Economy & Business

Why can't we insure against war?

29 September, 2022

We can buy insurance to cover most catastrophes, but not the risk of war. There are good and justifiable reasons why, but that isn’t very helpful for the ordinary homeowner, or for a business that wants to set up in Taiwan. Is there any way out of this conundrum?

By Lee Faulkner

If you live in Taiwan it’s virtually impossible to avoid being asked your view about the likelihood of a Chinese invasion - it’s a perverse part of the otherwise overwhelming charm of living here. But the threat of war, more specifically the threat of damage to or loss of your own property if war were to occur, should be addressed more openly because the risk of war isn’t going away any time soon.

The basics of insurance
The basic principles of insurance are a good place to start when looking at war risk. For a risk to be insurable, and for an insurance policy to be valid, there needs to be something called “insurable interest” - you cannot insure someone or something if you have no financial interest in that person’s life or in the wholesomeness of a particular property. For example, you can insure against the death of your spouse or anyone else you have a financial relationship with, as their death could cause you economic hardship; but you can’t insure against someone unrelated to you just as a random gamble on their life. Similarly, you can insure against your own house burning down, but you can’t insure against an office building on the other side of town collapsing from an earthquake unless you owned a part of that building.

Another core principle is that you cannot benefit from illegal acts or where your behaviour is a contributory factor to a claim arising. For example, you can’t take out and then claim on a life insurance policy if you murder the person you’re insuring, nor can you claim for fire damage if you’re an arsonist. Obviously most cases aren’t as blatant as this - for health and life insurance how liable are you for the consequences of smoking, or drinking too much, or for having a lousy diet? If you should have installed, and tested, a smoke detector in your home but didn’t, are you liable if there is a fire? These nuances are usually dealt with at the initial stage when you take out an insurance policy - the “underwriting” phase - and in the details of the policy conditions - the “ongoing rules”. Most of us know this from a quick read of a common travel insurance policy - it won’t, for example, cover you if you use recreational drugs while on holiday.

Most of us, I think, understand the core principles of insurance - you need to be upfront and honest when you apply for an insurance policy, and you can’t contribute to the chances of a claim event occurring through your own actions or negligence. War risk meets both of those principles - everyone knows about the risks of war but very few have any particular additional insight into those risks, and our daily activities aren’t going to have any impact on the risk of a war occurring - so why isn’t war risk insurable?

Insuring catastrophic risks
War risk can be categorised with other “catastrophic” risks, that is risks that are so widespread and so potentially serious that the financial impact of their occurrence would be devastating. A good example in Taiwan is earthquake risk - if we suffered a major earthquake then, contemporary building standards notwithstanding, the consequences could be serious. Similarly, a major typhoon, or flooding, could affect many and be very costly indeed.

Insurance companies do cover these risks and should be able to withstand the economic pain if anything like this were to happen. Their financial resilience comes from observing a combination of prudent capital requirements, proper reserving methods and adequate pricing. Regulators insist on insurance companies having sufficient capital to cover any reasonably foreseeable circumstances, and by making sure that the premiums they charge are adequate; if they aren’t then the regulator will require the insurance company to hold sufficient reserves to make up for any potential inadequacy.

Insurance regulation varies by country, and each has different levels of toughness, but standards in general have been getting stricter (and more complicated) over recent years. Many regulators are now looking at the consequences of climate change and extreme weather events on future insurance claims, and on the capital adequacy of insurance companies - for my profession the mathematical modelling of possible climate scenarios is a big growth area.

Insurance companies also have the option to reinsure, that is to insure the risks it’s already taken on with other insurance companies or specialist reinsurers - that spreads the consequences of catastrophic risks occurring across other companies and also internationally.

But war?
The options of spreading risk aren’t, however, available for war risk. Worldwide, the consequences of war, civil insurrection, invasion and terrorism are excluded from insurance and reinsurance policies. Sometimes the risk of terrorism is covered but usually only for very specific events such as a short visit of a high-profile business person to an area with a high risk of terrorism.

But why is war risk excluded? There are two main reasons - the inability to underwrite, that is the inability to assess the probability of a war occurring, and the inability to estimate the scale of the damage if it did. There is no scientific analysis that an insurance company can use to quantify what the probability of a war occurring might be - despite the multitude of knowledgeable politicians and political commentators in Taiwan, nobody can pretend they can estimate the risk of war with any certainty. And nobody can even hazard a guess as to how destructive a war might be - the damage might be minor, or catastrophic, it might be physical but it would also more likely be economic.

Nuclear disaster - another excluded risk
As well as war risk, another risk that is commonly excluded is the risk of nuclear accident. The most well known nuclear accidents that have occurred in my lifetime - Three Mile Island, Chernobyl and Fukushima - were serious but ultimately contained. But will we be so lucky with the next one? Nuclear power stations are often located in sparsely populated areas, and by coasts, as a means of damage mitigation if an accident were to occur, but even then, we don’t know what the ultimate consequences might be. This is not to knock nuclear companies, as their safety records are generally good and their managements are professional and competent, but the key point - the unquantifiable nature of the consequences of any accident - is similar to that of any war, which is why the risk of nuclear accidents is usually also excluded from insurance policies.

Can’t money conquer all?
As the famous saying goes, there is a price for everything - if you charged enough an insurance company maybe could cover war risk and nuclear accident risk, but the uncertainties in terms of probability of occurrence and the potential damage mean that you’d have to charge an absolute fortune in insurance premiums to cover those risks, way beyond the means of most people or companies.

So should the government cover the risk of war? Has any government said clearly and unequivocally what they would do if someone’s property was destroyed in an aerial bombardment by the PLA? Presumably they would find temporary accommodation to house the people affected, but would they commit to providing a replacement apartment or house after the war finished? What about commercial property - would the government provide the funding for rebuilding factories or offices destroyed in a war?

The government is the only body with sufficiently deep pockets to be able to contemplate covering war risk, but even the government would struggle if the destruction were serious enough. Not talking about the consequences of the problem is part of the problem itself - we all know the risk of war is there, but talking about how we might deal with the destruction of property, and who would pay for its restitution, would at least take away some of the uncertainty even if the answer was “you’re on your own mate!”. I suspect that most people think the government would bail them out in some way, but I’m not so sure they would or could.

Is the conundrum here to stay?
I am sure that any company thinking of investing in Taiwan considers political and, ergo, war risk before making any decision. And I presume that the uninsurability of plant and people, because of war risk is a factor they will consider. So, isn’t there a need for the government to be totally clear now about what it would or wouldn’t do in the event of war? If we want more international investment in Taiwan, and we want more people to move here, don’t we have to be more open and at least recognise the issue even if we can’t solve it?

On a personal level, aren’t we all collectively burying our heads in the sand about war risk? Has any property owner, or potential buyer, even thought about this? Perhaps we should - we can’t make risks go away, but we can at least live with a proper understanding of them.

Lee Faulkner is a Fellow of the Institute and Faculty of Actuaries, the UK’s actuarial body, and has more than 30 years’ experience in the world of financial services in Asia, Europe and Latin America. He is a Taiwan Gold Card holder and now lives in Taipei.


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