A tailored approach to managing risk

Insurers have faced a heady mix of travails: an unrelenting spate of natural disasters, many of which have been linked to climate change; a global economy that has never fully recovered its equilibrium since the global financial crisis; the Hayne Royal Commission, whose consequences have included reputational damage, tougher regulations and class actions; and the devastating social and economic impacts of COVID-19.

Insurance companies are reeling and this is not without ramifications for the corporate sector in its management of risk. When the insurance industry sneezes it’s policyholders who usually catch a cold.

According to KPMG’s annual General Insurance Industry Review, the Australian insurance sector’s profits plunged by almost 50 per cent to $2.3 billion in the year to June 30, 2020.

Major factors behind the slump included the catastrophic bushfires in Queensland, NSW and Victoria and severe storm activity (hail, rain and flooding) across the eastern states between November 2019 and February 2020.

The “decimation” of investment income, down 91.3 per cent from $3.1 billion in 2018-19 to just $268 million – due to investment markets being ravaged by the pandemic and a continued reduction in interest and yield curves – was another “significant problem” for the insurance industry, according to KPMG.

And while the industry recorded a 4.76 per cent increase in gross written premiums to $47 billion, insurance margins fell to their lowest level in seven years (6.8 per cent).

While 2020 was “a very difficult year” for the industry, KPMG Insurance lead partner David Kells says the pain may not be over yet.

“[T]he situation has become more challenging with the recent court ruling on business interruption losses due to COVID-19 not being excluded under the Quarantine Act. If the judgment survives the proposed court appeal, this will have significant implications for many insurers.”

Insurers have insisted that business losses as a result of pandemic-related shutdowns were never intended to be covered by business-interruption policies and have refused to pay COVID-19-related business interruption claims on the basis that their policies explicitly exclude interruptions caused by ‘‘quarantinable diseases’’.

But many of these policies referred to the Quarantine Act, which was repealed in 2015. The NSW Court of Appeal ruled in November last year that exclusions that relied on the defunct act were void and could not be used to refuse claims. Insurers are facing thousands of pandemicrelated business interruption claims, although the insurance industry plans to appeal to the High Court.

“In addition to the outcome in respect of business interruption, the current environment remains uncertain for insurers as a result of the COVID-19 pandemic and the further impacts that could arise,” Kells says.

Alex Haslam, Sydney principal at law firm Gilchrist Connell, a litigation and disputes firm specialising in insurance, says the current environment has resulted in “tensions” between corporates and insurers.

“We’ve been in a hard insurance market for the past two or three years during which time the ability to obtain insurance has tightened considerably,” he says.

Haslam says that large-loss natural disaster claims, the global recession, the rise in securities class actions and a reduction in insurers’ investment income have collectively limited their ability to provide broad levels of cover for their customers.

“The capacity and appetite for risk just isn’t there for insurers to offer the types of insurance and broad cover that corporates are used to. If they are able to get cover, it’s often with higher premiums and on tighter terms.’’

Haslam expects a significant increase in claims in 2021 and that, due to the tightening of the market, more claims are likely to fall outside the terms of coverage.

The economic impact of COVID-19 is expected to drive claims in such areas as business interruption, cyber security and employment practices liability.

Issues linked to working from home are also expected to come to the fore, including cybercrime, online bullying and discrimination: for example, how are employers going to deal with who gets to work from home and who has to come into the office?

Haslam says companies should understand their exact insurance requirements and be very clear on their insurance cover.

“Companies need to understand that in many cases it’s no longer going to be possible to get wide cover for limited premiums,’’ he says. ‘‘The solution may be negotiating a tailored insurance policy rather than relying on off-the-shelf insurance.

“Insurers have indicated that their appetite for risk has diminished. They are going to be more flexible than they used to be and will be more willing to offer a tailored or bespoke policy of more limited scope if it means taking on lower risk.”

Haslam predicts that in a vexed insurance environment tailored insurance policies will become the new norm.