Hyperinflation, Currency Crises & Insurance Industry Collapse

Hyperinflation destroyed Zimbabwe’s insurance sector, and decades later, it still hasn’t recovered. Currency crises in Lebanon, Argentina, and Venezuela have crippled financial institutions, showing how fragile financial systems can be when trust in money itself disappears.

A recent discussion started as a tongue-in-cheek debate: Is inflation a more efficient way to raise revenue than taxation? But it evolved into a broader debate on monetary risk, Bitcoin, inflation, and long-term economic trends—and why so many common arguments deserve scrutiny.

How Inflation Impacts Insurance

Premiums & Inflation Risk
High inflation makes level premiums unworkable, erodes the real value of cover. Optional benefit increases create adverse selection problems in life insurance. Even constant percentage increases fail under volatile inflation, and real wage stagnation worsens affordability pressures.

Monetary Instability & Insurer Solvency
Currency collapses create huge challenges for insurers trying to meet liability obligations in real terms. When inflation spikes, reserves built on past assumptions become grossly inadequate, leading to solvency concerns and even industry-wide failure.

Crypto & Smart Contracts in Insurance
Blockchain has potential for parametric insurance, automated claims processing, and fraud reduction. But much of the excitement outpaces practical application—or solves problems that were already solved while not addressing key remaining challenges.
(And let’s be real—just because a smart contract auto-executes doesn’t mean lawyers won’t find ways to argue intent and “meeting of minds.†)

My (Cautious) View on Blockchain

I spoke at the 2016 ASSA Convention on Seductions of the Blockchain, and my position remains:

• Cautiously optimistic
• Interested in opportunities
• Frustrated by the lack of rigorous debate from both fanatics and skeptics

The fanboys see blockchain as a cure-all, while the status-quo-invested skeptics dismiss it entirely. Reality, as always, is more nuanced.

Key Arguments & Concerns

1 Inflation as an ‘Efficient’ Tax?

Some argue that taxes are administratively complex, difficult to collect, and inflation acts as an “invisible tax† that transfers wealth to the state with less friction.

The Problem? Inflation isn’t a neutral mechanism:

• Distorts price signals and makes long-term contracts unreliable.
• Increases uncertainty and raises borrowing costs.
• Disproportionately harms those without inflation-protected assets—often the poorest.
• Erodes trust in government’s ability to manage financial stability.

Hyperinflation isn’t just caused by overspending—it requires excessive money printing to cover deficits. Many governments (e.g., Japan, the US, and EU countries) have run huge deficits for years without hyperinflation because they borrow responsibly instead of monetising debt.

Friedman’s famous quote:
“Inflation is always and everywhere a monetary phenomenon in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.”

2 Bitcoin as a Predictable Alternative to Fiat?

Bitcoin proponents argue that a fixed supply prevents inflation and provides monetary certainty. But there’s a flip side:

The Problem? A rigid money supply is deflationary, which discourages spending and investment:

• BTC expansion (~0.9% today, falling below 0.5%) is well below global population and economic growth.
• Fixed-supply currencies have historically failed because economies need monetary flexibility to adjust to shocks.
• A deflationary currency discourages productive investment. If BTC’s price is expected to rise, why spend it? Why take out a loan?

This is why almost all mainstream economists—from Keynesians to monetarists—support some level of controlled monetary expansion.

Academic reference: Friedman advocated rules-based money supply growth, not a hard cap. Even Hayek, a proponent of free-market money, acknowledged the need for adaptable monetary systems.

A bigger issue: Some crypto coins have fixed supply, but the total universe of crypto coins is unlimited. New projects, forks, and tokens emerge constantly, meaning there is no true scarcity at a system-wide level.

3 Credit Risk & Smart Contracts – Who Pays When the Funds Aren’t There?

Smart contracts don’t solve credit risk. Traditional insurers must hold capital reserves and meet solvency requirements to ensure claims can be paid. Smart contract-based insurance lacks an equivalent safety net—yet.

