Counting the cost

Events during July, where rampaging mobs of people in KwaZulu-Natal and Gauteng looted and burnt shops, warehouses and factories, left many perplexed, worried and traumatised. Sadly, more than 270 lives were also lost. Professor Robert Vivian and Dr Albert Mushai make sense of looting losses through an insurance lens.

Many business owners had to watch helplessly as their investments were destroyed in front of their eyes. Reports indicate that about 200 malls were looted (in the course of the looting of other property like cash tills and shelves, glass doors inevitably got damaged as well) and about 600 stores were either burnt or damaged.

At this stage the exact cost to business and other hard-to-quantify losses from lost jobs and livelihoods remains unknown. However, the recent events are likely to be the costliest seen in post-independence South Africa.

No doubt, some of the affected businesses would have had some form of insurance and are expecting indemnification for the losses they suffered. Others, especially small-scale ones, probably had no form of insurance, unfortunately, which means that they would have had to close their doors.

As is the nature of insurance, now that insurers know that something like this is not only probable, but real and possible, getting coverage by companies against such losses will prove expensive at best and impossible at worst. Nothing is more difficult than trying to buy flood insurance when the stormwaters have already arrived.

Insurance is only relevant where there is risk. It relieves the person facing risk of the responsibility to bear the financial consequences of that risk. We have pointed out in previous contributions that insurance works on the premise that the risk in question is diversifiable.

A simple illustration of risk diversification is when a group of 1 000 individuals, facing a particular risk, buy insurance so that any losses affecting one or some of them are recovered from insurers.

The assumption here is that not every person among the 1 000 will suffer loss. If 287 out of 1 000 suffer loss and the remaining 713 do not, risk is diversified in the sense that the 287 that suffer loss are indemnified from the premiums paid by 1 000 individuals.

In other words, losses of the few are borne by many. As long as this principle holds, insurance works well and, more importantly, there is no threat to the financial integrity of insurance as an industry.

Losses that result from events like the mass looting test the boundaries of insurance, since they increase the chances that every individual who has bought insurance suffers loss at the same time.

That said, where do the losses arising and likely to arise from the recent looting fit within the insurance framework?

Cars and buildings were burnt, businesses were forced to shut down and goods were stolen from shops. These are some of the elements of looting. In the process some property was also vandalised for the sake of it. This automatically brings certain types of insurance into play.

Burning cars implies that the owners will turn to their motor insurers for indemnification while those whose property was destroyed would turn to commercial asset policies for recovery. Likewise, those businesses whose premises and or assets were destroyed or looted leaving them unable to operate will turn to their business interruption insurers, and so on.

Therefore, looting can bring several classes of insurance into play at the same time. This implies that one insurer could pick many claims through the different insurance portfolios they hold in their books such as motor, commercial insurance and business interruption.

It is also worth noting that South Africa’s short-term insurance industry is structured in such a way that these types of losses are more likely to be payable by particular insurers rather than others. As things stand, most losses arising from political and non-political riots, strikes, social unrest, terrorism, protests and acts of a similar nature are more likely to be covered by one insurer, Sasria SOC Limited.

By operation of law, other short-term insurance companies in South Africa are actually prohibited from insuring losses arising from these events. The only insurer authorised to insure them is Sasria, which is a state-owned company formed in 1976 in the aftermath of the June 16 student riots of that year.

Most people and businesses who buy insurance in South Africa to protect themselves against loss or damage to assets are usually encouraged to also buy Sasria insurance. Therefore, a person who decides to insure their car or business assets tends to also buy Sasria cover to protect themselves against losses from the aforementioned defined events that only Sasria, and no other insurer, can insure. What determines whether a particular claim is a Sasria or other commercial insurance claim depends on its circumstances – particularly the question of causation.

In order to understand how things work in practice, consider this simple hypothetical example. Suppose you are driving your vehicle and, due to a momentary lapse in concentration, you lose control of the car and it is damaged. You have both conventional motor insurance cover as well as Sasria cover on the car.

Which between these two insurances will pay the claim? The answer depends on the cause of the loss. In this case the loss was due to driver error and does not involve any of the defined events Sasria covers. Therefore, it is indemnifiable under conventional motor insurance.

Suppose, unbeknown to the driver, he gets caught up in a riotous mob with a grievance against the authorities, instead, and the car is stoned or damaged. Alternatively, the car could be damaged as the driver attempts to run away from the rampaging protesters. In this latter case, the car is damaged because of the actions of a group of people engaged in riotous behaviour or some civil commotion, of sorts, which are defined events that Sasria insurance is meant to cover.

The damage to the car translates into a Sasria claim because of that. In other words, the damage is caused by defined events that Sasria is required, by law, to insure against and other insurers are prohibited from insuring.

Yet another point to note about the structure of the South African short-term insurance industry is that the Sasria insurance is not a stand-alone cover. Its validity depends on the existence of a conventional assets policy from a commercial insurer. A person buying insurance in South Africa cannot decide to buy Sasria cover alone, without conventional cover on the same assets. This means the Sasria cover operates as a form of derivative cover whose validity derives from the existence of a valid assets policy from a registered commercial insurer.

Therefore, in the hypothetical situation concerning a driver whose car is damaged by a riotous group of protesters, if we assume he does not have a motor insurance policy with a registered insurer, any Sasria cover he might have automatically becomes null and void since a pre-condition for Sasria cover is the existence of a valid conventional policy covering the same asset.

Finally, even though Sasria will bear the full brunt of the looting losses, other insurers will not escape unscathed. This is because, insurers invariably rely on reinsurance for extra capital support for their risk-taking activities. The recent events would surely have made many international reinsurers nervous. This will translate into stiffer terms and prices quoted for local insurers by these reinsurers.

In turn, the insurers will seek to pass on these costs to policyholders, who will in turn seek to factor the high cost of insurance into the cost of their products.

At the end of the day, we will all pay a price for the recent events. Instead of losses of the few being borne by many, it is now a case of actions of the few costing many – dearly.