COVID-19 and the future financial health of re/insurance

“Manuscript policies, which are individually tailored to policyholders, may have unclear terms and conditions, which will likely lead to coverage disputes and litigation in the months ahead”. Moody’s report titled Coronavirus outbreak, economic shock will weigh on profitability and capital.

· Analysts expect economic shock to hit industry earnings hard
· Premiums at risk in event of “severe and prolonged” slowdown
· Proposed legislation on retroactive cover is "existential threat"
· Low oil prices add additional pressure for insurers in gulf

China may be coming out of the other side of the pandemic but much of Europe and the US still have the peak to come as analysts examine the financial consequences for the re/insurance industry.

As the global economic damage caused by coronavirus continues to mount, analysts have been crunching the numbers to give insight into the financial health of the re/insurance industry now and beyond the end of the crisis.

Economic projections at the end of March 2020 suggest real gross domestic product for G-20 economies will contract by 0.5 percent in 2020, says Moody’s in its global reinsurance report ‘Coronavirus outbreak, economic shock will weigh on profitability and capital’, published April 1, 2020. Using its baseline scenario, the credit ratings firm said this contraction could be followed by G-20 GDP growth of up to 3.2 percent in 2021.

However, if the economic slowdown is both “severe and prolonged”, it warns, re/insurance premiums would decline, while a sharp decline in equity markets, low interest rates and widening credit spreads, “will weaken reinsurers’ investment portfolios, capital and earnings”.

Downside risks to growth are still viewed as “sizable”, even though fiscal and monetary authorities around the world are attempting to shore up national and federal economies with stimulus packages like the $2.2 trillion passed by US congress on March 26, 2020. However, it is already being suggested that even this staggering amount signed off by President Donald Trump may not be enough.

“We expect policy measures to continue to grow and deepen, as the consequences of the shock in terms of depth and duration become clearer,” the Moody’s report says.

“The severe compression in demand over the next two to four months will likely be unprecedented.”

The majority of primary insurance cover may be mandatory but the firm’s analysts expect the economic shock to negatively impact business insurance exposures and related premiums that go to commercial insurers. “As business sales and payrolls decline, insurance premiums will also decline generally on a lagged basis. [This will impact] lines such as general liability, commercial auto and workers’ compensation with a knock-on effect on reinsurers’ premium volume.”

Moody’s also expects underwriting losses will emerge in non-life business lines including event cancellation, trade credit, accident and health, business interruption, D&O and a few other lines.

Underwriting losses in the P&C re/insurance businesses are expected to be “manageable overall for most reinsurers”, although the firm adds that losses for some reinsurers could be sizable from event cancellation and trade credit.

The Tokyo Olympics has become the poster boy for events disrupted by the pandemic. But the International Olympic Committee and Japanese Government has only postponed it to 2021, so losses may be less than initially feared. Moody’s says: “To the extent that such events are postponed rather than cancelled, ultimate losses could be lower, although this will largely depend on specific policy and contract terms.”

Interestingly, the report highlights that business interruption cover generally requires physical damage to the property to trigger payouts and most property policies contain an exclusion related to viruses. “However, manuscript policies, which are individually tailored to policyholders, may have unclear terms and conditions, which will likely lead to coverage disputes and litigation in the months ahead,” warns the report.

Analysts highlight legislation that has been filed in several states in the US that, if passed, would force insurers to retroactively cover small business for business interruption losses caused by COVID-19 under their property policies despite explicit policy exclusions for viruses. The states include New Jersey, New York, Massachusetts and Ohio.

“The losses involved would simply swamp the ability to pay,” Joseph Wayland, general counsel for the US insurer Chubb told the Financial Times. “It is an existential threat to the industry if it had to take responsibility for a risk it never underwrote and never charged for.”

Bruce Carnegie-Brown, chair of Lloyd’s of London, also warns that a legislative change of this magnitude would put the insurance industry “in jeopardy”.

Moody’s report says: “If such legislation were to gain traction in these states and expand to other states, this would represent an area of significant exposure for P&C re/insurers. Such legislation would likely be litigated extensively given established contract law. This is an area to monitor given that reinsurers would generally follow the fortunes of their primary companies, subject to specifics of the reinsurance contracts.”

Another area to watch is pricing. The report says that January pricing renewals were favorable for loss affected accounts and Moody’s expects the trend to continue in the April renewals. “Reinsurers remain disciplined in allocating catastrophe capacity,” says the report.

Casualty reinsurance pricing has also been positive and the credit ratings firm expects reinsurance pricing is likely to remain favorable “given the sizable trapped capital in the property retro market, rising loss cost trends in US casualty lines and low interest rates”.

Looking ahead to the summer, Moody’s adds that reinsurers are likely to be “judicious” in allocating catastrophe capacity at the June/July renewals in light of the uncertain economic conditions and volatile financial markets.

S&P Global Ratings says that as a result of the pandemic, the top risks its credit conditions committee is watching include the potential failure of coronavirus containment measures, worsening financial and commodity market volatility, and the prolonged drop in demand combined with an escalation in supply disruption.

The firm highlights the additional threat of low oil prices for insurers in the Gulf Cooperation Council (GCC) region. In its report, titled ‘GCC insurers’ earnings are under threat from COVID-19 and low oil prices’, published April 1, 2020, S&P says the combination of market pressure “could weaken the credit quality of some insurers in the GCC”.

Emir Mujkic, credit analyst at the firm, says: "Most insurers we rate in the GCC region benefit from robust capital buffers and should be able to absorb COVID-19-related claims and capital market volatility.

"However, the significant fall in equity markets, widening bond spreads, and ongoing decline in real estate prices will damage earnings and capital buffers of insurers with material exposure to these asset classes."

S&P explains that as many businesses try to delay their premium payments in an attempt to survive, there is likely to be a slowdown in premium collections. This could put further stress on liquidity, asset quality, and, as a result, on credit conditions for insurers over the coming months. "This could lead to some negative rating actions in 2020, particularly on insurers that have thin capital buffers," says Mujkic.

The sharp decline in the oil price to around $25 a barrel in March has also hit economies in the Gulf.  It represents the lowest price level in 17 years and has plummeted from around $66 a barrel in early January, as oil markets “head into a period of severe supply-demand imbalance”. S&P adds that lower oil prices will have a negative impact on many sovereigns, including on their balance of payments, fiscal revenues, and GDP growth.

The firm says: “Demand for oil and oil products is already weak and will almost certainly decline materially in the second quarter [2020].”