Key Risks:

• No Guarantee of Payouts: If a smart contract is underfunded, it can’t issue emergency capital or negotiate claims—it just fails.
• Over-Collateralization Isn’t a Perfect Fix: Many DeFi protocols require excessive collateral to mitigate risk, but this limits scalability and locks up capital inefficiently. Actuarial approaches to capital adequacy could provide a smarter balance.
• Cascading Failures in Market Shocks: A major market downturn can cause mass liquidations, leading to systemic failures—just like traditional financial crises, but with fewer stabilizers.

Future Opportunity:

• As DeFi regulation increases, some form of capital adequacy requirements (like Solvency II for insurers) may emerge.
• Actuaries and insurance risk experts could play a role in designing smarter DeFi risk models.

Final Thought: Smart Contracts Are an Exciting Tool—but They Need More Work

Smart contracts introduce new efficiencies, but they also introduce new risks:
They remove intermediaries—but also eliminate safety nets.
They change fraud risk—but introduce oracle manipulation risk.
They enable fast, automated transactions—but don’t guarantee funds will always be there when needed.

For insurance, finance, and risk management, blind reliance on smart contracts is dangerous. But recent advancements show promise:

• Regulators are starting to provide legal clarity.
• Hybrid smart contracts (automated + human oversight) are emerging.
• Decentralized oracles & improved collateral models are evolving.

The real opportunity? Combining smart contract automation with actuarial risk management principles to build more resilient decentralized insurance solutions.

Would love to discuss with those working in insurance, risk management, DeFi, and blockchain regulation.

#Inflation #Blockchain #BTC #ETH #DeFi #DistributedLedger #MonetaryPolicy #FinancialRisk #Insurance #RiskManagement #Actuary #Economics #LegalRisk #ParametricInsurance

Understanding the Basics: Banks vs Insurers

The classic banking model of liquidity risk is straightforward: banks transform short-term deposits into long-term loans. This maturity transformation creates inherent liquidity risk – even a perfectly solvent bank can face a crisis if too many depositors demand their money simultaneously. This fundamental risk drives the existence of central banks as lenders of last resort.

Insurance traditionally operated differently. With predictable claims patterns, regular premium income and unoptimised balance sheets, insurers weren’t thought to face significant liquidity risks. However, modern insurance practices and product designs have created more complex liquidity dynamics that challenge traditional frameworks. These liquidity-risk-increasing practices include some risk management choices (hedging and use of derivatives) and balance sheet sweating.

Sources of Liquidity Risk for Insurers

Insurance companies face several distinct sources of liquidity risk, some traditional and others emerging from modern practices:

Derivatives and Modern Asset Management

Modern investment strategies create significant liquidity demands:

• Use of illiquid assets through debt origination, greater use of corporate paper in general to provide higher yields for annuities and guaranteed/fixed bond products, private equity and other alternatives seeking additional yield
• Variation margin calls on derivatives require immediate cash as markets move
• Derivative roll risk creates periodic liquidity needs
• Rolling medium term corporate paper maturities into new instruments has elements of liquidity risk as part of the broader roll-risk universe
• Repo arrangements require careful liquidity management
• Hedging programs, while reducing other risks, increase liquidity demands

Policy Surrenders and Lapses

The liquidity impact of surrenders and lapses varies significantly by product type:

• Savings policies backed by liquid assets present limited liquidity risk
• Corporate policies often include liquidation notice periods
• Market value adjustments can share losses with policyholders
• Risk policies with negative liabilities create complex dynamics – while lapse might improve solvency ratios, the loss of positive cash flows can create future liquidity strains
• Loss of shareholder value is still likely the major risk for lapses and surrenders – and as a result it usually gets plenty of attention without the liquidity risk lens.

