Covid-19 through the lens of insurance company accounts

At a high level, we expect many insurers’ profits in the short term to reduce.

The extent to which this holds true depends significantly on the risk profile of the business, taking account of the expense structure, type of insurance product underwritten and investment strategies.

We explore the details below.

Overall, we expect many insurers’ operating expenses in the short term will increase.

Perhaps the biggest worry for an insurer at the moment, like firms in many other industries, is operational risk associated with coronavirus and ensuring consumer outcomes are not materially adversely affected. With the UK recently moving to a ‘delay’ phase, how robust insurers’ business continuity systems are to continue operating during these uncertain times will be tested. A number of insurers had already started testing ‘working from home’ days to ensure their systems can manage.

For example, insurers will need to consider the impact of:

• Key function risk – it is possible key functions of an insurer’s business become severely affected (i.e. either slow down or in extreme circumstances temporarily shut down) because of an aggregation of many individuals falling ill or not being in the office to carry out their duties. Therefore it would be wise to run tests as mentioned above sooner rather than later.
• Key person risk – can insurers cope with key individuals falling ill, not being in the office to carry out their duties or, in extreme circumstances, death? In principle, we expect this is a risk that has always been part of the basic risk consideration of a going concern.
• Outsourced/external functions – loss adjusters and administrative functions, if outsourced, are likely to be affected. This could also lead to knock-on effects and increased costs for an insurer. For example, lack of resources at a loss adjuster could lead to claim delays and possibly inaccurate assessments of losses leading to additional cost for an insurer.
• A general slowing down of the business – as things take longer to get done, this will likely lead to increased cost or possibly the risk of poor management decisions based on incomplete or inaccurate information.
• Office closures – over this time rent is still likely to be due.
• Unusually high levels of staff sickness – although salaries will still be payable.
• Reduced efficiency, potentially, of staff working away from the office – inefficiency leads to increased cost

Overall, we expect that many insurers will see a reduction in the premium written in the short term, driven by a general slowdown of economic activity as well key functions being absent.

Over and above absenteeism of key functions affecting the execution of underwriting contracts, there are number of factors to consider across demand (and volume of sales) as well as supply and premium rates in the short term. The impact for a specific (re)insurer may be an increase in sales turnover when some of these specifics are taken into account.

There may be an increase in policyholders lapsing their policies, as they self-quarantine, perhaps have a reduction in household income, and decide an insurance policy is a less pressing expense compared with other household expenses.

Generally, we do not expect much can be done about the policies already underwritten. Therefore the timing of the (re)insurers’ peak periods is an important consideration. For example, a (re)insurer with all policies underwritten on 1 April would likely be affected differently than another with all policies underwritten on 1 January.

There will likely be an increase in demand for certain lines of business. This could be due to policies being taken out to guard against the effects of coronavirus.  For example:

• travel insurance
• event insurance (whether this may be large public events such as sporting events or private events such as weddings)
• business interruption policies

However, we are already seeing insurers react to this uptick by firms reviewing their policy wording. This is being done to reflect only the perils that their pricing teams and underwriters have allowed for when setting premiums, or simply to exclude coronavirus impacts such as delays or cancellations in flights to control cost of claims. The impact of this could outweigh the increase in demand for the types of products above.

It is likely also that premium rates will increase across products renewing in the future, but expect this to take effect over the course of the forthcoming year. A (re)insurer selling insurance products with key rating factors being turnover could see an increase. Examples of this could be Professional Indemnity (PI) for doctors, or auditors (who may see more activity due to the potential of a recession looming).

Inwards claims are likely to increase.

Changes in claims will depend on lines of business. We expect the most materially affected lines to be travel insurance, trade credit insurance, business interruption insurance and income protection insurance. Insurers will need to consider their exposure to affected lines; e.g. sum assured, age and geographical exposure. 

It is noted that simply having an insurance policy does not necessarily mean claims will be paid. Policy wording is key. Many non-life insurers had already tightened up their policy wording following the outcome of similar outbreaks in the past (e.g. SARS in 2003) to avoid an increased number of claims resulting from uncertain perils, such as the coronavirus.

Nevertheless, consider Directors & Officers or business interruption insurance.  Here we could see a number of insurers facing an uptick of claims due to poorer management decisions being made in a time of uncertainty, or supply chain breaking down. Event and festival insurance would have already seen claims increase. A key looming potential claim to the market could be the 2020 Summer Olympics, with one source suggesting an insured loss of c $800m (1).

Where had all the scammers gone? Suddenly, every day wasn’t another sage of escalating threats and attempts at intimidation from the liberation boiler rooms. Weeks could go by without anyone threatening our jobs, reputations or businesses. Had the overseas transfer charge driven the overseas scammers into permanent retreat? Or were they just rapidly googling how to re-register their schemes somewhere within the European Economic Area (EEA) to circumvent the charge?

An FOI request from Royal London to TPR, reveals £60bn of DB transfer activity since the introduction of pension freedoms, with £34bn in 2018/19 alone (close to 250% of the previous year’s figure) and more than twice as many individual transfer cases (210,000 compared to 100,000 in 2017/18).

Outwards reinsurance recoveries are likely to increase.

From an insurer’s perspective, depending on the reinsurance terms, it could take a significant increase in the number of claims before some of this exposure is passed on to reinsurers.

From a reinsurer’s perspective, consideration should be given to contracts that are likely to lead to claims in circumstances not requiring a significant increase in claims to the insurer; e.g. quota share treaties or treaties with relatively low ceding amounts.

The overall impact of the investment returns will vary depending on the investment strategy and asset mix of the insurer.

To date, trillions have been wiped off equity investments because of fears that companies’ profits will be adversely affected by coronavirus. Gold prices (and the price of other safe havens) have increased and gilt yields have become negative for the first time ever, as investors seek to preserve capital during this uncertain time (2).

We have seen various authorities providing assurances and implementing measures, hoping to quell investors’ fears and settle the markets. Here in the UK, the Bank of England made an emergency decision to reduce its interest rate down to 0.25% pa – its lowest ever level not seen since 2017.

Insurers holding a significant proportion of gilts will have noticed an increase in their bond values, while any equity holdings will have reduced.

We expect the immediate impact to be a decrease in insurer solvency and financial strength. 

This will be driven by the fall in the value of balance sheet assets because of how the financial markets have reacted to coronavirus. It will be compounded by an increase in reserves held by insurers if they think their claims experience will deteriorate (see P&L section).

Insurers hold risk capital, and the way this is calculated has built in mechanisms to help avoid pro-cyclic behavior; for example the equity symmetric adjustment in the standard formula. This means that the impact on insurance company financial strength is less than we might initially imagine. 

Where insurers use bespoke capital models, they should be considering the impact coronavirus will have, possibly amending their models or introducing validation tests to reflect more appropriate 1-in-200 events resulting from a severe spread of the coronavirus.

The significant fall in yields over recent weeks would have resulted in a material increase in the risk margin for writers of long term business, like annuities.

On 11 March 2020, the PRA announced that its view was that the risks posed by the advent of coronavirus are sufficient to meet a broad definition of a change in risk profile that could be considered material. Consequently, the PRA has invited firms to consider applying to recalculate the transitional measure on technical provisions (TMTP).

Successful applications will result in an increase in the value of the TMTP, which will offset the initial increase in the size of the risk margin.