Testing times for political violence cover
This article first appeared in the March 2012 issue of Middle East Insurance Review and is reproduced with their kind permission. www.meinsurancereview.com.
Increased certainty in the insurance and reinsurance industry is the key to helping property owners and businesses mitigate the risks posed by the threat of political violence.
The tumultuous uprisings and civil disturbances that beset North Africa and the Middle East last year have created uncertainty for businesses because apparently stable countries are no longer immune from the perils of civil and political unrest. As a result, businesses need more than ever to protect their personnel and their balance sheets against the risks of civil disturbance and political violence. Investors and banks are also insisting on more stringent requirements for companies raising finance to demonstrate that they have adequately mitigated such perils.
Need to reassess terms and reinsurance arrangements
The demand for insurance and reinsurance products for such risks is therefore high and political violence cover in particular is under the spotlight. However, the unprecedented events of last year have caused insurers and reinsurers to reassess the terms on which they are willing to provide cover, and in some cases to withdraw their products altogether.
Insurers should also reassess their reinsurance arrangements to make sure that their exposures and potential loss aggregations are adequately protected. The increased risk and uncertainty does, of course, also present commercial opportunities for those who are prepared to rationalise their capacity to assume political violence risk backed by suitable reinsurance. In effect, this means:
- Scrutinising the perils that are covered or are excluded to make sure that it covers the right risks.
- Making sure direct policies are protected by reinsurance that will respond reliably when there may be doubt about the true nature of the circumstances giving rise to losses.
- Stress-testing your cover by applying realistic disaster scenarios. This is particularly important for cedants who rely on treaty reinsurance because losses may aggregate differently depending on the applicable insured peril, which can dramatically affect how much indemnity can be recovered. Furthermore, thorough quantitative and legal analyses of the potential exposures will en able insurers and reinsurers to quantify their exposure to regional accumulations and aggregation, and to make capacity available where the demand is greatest.
Limitations of “all risks” cover
The types of insurance upon which global business depends, such as property, business interruption, cargo, and trade credit insurance, are typically written on an “all risks” basis, excluding risks of war, terrorism and some forms of civil unrest. Perils may be written back, of course, for extra premium.
However, it is worryingly common for policyholders to assume that their “all risks” cover will pay if they suffer a loss as a result of a civil disturbance. It is undoubtedly in everybody’s interests for insurers and brokers to make sure that policyholders are aware of the limitations of standard “all risks” cover when it comes to civil unrest and political violence.
The political violence spectrum
The most basic cover is available by a write back for Strike, Riots and Civil Commotion (SRCC). The SRCC write back simply cancels the standard exclusion of these perils in conventional property and cargo policies, in exchange for additional premium, thereby providing cover for strike, riot and civil commotion. On the surface, the cover afforded by the write back is quite broad:
“Civil Commotion” includes losses caused by “Any act committed in the course of a disturbance of the public peace by any person taking part together with others in such disturbance”.
“Riot” is more narrowly interpreted, at least under English law. A “riot” means a violent disturbance by a group of persons assembled together for a common purpose which threatens public peace. Many of the disturbances in recent times may appear to fall within the definition of a riot or civil commotion. However, appearances can be deceptive because of the potential overlap with other exclusions that still apply. Depending on what the “common purpose” is, the peril of “riot” may overlap with other perils that are excluded on the basis that they have a political or ideological dimension. The more widely drawn definition of “civil commotion” can also overlap with perils that are excluded, despite the SRCC buy-back.
Since the events of 11 September 2001, perils that fall within broad definitions of “terrorism” will generally be excluded, as are various perils falling within the category of war risks. It is the political or ideological aspect of terrorism and the organised and/ or partisan aspects of war risks that blurs the scope of cover afforded by an SRCC buy-back and it is important to appreciate the limitations on SRCC that such exclusions pose. For example, acts of terrorism include:
“the use of force or violence, of any person or group(s) of persons, whether acting alone or on behalf of or in connection with any organisation(s), committed for political, religious or ideological purposes including the intention to influence any government and/or to put the public in fear for such purposes.”
Terrorism cover is available, either as a standalone terrorism/malicious damage policy, or as part of a comprehensive “full political violence” policy.
As for war risks exclusions, these include, at the extreme end of the spectrum, war between sovereign states but also armed conflicts between two (or more) “sides”, capable of being identified by reference to a community of leaders, objectives and administration. On the other hand, a civil war is a war that has the special characteristics of being civil, ie, internal rather than external. Nevertheless, a civil war is still a war.