Internal Hedging and Optimisation

Insurance liquidity isn’t just about having assets to meet claims. Insurers often use positive cash flows from some policies (particularly risk policies with negative liabilities) to fund claims on other, especially older or maturing policies. This practice, while potentially efficient in normal times, creates hidden liquidity risks.

If these positive cash flows diminish (through lapses or reduced new business), the liquidity characteristics of the underlying assets become crucial. An insurer might appear to have strong liquidity based on expected premium inflows, but this can quickly change if those inflows reduce or stop.

Further, using negative liabilities (from profitable, early duration risk policies) to match positive ones (e.g., guaranteed savings products) creates hidden liquidity risk. This practice is another example of the “improvement” of an old, “lazy” matching approach that missed this opportunity for internal hedging, but perhaps reduces implicit buffers we may have come to rely on.

Claims Concentration

Sudden spikes in claims can create liquidity pressure:

• Natural catastrophes affecting property insurance
• Pandemic-related death claims
• Industrial accident clusters
• Legal or regulatory changes triggering multiple claims

Throughout these claim concentration risks, the performance of reinsurance and cash timing is also critical.

Premium Collection Disruption

Disruption to premium income can occur through:

• Economic downturns affecting customer ability to pay
• Operational disruptions to collection processes (South Africa experienced this a few years ago with the failure of a notable, concentrated exposure to a single premium collector)

Investment Portfolio Liquidity

Asset liquidity can become constrained through:

• Property/Real Estate holdings requiring time to sell
• Private equity/debt with limited secondary markets
• Complex structured products becoming illiquid in stress scenarios
• Market-wide liquidity stress affecting even traditionally liquid assets
• Money market fund holdings proving less liquid than assumed when stressed

Regulatory plans for improved liquidity risk management and reporting for insurers

Regulators are understandably keen to get a better handle on liquidity risk within the insurance sector – and are keen for insurers to take liquidity risk more seriously. Existing measures are widely considered imperfect (at best).

While we don’t want perfect to be the enemy of the good, there seems to be an opportunity to aim for better than current proposals.

The High-Quality Liquid Assets (HQLA) Paradox

A crucial distinction between banks and insurers lies in their access to central bank facilities. Banks can convert HQLA to cash via central bank discount windows, making these assets effectively cash equivalents. Insurers, lacking this access, face a different reality: even “highly liquid” assets can become illiquid during market stress. Insurers and other non-bank financial institutions may want access to the discount window, but my understanding is that this idea is a non-starter.

This creates an interesting regulatory paradox. Bank-style liquidity reporting, with its focus on monthly reporting, micro bucketing of asset maturities, but with implicit and assumptions about central bank access, may be suboptimal for insurers. Yet some regulatory frameworks still look to apply bank-centric thinking to insurer liquidity management.

Systemic Risk and Money Market Funds

A particular concern arises with money market funds, often assumed to be perfectly liquid. While an individual investor can usually liquidate their money market holdings easily, this isn’t true for the market as a whole. If the underlying instruments become illiquid, large-scale redemptions become impossible.

This creates a systemic risk: the appearance of liquidity in normal times masks the potential for market-wide liquidity crises. When multiple institutions rely on the same sources of apparent liquidity, the system becomes more fragile.

Testing Liquidity – Easier Said Than Done

Testing the ability to liquidate assets remains challenging. Current approaches to estimating liquidation costs are still maturing in many markets. Desktop exercises and historical analysis of liquidity crunches provide insights but have limitations.

Testing available liquidity by transacting in large volumes under normal conditions is expensive and, more importantly, tells us little about the ability to transact in disrupted markets. Tests of notional volumes may generate a false sense of security rather than inform real liquidation measures.

The true test of liquidity often only comes during stress events – precisely when you most need it to work.

When “Liquidity” Masks Solvency Issues

Some apparent liquidity crises are actually solvency issues in disguise. A prime example is minimum surrender guarantees in a rising rate environment. When interest rates rise significantly, policies with guaranteed surrender values can become deeply unprofitable. Each surrender crystallizes a real economic loss – no amount of liquidity support solves this underlying problem.

