipline and ensuring that the security systems are up to date to protect themselves more effectively from cyber attacks. As cybersecurity is a business issue, not an IT issue, insurers must look into developing a comprehensive risk management programme to promote cyber resiliency.