Man-made catastrophes: a Gray Swan event?

On Saturday, October 19, 2019, Santiago de Chile woke up under lockdown as the armed forces took control of the city to restore order and to "protect both public and private property" ¹ after weeks of increasingly violent protests that led to a declared State of Emergency. An increase in subway prices had triggered the social unrest that quickly escalated into a broader demonstration against inequality. These spread throughout the country, lasting several months, and culminating with the drafting of a new Constitution. Dozens lost their lives and hundreds got injured during the protests. Adding to this humanitarian catastrophe, estimated insured property losses range between $3 to 4 billion.

Insurance sector complacency was one of the factors that led to insured losses of such magnitude. Regarded as an oasis in a region otherwise prone for political violence and social unrest risk, in Chile the inclusion of coverage for strike, riot and civil commotion (SRCC) in property policies was standard.

The insurance sector was not alone in its assessment: the 2019 global peace index² ranked Chile among the safest countries, only a few notches below Germany and ahead of Spain, Italy, and France, to name a few. As a reference, Portugal ranked third safest country according to the same index and has since slipped to 6th place in 2022. As loss reports mounted in Chile, event definitions for both policies and reinsurance treaties, which had generally been designed with natural catastrophes in mind, had to be revisited in light of this seemingly unexpected peril.

Chile is not alone. Rioting in South Africa over former president Jacob Zuma's jailing in 2021 led to over $2 billion insured losses according to Sasria, the state-owned political violence insurer, while insured damages following the Black Lives Matter protests in 2020 were the first to surpass the billion-mark in the United States. It is tempting to write-off these catastrophes as Black Swan events, something so unpredictable that the industry cannot convincingly point to its possibility and prepare adequately. However, as these events multiply across the globe, and insured losses rise to billions of dollars, the need for a different approach is clear. Re/insurers must look at SRCC as Grey Swans instead: rare and unlikely, but definitively possible, large, and consequential events. Just like with natural catastrophes, our industry needs to be ready for infrequent but extremely severe man-made losses for which a premium is needed.

Today, rising food and fuel prices are putting additional stress on livelihoods that have yet to fully recover from the pandemic shock. Growing inequality, fears of recession and inflation levels never experienced by our generation, all breed frustration against the system and could give way to new surges of violent protests. As the number and the intensity of political unrest events soar, many point to cell phone usage and social media as key factors that facilitate the coordination and mobilization of large masses. In a working paper, IMF's Chris Redl and Sandile Hlatshwayo utilized mobile phone penetration, together with food price inflation and high current and prior levels of unrest, as key drivers in their predictive model for political violence. An additional, important - and often overlooked factor - is "contagion" from neighbouring states³. Just as no man is an island, political violence risk hardly ever happens in isolation; historical safe heavens might actually find themselves in the eye of the hurricane.

What can (re)insurers do against the rising tide of political violence? Even with sophisticated machine learning models such as Redl's and Hlatshwayo's (2021) it may prove impossible to predict where and when the next man-made catastrophe will break out. What we do know is that social, political, and economic inequality have built up in many countries and all it takes is a spark to set off the powder keg.

In Chile, it was a seemingly ordinary price increase in subway fares; but quickly it became clear that, as protestors denounced, "it was not 30 pesos, it was 30 years". Re/insurers would do well to monitor their portfolios for political violence, assess how their wordings would react in case of an event and avoid granting blank cover without properly underwriting and adequately pricing the exposure.

This article was originally published in 'The Fullcover' magazine of 15 September 2022.

¹ Presidente Piñera decreta Estado de Emergencia en las Provincias de Santiago y Chacabuco y en las comunas de San Bernardo y Puente Alto para normalizar el orden público, Prensa Presidencia, 19 de octubre de 2019