Dark clouds gather over South Africa’s insurance industry

South Africa’s insurance industry is under increasing pressure from rising reinsurance costs due to the country’s unique risks and adverse weather events. 

The Reserve Bank, in its first financial stability review for the year, explained that the entire financial system is at risk from an increase in severe weather events and that insurers have been the hardest hit. 

Climate risk is split into two key risk types, namely physical risk and transition risk.

• Physical risk refers to the potential financial losses that could be suffered due to extreme weather events caused by climate change.
• Transition risk arises from the movement towards a lower-carbon economy, which would reduce the value of non-qualifying financial assets. 

The increasing frequency and impact of extreme weather events result in more substantial property damage and, thus, losses for insurance companies, banks and other financial institutions. 

Such events dominated the domestic insurance industry’s claims statistics in 2022 and 2023. 

Insurers have experienced a sharp uptick in climate-related claims in recent years, a dramatic shift from when South Africa was a catastrophic event-free zone. 

In 2023, Old Mutual Insure recorded ten weather-related claims events, three of which were significant, amounting to millions of rands. 

These were the Western Cape storms in June and then again on Heritage Day weekend in September, as well as the Gauteng and Mpumalanga hailstorms in November 2023.

Among other implications, these climate-related changes have exposed insurers to a periodic increase in weather-related claims, heightened re-insurance premiums, and increased consumer premiums. 

The Reserve Bank warned that increased underwriting and liquidity risks from more frequent and severe weather-related claims could weaken insurers’ solvency positions. 

Furthermore, extreme climate and weather-related changes may hinder insurers’ ability to forecast losses due to the unreliability of past data and the randomness of events across regions.

The bank warned that this introduces implications for financial stability across various sectors. It has implications for households, firms, governments, banks, and other financial institutions. 

For households and firms, a lack of product offerings and/or higher premiums hinder post-disaster construction financing in the form of lower productivity and output, negatively impacting GDP. 

Governments may face increased debt burdens, placing additional pressure on the fiscus and potentially exerting upward pressure on bond yields, impacting banks and insurers as sovereign investors. 

Banks may experience increased credit risk due to a reduced pool of eligible collateral, while declining property values may significantly impact wealth creation. 

Chief actuary at Old Mutual Insure, Ronald Richman, said this is a global phenomenon and is threatening an insurance crisis. 

Global data shows that severe convective storms were predominantly responsible for catastrophic event losses, accounting for 68% of global insured natural catastrophe losses in the first half of 2023.

Whereas large single events, such as hurricanes or earthquakes, have often been the driver of record CAT losses in previous years, data from 2023 suggests that smaller events were the main issue during 2023. 

This was also the case in the South African environment.

“Given this picture, it is not far-fetched to believe climate change has the potential to destabilise the global insurance industry, with ripple effects for South Africa,” said Richman.

Signs of stress are already emerging in several parts of the United States, with companies withdrawing coverage from California and Florida.

He says that structural changes in the reinsurance market have compounded the challenges.

“While many of the recent events have not been unprecedented, insurers have experienced them as particularly acute losses hitting their bottom lines and capital reserves.” 

“This is due to reinsurers taking significantly less risk from these types of events, leaving insurers unable to smooth out the losses over time,” said Richman.

This is compounded by unique risks in South Africa, such as political instability, load-shedding-related claims, and water shortages. 

Thus, local insurers are facing increasing pressure from rising reinsurance costs, forcing them to either hike prices to accommodate the elevated costs or reduce coverage.