Technological & natural environment

The "Swiss Re SONAR 2018: New emerging risk insights" report aims to get us talking about what tomorrow's risk landscape could look like.

Dumbed down – is digitisation undermining human skills?

Ever been impressed by a child using the latest tablet as if this were an instinctive skill? Maybe you have watched a child trying to swipe a finger across the page of a printed book only to learn it needs a different movement to turn the page. The more we digitise the more our analogue skills atrophy.

Digital assistance systems makes us complacent, obedient and less skilled. Car navigation systems are just one case in point. We see strange accidents where cars drive off a cliff or into a lake seemingly for no reason. Scientific research has shown negative effects of reliance on digital systems for human long-term memory. There are also reports of addiction to digital tools and contents, with detrimental effects on psychological well-being.

While our trust in assistance systems remains unbroken, and their usage increases, humans are still held accountable and are expected to be able “take over the wheel” any time. Take autonomous driving, which is already in operation in some cars on the roads. While the law treats drivers mainly as it used to, actual driving practice and alertness are decreasing. The consequent widening skills gap not only impacts insurance risk, but also operational risks. What happens, for example, if underwriting or risk management rely on tools that are no longer supervised, controlled and – ultimately – understood by human experts? Unintended consequences can be reinforced if intelligent machines receive feedback from humans who understand less and less about the underlying problems.

This “mushy middle of automation” makes us feel safer than we actually are. Once we have fully autonomous systems many traditional human skills may become completely obsolete.

Potential impact:

  • Overreliance on digital assistance can increase the number of accidents, e.g. in motor.
  • For autonomous driving, the regulators may increase hurdles for fully autonomous driving. Who wants to drive an autonomous car, if you need to be alert and able to drive? This problem may affect the development of non-human driving systems/assistance and motor insurance.
  • As humans gradually cede control to digital systems, the emerging risk becomes systemic.
  • Shifts regarding liability lines (e.g. from motor to software liability for autonomous machines) with adequate governance of algorithms need to be considered.
  • Catastrophic event losses may significantly increase should assistance systems fail and human skills are not available for work arounds.
  • Trade-offs between digitisation and human skills entail significant operational risk to any re/insurance company embarking on digitisation.
  • Digital addiction may be a cause for liability claims against tool manufacturers and digital content providers.

The backbone of the 21st century: Supplies of metals and minerals

The age of the steam engine was the age of coal. Coal was the force behind the railway age and early industrialisation. In the petroleum age of the 20th century, oil and gas became the drivers. What will be the game-changing resource of the 21st century? Some say it’ll be big data. But what’s big data without the computer? In essence, digitisation has a basis in tangible materials. It’s founded on minerals and metals, as is the success of electric cars, or the trend from CO2-intensive fossils to renewables. Hence, when we talk about digitisation, new mobility and the energy transition, shouldn’t we think about the scarcity of these materials? They do, after all, form the backbone of the 21st century.

Minerals and metals, vital ingredients in smartphones and other digital hardware are hard to collect and isolate. Often they’re mined under unsustainable social, labour and environmental conditions. Cobalt, for example, is a vital ingredient in lithium batteries, used for example in electrical cars. And global supplies of this commodity, expected to run short in the future, are largely sourced from the politically unstable Democratic Republic of Congo, where about a fifth of it is mined by the hands of children.

The global demand for green-technology products places a huge burden on existing commodities. Electric cars and wind turbines are becoming more attractive as a sustainable option. However, we often overlook the strain this places on demand of so-called rare earth elements. Usage of magnetic rare earths in electric vehicles is expected to grow from about 2 000 metric tonnes last year to 7 000 tonnes by 2020 and 12 000 tonnes by 2024.80 China is one of the few major countries to mine these materials: in 2016, it contributed 85% of the global rare earth element production.81 This also means that control of market availability and pricing is concentrated.

The increasing economic centrality of these commodities will make them even more valuable and increase the need for recycling scarce metals and minerals. But engagement in their extraction and trade may also raise reputational issues and corporate responsibility challenges. Can these materials be mined in more sustainable ways? Re/insurance can contribute to set standards with regard to sustainable insurance and responsible investments.

Towering infernos – combustible cladding

Last year, London’s Grenfell Tower fire tragedy claimed many lives and made global headlines. But this was just the latest example of a risk that had emerged much earlier and is still inherent in many of the world’s buildings, namely combustible façade cladding. Pre-dating the Grenfell event were the three separate fires engulfing skyscrapers in the UAE.

