War in Iraq: The Known and Unknown Consequences

As President Bush and his advisers made good on their defiant promise to act alone if necessary to get rid of Iraq’s tyrannical régime, the world heard echoes of Mark Antony’s cry of rage and revenge, “Cry ‘Havoc!’ and let slip the dogs of war,” for that is the reality the U.S. and the global community now faces.

Although the Pentagon has undertaken to try and minimize the havoc, at least among the civilian population, the hostilities will undoubtedly cause a lot of destruction before they’re over. While the dogs may swiftly return to their rest, they may also roam free for a long time, increasing the number of unintended and adverse consequences flowing from the American government’s controversial decision.

So far the immediate effects, at least for the insurance industry, have been surprisingly minimal—mainly increased premiums on cargo vessels and surcharges for airlines operating in the Middle East. The ultimate question on the minds of most insurers, however, is what the longer-term economic consequences will be, and that will largely be determined by how long the war lasts and what kind of peace is constructed when it’s over. The daily swings in the world’s stock markets—up when the war first began and looked ready to end soon, down on news that it may last at least a couple of more months—adequately illustrates the uncertainty it has generated.

While the Bush administration sees a short, sharp war, ending in weeks, many other observers have noted that war is perhaps the least predictable of human activities; a short war is only one possibility among many. After all, everyone thought that World War I would be over by Christmas of 1914. The longer hostilities last, the more serious the economic fallout is likely to be.

A related question, which concerns not only the insurance industry, but also the rest of the world, is how much damage the post World War II system of agreements and alliances, which has ordered political relations and economic activities for almost 60 years—the UN, NATO and U.S./EU relations, as well as the newly emerging World Trade Organization—has sustained. Major economic upheavals could occur if the system is truly beyond repair.

The insurance industry is right to be concerned about the war’s economic impact, particularly its effect on global stock markets and on the prospects for a recovery in equity values and interest rates. According to London’s Financial Times around $250 billion has been “wiped off the global industry’s balance sheet in the past three years.” Insurers, including some of the world’s biggest, Allianz, Zurich, Munich Re, ING, R&SA, Swiss Re, etc., have been forced to write down billions of dollars in the value of their investments, while interest rates have declined and claims reserve requirements have increased. As a result profits have fallen for most insurers and many have posted losses.

A short war could lead to an upsurge in equity values that would restore tattered balance sheets and increase excess capital and therefore capacity. A long one could well have the opposite effect. At this point it’s too early to discern what scenario will prevail; therefore all the industry can really do is adopt the classic position of hoping for the best, while preparing for the worst.

Near term consequences are a different matter, however. As the war began commercial insurers warned their clients—mainly cargo shippers and some airlines—that coverage for losses in the Middle East could be cancelled. A number of erroneous reports indicated that this could be done on 48 hours notice. In fact, as Jim Burcke, spokesman for Lloyd’s Catlin Underwriting Agencies Ltd. explained, “most [marine] policies have a standard seven day cancellation clause, as far as I know the 48 hour provision only applies if two permanent members of the UN Security Council go to war [against one another].” While there may be some superhawks in the Bush administration who would like to declare war on France, they have not as yet done so. Burcke added that he knew of no coverage that has been in fact cancelled.

A complicated scenario
Marine coverage is a complicated and arcane field with its own special rules. “To begin with ‘normal war risk’ is not part of standard hull coverage,” said Burcke; “it’s an option that can be obtained for a year for additional premium of between .04 and .05 percent of the vessel’s [insured] value.” It normally applies globally, but, if hostilities are declared, insurers can give notice under the policy of “held cover.” This means that “the ‘normal war’ cover is no longer in force in the designated areas.” Ships in the affected zone do, however, retain coverage for the voyage out of the area.