Policyholders can withdrawn their funds, benefit from the rising interest rate environment and re-invest in a new policy or other structure taking advantage of higher interest rates. It should be no surprise that this is the result of the dangerous combination of higher interest rates and guaranteed surrender values. (There are ways, complex, expensive ways, to manage this risk, but that first requires an appreciation of the risk. This requires at least adequate liability measurement, robust scenario testing that doesn’t assume prior low volatility periods will continue, and consideration of dynamic policyholder behaviour.)

Is this a liquidity risk? Firstly it is a solvency risk. Th value of “matching” assets has declined while the value of liabilities has not. A liquidity risk is only a liquidity risk if the provision of liquidity solves the problem.

When measuring liabilities and therefore solvency, it seems dangerous to rely on assumed policyholder irrationality (expecting them not to surrender when it’s clearly in their financial interest to do so) to support solvency calculations. Good risk management and appropriate liability measurement must recognize that policyholders will likely act in their financial interests, especially when the benefits of doing so become obvious.

Now there may also be a liquidity risk. If surrenders require liquidation of illiquid assets that may further depress asset prices, increasing yields and/or spreads. Resultant concerns around insurer solvency can also lead to a run on the insurer. It’s a mistake to think of all of this as a liquidity risk.

Implications for Risk Management

Liquidity risk is real, and may still be underestimated by many insurers. Insurers should be carefully evaluating their risk management systems for adequate coverage of liquidity risk.

These complexities demand sophisticated risk management approaches:

• Regular stress testing must consider both solvency and liquidity impacts
• These stress tests must be severe enough and must consider interactions
• Liability measurement needs to incorporate realistic policyholder behavior assumptions
• Investment strategies must balance efficiency with liquidity needs
• Liquidity buffers should consider both immediate and slow-burn scenarios
• Risk frameworks must recognize the limitations of market liquidity assumptions
• Consider when your sources of liquidity (money market fund contractual promises) may necessarily fail in systemic liquidity challenges

Insurers, unlikely retirement funds, have to hold risk-based capital against the risks inherent in their investments. This makes it more difficult to underestimate the risks and services as a deterrent to large allocations.

Infrastructure assets can play a part in linked funds for life insurers, where the investment risk is passed straight back to the policyholders and no market risk capital is held by the insurer.

Under this policy construction, the risks can be similar to a defined benefit retirement fund. These include the practical challenges of pricing and valuation, and conduct and fairness issues of managing investment and divestment prices, liquidity with large withdrawals and transparency of pricing.

These liquidity constraints also make this a poor investment for non-life insurers or smaller life insurers, especially where they primarily write risk business.

Where are alternative assets used in insurance?

The three areas where infrastructure assets have a meaningful place to play in insurance are:

1. As a part of a portfolio of assets for long-dated, predictable and illiquid annuity liabilities.

2. Part of a with-profits portfolio, whether this is accumulation phase or with profit annuities in payment.

3. Part of large, well-capitalised insurer’s shareholder portfolio, subject to risk appetite constraints.

How are infrastructure assets treated for insurers for regulatory purposes

In 2014, EIOPA started to consider whether the Solvency II regulations would discourage insurers to invest in infrastructure assets. It was carefully phrased as “removing disincentives† but the line between that and deliberate incentives for insurers to invest in infrastructure assets is invisible.

Right towards the end of the development of South Africa’s Solvency Assessment and Management (SAM) regulatory overhaul, Task Groups of the SAM project were asked whether any adjustments were recommended.

Technical Provisions adjustments for infrastructure assets

The answer from the Technical Provisions Task Group was “no†. Technical Provisions were intended to be market consistent and, with possible exceptions for illiquidity premium / matching adjustments (already a part of the regulations) returns on assets should not, in general, affect the measurement of liabilities.