All three events shared the same ingredients:

  • A gap between the external cladding and the building’s walls, which created a chimney effect increasing the intensity and facilitating the rapid spread of the fire.
  • Lack of testing on the combination of certain types of material.

The main difference between Grenfell and the buildings in Dubai was that, in the latter, there was additional fire protection installed inside the buildings. So everybody in the Dubai fires was able to escape alive and the structural integrity of the buildings remained intact.

Still, there are potentially tens of thousands of buildings around the world wrapped in combustible cladding. Dubai Civil Defence estimates that roughly 30 000 buildings in the state have combustible cladding. Other countries have also identified several thousand buildings that could be exposed to this kind of risk. This presents a smouldering danger in the insurance industry’s books. At risk are:

  • property policies
  • contractor all risks policies
  • professional indemnities for architects and engineers who recommend/use the material
  • professional indemnity for faulty workmanship, because the risk can increase if the material is not installed properly
  • product liability and recall because it is now clear that the use of the material is problematic
  • directors and officers policies

Potential impact:

  • Depending on how thoroughly buildings are now reviewed worldwide, we may see refurbishments of existing ones. There can also be new cases of fires. Especially concerning are high-rise buildings in the fast-growing regions around the world. The overall design and the related fire protection of a building will determine if a façade fire spreads rapidly or is contained. A small fire may only require repairs. A major event can impair the structural integrity of the building, making a complete rebuild necessary. Faulty/combustible materials used or cladding installed in the wrong way add to the risk.
  • Several countries like Australia and the UAE have already tightened fire regulations or banned combustible exterior cladding for certain uses. More action can be expected. Ongoing shifts in regulations require insurers to be alert. Risk assessment and underwriting policies may need adjustment to the new regulatory requirements.

Algorithms are only human too – opaque, biased, misled

Are computers providing better decisions? Increasing numbers of business processes are driven by algorithms. We are seeing algorithms take over advanced service functions at an ever faster pace. This development is eminently relevant for the insurance industry, since it has a dramatic effect on several risk environments namely, financial systems, the analysis of risk pools and the pricing, underwriting and marketing of risk transfer.

Often, algorithms are portrayed as being objective, without human bias. But algorithmic applications are not infallible. The fact that “intelligent” algorithms base their actions on what they’ve learned from flawed human judgement may lead to discriminatory effects. Discriminatory bias may also translate into defective modelling and prediction, bringing a two-fold risk to insurance and other industries.

The risk can be increased by non-transparent or black-boxed algorithmic services. For example, doctors are still responsible for errors that may occur from their diagnoses and procedures, even though they may not be able to assess the reliability of the AI-device they are using. The problem of blackboxing may also affect parts of insurance underwriting supported by intelligent digital tools. This also challenges auditability. The black box problem of algorithms has invited a new research area dedicated to reconstruct the backgrounds of algorithmic findings.

Regulatory authorities are increasingly focusing on the “algorithmic economy”. There is also a growing ethical debate around this topic. Up to now, there has been a lack of clear governance around development and application of algorithms. That said, antitrust laws have prompted the filing of charges relating to the non-transparent pricing tools applied by airlines.

In October 2017 in the context of new EU data protection regulation, the EU stressed that profiling and automated decision making are prohibited unless certain conditions are met. This regulatory risk could have drastic impact in the fields of telematics, as well as in predictive or automated underwriting.

Potential impact:

  • Significant impacts on investments in financial markets are likely if automated high-frequency trading can be abused.
  • As far as the insurance industry is concerned, algorithmic risk pooling, assessment and pricing have to be carefully analysed, as overreliance on models may prove costly. In underwriting, reliance on black-boxed underwriting tools may reinforce certain biases.
  • Demands for specific skills such as data scientists will increase and may lead to shortage in the market.
  • Insurance and/or its clients may be affected by property losses or liabilities, triggering respective covers.
  • Feedback loops can amplify false inputs, potentially leading to losses.
  • Regulation is paying increased attention to algorithmic business procedures, and pricing tools can come under scrutiny. Initial emergence of requirements relating to ensuring algorithms are “compliant by design” (e.g. data protection legislation, antitrust laws).

Coming back to bite us – lurking cyber risks

New computer systems and software may have teething troubles, which get fixed after a short while. But some flaws and vulnerabilities in hardware (chips) and software may remain undetected for longer. This dormant threat may be in the form of old bugs in “ancient” devices. Studies on medical technology found literally thousands of these vulnerabilities in such essential devices as pacemakers. The more digital systems are integrated and connected, the larger accumulated losses can become.