Marine insurers have given their customers the “held cover” warning, and have defined the various exclusion zones. If vessels now want coverage to enter affected areas, they must apply for it separately on a “per voyage” basis, and pay the applicable surcharge, as determined by the marine underwriter. “It’s simply a question of increased risk,” Burcke said. “As long as there are hostilities in the region there are higher risks—the ability to shoot a missile, or [load] fishing boats with TNT increases the risks.” A supertanker can be valued at around $85 to $90 million, and frequently carries cargo worth about the same. “That’s a $160 million loss,” he said, “and you need a lot of additional premium to make it up.” He pointed out, however, that during the Gulf War in 1991 there had been no losses.

Marine underwriters determine the extent of the increased risk mainly by the locations involved. “As far as Kuwait and Iraq are concerned, nothing’s going there,” said Burcke. If vessels, such as those bringing relief supplies, do eventually seek coverage, they would have to pay surcharges of as high as 10 percent of the ship’s value—on a “per voyage” basis. However, Burcke indicated that vessels, including oil tankers bound for other Persian Gulf destinations such as Saudi Arabia, might pay only a .025 percent surcharge—per voyage. Ultimately it’s the underwriter’s calculation of the gravity of the risk that determines the amount of the additional premium.

A fatal blow?
For the airlines, most of whom are still suffering from the downturn in travel following the Sept. 11 attacks and the general global economic slowdown, a new war and higher insurance costs could be a fatal blow. The U.S. has already indicated that present programs providing emergency coverage that were put in place after Sept.11 will continue, and Congress is currently considering other financial help.

The British government has said that it’s prepared to offer emergency coverage, if necessary, and the European Union has promised to allow member states to help their air carriers cope with increased security expenses, and will relax rules on when an air carrier is subject to losing a “slot” if it isn’t used enough. Carriers have cut back on flights not just to the Middle East, but in Europe generally after the war began. The European Commission, however, has indicated that it will not permit direct help to the EU’s airlines along the lines of the U.S. proposals.

Europe’s airline insurers have indicated, however, that, although they may raise some rates, they would not generally cancel coverage. A spokesman for the Aviation Insurance Offices Association, the London-based organization that represents airline insurers, told Reuters that he thought “insurers will be trying hard not to cancel coverage completely and therefore there should not be a case for government intervention.”

In the same article Ken Coombes, Sr. VP for aerospace at Marsh Inc., observed that during the first Gulf War insurers had continued to provide coverage. “We don’t see the insurance market withdrawing cover,” he stated, pointing out that, as the risks were higher, the returns would be proportionately higher as well.

American International Group, one of the world’s biggest airline insurers, indicated that so far no coverage had been suspended, but said that when flights to the region resume it will institute a “per flight charge” of an as yet undetermined amount.

Germany’s Allianz AG, one of the largest providers of coverage to the European Community’s air carriers, issued a statement indicating that, while it has no plans to cancel coverage on flights headed for the Middle East, its customers were asked to provide the company with information concerning any flights scheduled to go to the area.

Other than B-52’s, F-18’s and other war planes currently operating in the region, there are few flights headed for Iraq, and very few of those are likely to be insured by AIG or Allianz, but flights do continue to other countries in the Middle East, including Israel, Lebanon, Saudi Arabia, Kuwait and Eastern Turkey, that are subject to the notification requirements, and carriers will have to obtain special coverage on a per flight basis. The cost, as with the cargo carriers, will depend on the destination. While the overall effect will probably be minimal, certainly in the U.S. where air carriers can rely on the federal government, the cost per individual flight could rise by as much as 10 times.

Many industry analysts have indicated that, while the long-term affects of the war might be negative, the industry could profit in the short term from the premium increases it will create. War risks are not generally covered by commercial policies, minimizing the risks of large war related claims. AIG’s CEO Maurice “Hank” Greenberg even told analysts on a conference call “When you destroy something you have to rebuild it. When you rebuild it, you have to insure it,” suggesting that the industry may have new opportunities following the war’s conclusion.

However, for the moment that’s not the case. The dogs of war are loose, and uncertainty will continue to reign until they are once again at peace. May that day come sooner, rather than later.