The illiquidity premium is still very much relevant. Up to 50bps can be added to the risk-free yield curve for discounting life annuity cash flows, provided the backing assets are a good cash flow match and are managed separately from the rest of the portfolio. The illiquidity premium is calculated as 50% of the spread achieved on the matching assets.

In South Africa, most of the available corporate paper available to generate spreads has a term of five years or less. This greatly reduces the effective average spread that can be applied. Longer-term (20 or 40 year) infrastructure debt-based investments are very welcome in this scenario.

This allowance is not specific to infrastructure assets, but is important as part of the overall capital assessment of infrastructure assets.

It’s worth mentioning that the European Solvency II “matching adjustment† is far more generous. I regularly experience actuaries or consultants from the UK talking up great plans for assets in a SAM environment, assuming that the rules are the same in South Africa as they are across Europe.

(The volatility adjustment in theory also has a place in this discussion, but that’s a bigger topic and typically a smaller impact in any case.)

Solvency Capital Requirement (SCR) adjustment for infrastructure assets

The Capital Requirements Task Group followed the European lead and allowed reductions in the equity shock and spread shock that would be applied to qualifying, high quality, infrastructure investments.

• 33% shock for equity (which is 77% of the “SA equity† shock, or about 70% of “Other Equities† shock, which I’d argue would be the most typical classification in the absence of an infrastructure asset class)
• Symmetric adjustment = 77% of SA equity
• 70% of spread shock for debt
• 65% illiquidity premium shock

The 65% shock to the illiquidity premium is not specific to infrastructure. It’s also complete irrational and greatly reduces the benefit of the very limited illiquidity premium in the first place.

• The stated risk here is a narrowing of the illiquidity premium, but this could only be realized through an increase in the relevant asset prices, matched with an increase in liabilities with no net impact. Since the shock is defined as “A 65% fall in the value of the illiquidity premium used in the valuation of technical Provisions† there is no offset for the asset of this calculation.
• The actual risk, if there were one, would be an increase in illiquidity premiums in the market, resulting in a decrease in asset values, only partially offset by a decrease in liability values due to the 50bps cap.) 

Impact of SCR relief

The impact of lower SCR on after cost-of-capital investment returns needs to be calculated for the specific portfolio and how it interacts with other risks within the business. One might expect a 1% to 2% increase in penalized returns.

Qualifying criteria

To qualify as an “infrastructure asset† and benefit from the lower capital charges, a fairly lengthy set of criteria must be met. For insurers already intended to invest in only high quality (and therefore lower return) infrastructure assets, these criteria may overlap with existing due diligence and investment analysis processes.

Non risk-based criteria

Risk-based criteria

The Infrastructure project entity can meet its financial obligations under sustained stresses that are relevant to the risk of the project.

• Must be externally rated (in theory it doesn’t have to be, but in practice it really should be and questions would be asked by the Prudential Authority if it weren’t.)
• The off-taker must be either the South African government, or there must be a large number of, ideally independent, diversified customers.

• The Infrastructure assets and Infrastructure project entity are governed by a contractual framework that provides debt providers and equity investors with a high degree of protection
• For bond investments, significant additional covenants are required
• The cash flows that the Infrastructure project entity generates for debt providers and equity investors are predictable. This must be demonstrated through one of the following:
  • Availability based revenues
  • Rate of return regulation covering revenues
  • Take or pay contract
  • Output or usage and price imply low risk

Should insurers invest in infrastructure?

It’s unhelpful to say “it depends†, but of course it does. However, with appropriate due diligence and consideration of the financial and capital implications, life insurers with large with profits or annuity books can benefit shareholders and policyholders, as well as potentially the country as a whole, by investing judiciously in infrastructure assets.

The risk is that they are outbid by retirement funds with less risk sensitivity to the investments.