Remember the “millennium bug”? It referred to the problem expected to happen to older computers unable to deal with the shift of time digits from 1999 to 2000. To avoid the expected failure when entering the new millennium, software was fixed or replaced before that date. In retrospect, many considered the millennium bug merely a phantom risk that was overrated, since little of the perceived risk actually materialised in the end.

That said, the fact remains that assessment and mitigation of digital risks are a clear and present challenge. An example: Going into 2017, a company providing web-services and internet security to millions, Cloudflare, was caught out by the leap second added to the end of 2016 to synchronise terrestrial time with the earth’s rotation. The problem was resolved within 90 minutes, and reportedly only affected a limited number of users. Nevertheless, the reputational damage it caused was not inconsiderable and was due to an underestimated or overlooked glitch in the programming. The take-away is a strong likelihood of undetected and unmitigated cyber risks, which may culminate in large losses. They may arise directly from softand hardware failure. Or they could spring from pre-existing vulnerabilities sought by hackers as an entry point to “weaponise” the targeted systems and trigger mayhem, or abuse them to enrich themselves.

The worldwide WannaCry ransomware attack in May 2017 revealed that many organisations were using old Windows operating systems which were no longer serviced from the vendor (end-of-life), or did not have the available security updates installed. This kind of negligence allowed the ransomware to spread more easily. The attack was estimated to have affected more than 200 000 computers across 150 countries, with total damages ranging from hundreds of millions to billions of US dollars.

Meltdown and Spectre, hardware vulnerabilities affecting older, but very widespread chips such as Intel and IBM, recently taught further unpleasant lessons. Stemming from programmed life-cycle expectations for the systems, these weaknesses allowed a rogue process to read into the memories and processed data on affected computers.

Potential impact:

  • Hardware flaws can have a very long tail risk, allowing for system failure and inviting hacker attacks. This is particularly relevant for large and complex industrial processes and critical infrastructures.
  • Some “old” cyber risks may be underrated and mispriced.
  • Vulnerability in medical technology may translate into mortality impact.
  • In addition to the underwriting risk, (hardware) legacies may pose operational risk to insurance companies.

Paradise lost – the price of ecosystem services

Ecosystem services are the benefits humans gain from natural ecosystems. Biodiversity plays an important role for the proper functioning of ecosystems. A recent assessment sponsored by the United Nations stated that “biodiversity and nature’s contributions to people,” which “are the bedrock of our food, clean water and energy,” decline in every region of the world. The financial risk tied to this development was figured to double the global GDP of 2011. Climate change has been identified as one of the key drivers for the decline, together with habitat fragmentation, pollution and the lack of nature preserves and protected areas.

The most recent example to underpin these findings is the decline in global coral reefs. While accounting for only one square kilometre out of every 1 000 kilometres of open ocean surface, coral reefs are home to one out of four species of living creatures. They are the source of nearly all fishery, protect land against storm surges and provide significant income from tourism wherever they are present. According to the WWF one in four reefs worldwide is damaged beyond repair and two out of three remaining are under serious threat.

Insect abundance in a protected area in Germany tumbled 75% in 27 years. Studies from other areas in the world also indicate that populations of invertebrates are in decline. In respect to biomass, this means that the most abundant food sources at the base of the food pyramid are in serious decline. This development is threatening both fishery and the pollination of agricultural crops – witness the collapsing bee population due to factors such as pesticides and animal pests.

More examples of ecosystem services: in 2016, in Australia, the cost of managing the negative impact of the introduction of a species of weeds soared into the billions of Australian dollars. And if we look at our most precious resource, namely clean water, the bill is likely to become even larger. New York City, for example, has invested USD 2 billion in watershed protection to save USD 10 billion in water treatment costs.

Potential impact:

  • The loss of ecosystem services could potentially hit the insurance industry on many sides – partly at the same time.
  • Resource stress, e.g. a lack of clean water, increases cost for production and services, thus negatively impacting investment returns.
  • Civil unrest and conflict over water or food scarcity, triggered by environmental degradation, can impact growth negatively.
  • Losses in agriculture: If South American leaf blight reached Southeast Asia, the entire natural rubber production might collapse in a short time. This would cause potentially huge losses for the insurance industry.
  • Larger losses from hurricane storm surges: mangroves and coral reefs are hotspots for marine biodiversity but they also protect land against storm surges. Losing them may increase storm damages across the globe.
  • Ecological damage: The EU and the US have laws covering ecological damage, which include biodiversity losses. These legal frameworks are also becoming more widespread. The Environmental Liability Coverages the industry provides may be affected by this in the future.


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