Violent conflict falling short of full-scale war or civil war can fall inside war risks exclusions if what appears to be a civil commotion or a riot is more widely organised, rather than being a mindless mob. Excluded perils include insurrection, revolution, rebellion, mutiny and coup d’etat. Indeed, some of the uprisings witnessed in 2011 certainly appear to bear the hallmarks of “Insurrection, Revolution and Rebellion”, which is understood to mean:
“a deliberate, organised and open resistance, by force and arms, to the laws or operations of a sovereign government, committed by its citizens or subjects and/ or a rising against a sovereign government or other authority.”
Furthermore, in most jurisdictions, the burden is on the insurer to prove that a particular exclusion applies, but this is not always the case. For example, in the London market, it is common for policies to contain a clause reversing the burden of proof, so that the insured must overcome the difficult task of proving that his loss was not caused by an excluded peril.
Substantial overlap between perils
The spectrum of political violence perils cannot, unfortunately, be regarded as a neatly delineated scale because of the substantial overlap between the perils noted above. Uncertainty regarding the scope of cover is further complicated by the evidential difficulties in establishing the true cause or purpose of particular disturbances.
Property owners and businesses may therefore consider obtaining full political violence cover, which provides combined cover for SRCC, terrorism and war risks. Whilst full political violence cover is in theory the most desirable option, the availability and cost of cover depends on the capacity and appetite of the reinsurers that underwrite direct insurers.
In the case of trade credit policies, comprehensive “failure-to-pay” cover is increasingly being used in the Lloyd’s and London market. This helps address the various uncertainties as it focuses on simply whether the insured has been paid or not. When the wording is particularly insured-friendly, such policies only exclude the Lloyd’s-standard risks of nuclear contamination and insolvency material default by the insured itself, which of course makes this type of policies particularly attractive in the context discussed here.
The appetite and/ or ability of direct insurers to meet local demand for political violence cover depends on having appropriate reinsurance. Facultative (political violence) rein-surance in respect of property located in high risk locations may be difficult or expensive to place. Treaty reinsurance may be more readily available, however, to insurers that have a diversified and balanced portfolio.
Cedants (and their brokers) must, of course, ensure that the reinsurance obtained responds to the same perils and on the same bases as the direct risks ceded. If the reinsurance is facultative, cedants should ensure that the policies are “back to back” and that the excluded perils are expressed clearly, in the same terms as in the underlying policy. The governing law of the direct policy and the reinsurance should also match if possible.
In addition, the inclusion of a suitable “follow the settlements” clause will help to press reinsurers to settle claims on the same basis as the cedant (even if there may be doubt, for example, about whether a “civil commotion” is actually an insurrection or a rebellion). It would also benefit the cedant to include language that stipulates that the reassured shall be “sole judge” as to what constitutes one event or loss occurrence.
Stress testing to increase capacity
Reinsurers, on the other hand, will be concerned about regional accumulations and aggregation of losses resulting from political violence perils. It is therefore necessary for reinsurers to “stress test” political violence portfolios to assess the maximum foreseeable or probable loss exposures, on a regional and global basis. Exposure to regional accumulations may be assessed on a quantitative basis, by reference to the number and value of insured risks within a particular area. All reinsurers offering capacity for political violence risks will undertake some analysis of this type.
Aggregation issues may, however, complicate matters – particularly when a disturbance or event triggers subsequent disturbances in different regions or localities. Losses arising from a bomb detonated by terrorists may, for example, aggregate on a different basis to losses caused by fires started in the midst of a riot. The overarching “purpose” underlying a disturbance may also determine whether all losses are aggregated because they arose from one event, or whether they are deemed to be multiple “loss occurrences”, pursuant to a clause that individuates losses by references to a defined geographic area and period of time.
When political violence risks are retroceded into a political violence reinsurance programme, subject to high deductibles and limits, the bases on which the ceded losses aggregate often has a dramatic affect on what can be recovered by reinsurers from their own retrocessionaires. The ability of reinsurers to rely on their retrocession asset will, in turn, increase capacity that can be made available to local markets.
The industry’s role
In summary, increasing certainty in the insurance and reinsurance industry is the key to helping property owners and businesses mitigate the uncertainty posed by the threat of political violence. Local insurers and brokers can work towards this by continuing to identify regional demand and informing insurance buyers of the products available. On the other hand, reinsurers and retrocessionaires can meet the unprecedented demand for political violence cover with greater confidence by undertaking enhanced assess-ments of regional accumulations and aggregation. Finally, the industry as a whole will better serve global commerce and communities by clarifying the chain of risk transfer available so that the boundaries between the various perils and the scope of cover and limits available are better understood and addressed.