• The risk of contagion, where failure of an entity leads to distress or failures of others [micro prudential]
• The risk of an event that can trigger serious consequences for the real economy. [macro prudential]

If you are a narrowly focussed prudential regulator, you might be concerned with the micro-prudential view. After the Global Financial Crisis acted as a reminder of the Great Depression, the impact on the real economy of failures within the financial sector now cannot be ignored.

Individual entities can fail and, possibly, be well managed through their failure to limit the financial impact on customers. The failure of several entities could similarly be limited in the breadth of its impact. Mass job losses, decline in GDP, failure of businesses outside the financial sector and other leakage into the real economy has costs measured as percentage of GDP foregone, likely over several years. Inevitably this a much larger hit than the failure of even several entities.

I don’t view this as a choice, either the micro view or the macro view. The failure of several entities is more likely to drive real economy effects. As I’ll discuss when in a later post when I talk about “Tsunamis”, no individual entity has to fail for their to real economy implications. Similarly, the failure of several financial services entities that doesn’t have significant real economy impacts is clearly undesirable.

The most useful view is of both of these as systemic risks and outcomes to be avoided.

But another than playing on the well known book and movie title, this post has nothing to do with the book.

It has everything to do with cholera. And the very real possibility of a cholera or similar disease outbreak in Cape Town in the next year. Here is a little superficial analysis of the numbers.

The City of Cape Town now expects us to run out of municipal water

The City of Cape Town has gone from claiming unequivocally:

“we want to give the people of Cape Town an assurance that this well-run city will not run out of water.†

on the 17th of August 107 to 4 October 2017’s:

If consumption is not reduced to the required levels of 500-million litres of collective usage per day, we are looking at about March 2018 when supply of municipal water would not be available.

How are dam levels and consumption point away from achieving these targets

CT has been stuck persistently above 600Ml (million litres) per day for an extended period and this is down from a peak of 1,200Ml per day in January 2015. The low hanging fruit are long gone. I do not see how we will decrease consumption by another 20% (since we’re over 600Ml at the moment) and this therefore suggests we will run out of water.

The increased awareness may prevent an increase in consumption from October to January, but we have yet to see whether this will be contained. It has been evident in every prior year. To me the question isn’t whether we get down to 500Ml in time, or ever, or how close we get even, it’s whether we manage to simply not increase consumption above 618Ml from the last week.

This graph shows the multi-year extent of the problem.

• Several dry years in a row have resulted in declining dam levels.
• Peak to trough is between 50% and 40% (lower more recently as water saving measures have had an effect.)
• Peak is usually September / October each year. So right now basically.
• We are currently below 40% capacity.
• We are regularly told that the last 10% is extremely difficult to use, so probably somewhere between 30% and 35% useable water left.

So there we have it. We should expect to use about 40% of capacity and we have between 30% and 35% available.

This is why many people have been saying, while the CoCT has been denying, that we are more likely than not to run out of water. It seems clear that at a mininum we will face water interruptions. At the margin, the interrupted washing loads (and restarting of cycles) and storage of municipal water as emergency preparation may even contribute to increased consumption.

Will people die?

Most people worry first about drinking water. This is appropriate. But drinking water will not be the problem as that volume of water can be managed in a variety of ways.

Start thinking about your ability to flush your toilet.

Cholera can kill within 24 hours. The CoCT, to their credit, plan to keep water running in informal settlements / densely populated areas etc.  I.e. trying to maintian sanitaiton and hygiene in the areas least well prepared to deal with it. I am waiting on complaints about this, but it is absolutely the right move. Help should be focussed on those least able (economically and service infrastructure and possibly education and certainly in terms of access to healthcare services) to help themselves.

There is an oral cholera vaccine now available – of course cholera is just the most infamous of likely diseases.

This may be an extreme outcome, but it feels like it should have moved from place 100 on a city wide risk register to top ten. And that is not something I would have expected even a year ago.

We will also have to see how economic activity is interrupted and what the knock on impact of that is.

It’s going to be an interesting few months.