Claims: Controlling chaos, the risk versus reality
Joshua Koehler, Associate Director of Berne Union, examines BU claims data to see how well the industry has managed to predict risk since the pandemic.
The Berne Union has been collecting data on claims in our industry since 2005, so we’ve learnt a little about risk.
Claims can be helpful as they represent the crystallisation of the risk actually taken on in the industry. By tracking claims trends over time it is possible to see when and where they emerge compared to our expectations and take an industry-wide view.
High risks are nothing unusual for the industry. What matters is the ability to understand, price and mitigate risk. There are three scenarios. First, risk is assessed correctly (in aggregate over time). Second, the risk profile shifts unexpectedly, or, third risks were much higher than expected and the proverbial rug is pulled out from under our feet. The latter two grab more headlines as they imply we’ve been getting it wrong.
Since the World Health Organisation (WHO) declared the end of the pandemic, have we got it wrong? In short, not yet.
Firstly, claims tend to be a lagging indicator typically occurring two to three years after the catalyst. Post the Global Financial Crisis (GFC) in 2008, two tense years passed before a dramatic spike in claims fed through to Berne Union data.
We now have three years of data since the pandemic began. While claims did increase after 2019, before declining again in 2022, upon further analysis it appears claims were driven by acute, specific, events. This contrasts with a generalised deterioration in portfolios that many feared, or getting the risk wrong, despite the ‘permacrisis’.
When looking at the data, the initial picture doesn’t look particularly rosy. After 2019 we experienced the two highest years for aggregate claims in BU history. After this, claims dropped by 15% ($1.3 billion) and now are lower than 2019 levels.
Claims by product line ($ million)
The driver of claims was longer-tenor business, with domestic and short term (ST) claims contracting when compared to 2019.
First, it is important to contextualise claims. While claims were rising, the industry was underwriting more transactions than ever before – new business ended 16% higher in 2022 than 2019. With exposure rising accordingly (12% higher in 2022 than 2019), claims look more benign in comparison.
Claims ratio history (claims/exposure at previous year end):
A 10-year historical average results in a claims ratio of 0.29%, meaning 2022 was lower than the historical average by 2 basis points and the ‘highest years on record’ were more benign than the period between 2015-2017.
Those years between 2015-2017 are an interesting period which would make a nice candidate for the now ubiquitous phrase ‘permacrisis’. Over the period the world saw: the rise of ISIS, the European debt crisis, an oil price plunge, commodity price collapse, Brazilian economic crisis and Russia’s invasion of Crimea. While the present-day mix of hazards may be different, multifarious risk is nothing new for the industry.
To put this in perspective, two years after the GFC in 2008 the claims ratio quadrupled. Compared to 2008, and at the start of the COVID pandemic, the industry strove to ensure that access to credit remained open. This can be seen by the surge in underwriting activity over the pandemic. A key driver of this new activity has been a surge in dealmaking with corporate obligors in Europe and North America. Corporate obligors accounted for 60% of new MLT business in 2022, compared to an historical average of 42%.
What is driving claims?
Looking back at the aggregate figures, the rise in claims was driven by longer-tenor business lines. When looking at industry sectors, we find the ‘kerosene’ for claims between 2019-2022 was the transportation sector. Moving to 2022, recent emergences of claims appeared in PRI and infrastructure.
Longer-tenor claims (PRI, MLT & OCB, $ million)
Excluding for these (transportation, infrastructure and PRI), the stock of claims has fallen since 2020 suggesting that, beyond key hot spots, the industry experienced a relatively benign claims environment and not a widespread deterioration of portfolios as anticipated. Indeed, if transportation claims were normalised to 2019 levels the claims ratio would fall a further 3 basis points to 0.24%, a nine-year low.
And while claims were falling between over 2022, recoveries were rising. They totalled $3.2 billion (the highest level for the last six years) over the same period. Since 2019, recoveries have cumulated $11 billion.
Indeed, the sector that was hit the hardest, transportation, has one of the highest recovery rates due to many of the transactions being asset-backed, and those recoveries are already beginning to feed through. According to IATA, 2021 saw revenues per mile for cargo transportation return to normal levels and 2022 saw a strong recovery in revenues per mile for passengers – but this was dispersed regionally. We notice similar patterns in our data. Claims were also dispersed regionally, Asia-Pacific and LATAM seeing more persistent claims into 2022 compared to America and Europe.
Further to this, if you take the last 10-years of MLT recoveries and divide it by the last 10-years of MLT claims you find a ratio of 75% across all obligor lines combined (sovereign, corporate, project finance, etc). If this trend continues, the ‘permacrisis’ may be more temporary than anticipated.
On a less sanguine note, political claims have remained at an elevated level since 2019 and have been growing since 2020 against the backdrop of a more tense global environment. Despite this, not all risks are moving in the same direction. The risk from terrorism has been declining, according to the Global Terrorism index, with terrorist events falling every year since 2018.
Political claims by product line ($ million)
A larger driver of political claims has been the engorgement of PRI claims. While Ukraine is certainly a piece of that puzzle, interestingly, the highest two countries were Zambia and Madagascar – with political claims being highly project and policy specific.
When all claims are considered, Ukraine and Russia are again not the top destinations, despite the invasion and consequent economic fallout in Russia. Would you have put money on Norway and Türkiye being the top two European and countries for claims in 2022?
Indeed, across all countries we find the aggregate level of claims is declining, and claims are more evenly distributed among a wider pool of countries. The abatement of transportation claims towards the end of 2022 is a key component here.
Hot spots persist
Going forward, key hot spots may persist – concern around the rise in infrastructure related claims and political claims may drive future crystallisations. After surveying members, key destination markets remain areas of concern. Of those countries mentioned, just four account for $72 billion of industry exposure: Pakistan, Ethiopia, Ghana and Egypt.
Given that our industry is exposed to acute events, crystallisations have the potential to adversely impact large single transactions in particular. While the industry as a whole maintains a robust and stable claims ratio over time, there can still be adverse impacts on individual organisations hit by low-probability high-impact crystallisations.
Wider risk-sharing within the industry could be a potential antidote for this as the long term health of the industry has demonstrated itself to be robust. If we are getting risk analysis right (in aggregate over time), a higher diversification of risk within organisations will support the industry in turn to provide cover and protect international trade.
As a last point, since previous crises, the industry has continued to refine the products available to the market. The development of new products has meant a wider selection of risks and obligors are now being covered. While there may be correlations between products, such as the notable uptick in claims for bonds issued by members (up $45 million) during a period of bond market stress, expanding the types of risk covered could provide balance over the long term.
As we collect more data than ever, the Berne Union will be monitoring these developments closely and analysing what it means for our industry.
In summary, claims so far have been idiosyncratic and driven by hot spots of risks – sometimes diverging from general economic and political trends. In the long term, recoveries are high and crystallisations slight and temporal when compared to the exposure the industry has taken on as it continues to support global trade.
- MLT, OCB and PRI ↑
- MLT, PRI and OCB ↑
- For transportation, a significant portion of industry business is supporting aircraft finance. ↑
- International Air Transport Association ↑
- Including (but not limited to): inconvertibility / non-transfer; political violence; confiscation / expropriation / nationalisation; trade embargo; selective discrimination; forced abandonment; forced divesture; non-repossession of an asset; breach of contract / arbitration award default. ↑
- ST, MLT and OCB ↑
- Noting that bonds issued by members account for a small volume of total business, the uptick is proportionally large. ↑