COVID-19: minimising the re/insurance sector infection

“Based on the likely economic conditions in 2020 and beyond, we could see a reduced demand for P&C insurance.” Stefan Holzberger, senior managing director and chief rating officer at AM Best Rating Service.

· Virus aids conditions that could speed arrival of hard market
· Equities and real estate investment classes worst hit
· Primary companies may seek capital relief from reinsurance partners
· Connectivity exposure and risks from interlinked perils "hard to quantify"

Experts highlight the pressure points and areas for hope for re/insurers as the global economy buckles under the strain of COVID-19 disruption.

Global stock markets have slumped as the COVID-19 outbreak takes a heavy toll on human health and society - but the full impact is still to be seen.

Intelligent Insurer asked experts from AM Best and the Russell Group to give their insights on where it might lead for the industry.

“The severe downturn in the financial markets, caused by the pandemic, will affect the life & annuity segment and cause the likely downgrades of fixed-income securities across many sectors of the economy,” says Stefan Holzberger, senior managing director and chief rating officer at AM Best Rating Service.

Speaking to Intelligent Insurer on March 24, he explains: “Interest-sensitive products like variable annuities will be hit hard. Although life & annuity companies have added investment risk in recent years, the majority have done so in a measured fashion.

“These companies and investment portfolios are heavily weighted toward high-quality fixed-income securities. That said, life & annuity companies who are offering generous guaranteed returns will be under pressure in this low rate environment.”

Holzberger expects that there will be “ongoing pressure” on companies to cover these guarantees and maintain a positive spread between investment yields and guaranteed minimum returns.

For the non-life side of the industry, he says, investment volatility will certainly be a factor.

“Investment classes such as equities and real estate have been hard hit, and are not likely to recover in the near term. The reduction in economic output will put a strain on P&C premium volumes and profits. Some lines of business will be affected, such as travel insurance, event cancellation, business interruption, surety and trade credit,” he explains.

“But beyond these niche lines AM Best does not expect a major spike in the loss ratios for the main segments within personal lines, commercial lines and reinsurance,” he adds.

“One caveat to this is the potential for unexpected interpretations of contract language driven by the unprecedented nature of these events.”

Regional impact

In terms of markets and regions that are facing the greatest impacts, Holzberger points to emerging market economies, which are often the worst affected during global financial crises.

“Insurers operating predominantly in these markets are likely to be hardest hit. These forces will negatively affect insurers’ balance sheets more than demand,” he explains.

“Countries such as Italy that were not able to react quickly enough to flatten the curve in new cases of the coronavirus will be severely affected. Also, countries whose economies rely heavily on tourism and hospitality will experience a severe economic downturn.

“The high degree of linkage between economies in terms of the financial system, trade and commerce means that all countries will see a major economic downturn. The duration and severity is the big unknown at this point.”

Striking a positive note, he says that at a high level “all major insurance segments—life, non-life and health—are well-positioned from a balance sheet strength standpoint”.

Companies that are rated by AM Best at the secure level (bbb- or above) have learned important lessons from the 2008/09 financial crisis, he explains.

“They have improved their liquidity positions and risk-adjusted capital. The industry as a whole is positioned to handle an economic and financial market downturn.”

Holzberger says the ratings firm will be stress-testing these factors in the next few weeks to see how severe a strain individual companies can handle. But, he warns, there is the potential for individual companies in each of these sectors to be at risk of a downgrade—even if the segment as a whole remains in reasonably good financial health.

“The reduction in excess capital due to financial market losses, together with a continued decline in investment income in the low rate environment, could add fuel to the hardening market seen in late 2019, and further tighten terms and conditions,” he adds.

“As primary companies deal with a reduction in capital and a tightening credit market, they may seek capital relief from their reinsurance partners. This would benefit the global reinsurance segment.

“That said, based on the likely economic conditions in 2020 and beyond, we could see a reduced demand for P&C insurance.”

At a macroeconomic level, he says the “unprecedented nature of current events” could produce a deep economic contraction, a tight credit market offering limited liquidity, and a prolonged low interest rate environment. All these factors would support the need for strong underwriting discipline, creating a hard market, as the only means to produce reasonable operating earnings and restore lost capital, he says.

Interconnected markets

The global stock market has become “feverish” as the uncertainty surrounding the COVID-19 outbreak and the resulting impact on the global economy infects markets, says Russell Group managing director Suki Basi, speaking to II on March 23.

“Apple, for example, which is reliant on China for more than a sixth of its revenue, saw shares fall by more than 5 percent in European markets, which wiped out $70 billion from its market capitalisation,” he says.

“In terms of the impact on re/insurers you might think there would be a direct adverse impact on rated insurance companies’ balance sheets, but that might not necessarily be the case.”

Basi says that the impact of the COVID-19 virus on non-life insurers’ risk-adjusted capital levels, investment portfolios, reserve adequacy and other aspects of the risks could be blunted by the nature of insured commercial exposures.

“Their exposures, along with restrictive language in policies, will most probably limit property casualty carriers from a deluge of claims. The connectivity exposure and nature of risk that is defined by modern supply chains, credit, political, cyber, and other interlinked perils is harder to quantify, however,” he says.

He believes that to gain a deeper understanding of pandemic risk and the way it impacts on a reinsurer’s portfolio is going to require new investment in data that measures the flow of money across supply chains and territories at an increasingly granular level.

In terms of which markets or regions face the biggest impacts, Basi highlights how the uncertainty surrounding coronavirus has sparked fears of a European recession, with the lucrative Chinese exports markets closed off.

“Such fears have spread across the German economy. Daimler, the German carmaker, saw its shares fall by 1.9 percent.

“Continental, the leading German manufacturer, fell by 1.4 percent and Heidelberg was down by 1.3 percent.”

Basi says the story is similar in the US. “In a note to investors, Apple said that global iPhone sales will be impacted as Chinese factories have been closed since the Lunar New Year at the end of January. Apple’s wider supply chain has taken a hit.

“Shares in STMicroelectronics, which supplies chips used in the iPhone, fell by 2.5 percent. Dialog Semiconductor, another supplier for the iPhone, saw its shares plunge by 6 percent.

“Shares in AMS, which provides optical sensor systems used in the 3D facial recognition features on iPhones, fell by 4.5 percent,” he explains.

The figures Basi quotes show how closely economies are interconnected. As a result, opportunity and risk are tightly interlinked, which creates connected exposure, he adds.

“This connected exposure must be fully understood to ensure operations are successful, sustainable and resilient to failure.”

Basi says that over the next few months, a key challenge for risk managers and re/insurers will be to track the flow of goods and services coming in and out of different regions and organisations.

“Achieving some form of equilibrium will be a challenge but necessary, particularly as the virus’s spread shows no signs of abating, as fears grow for a global and potentially crippling global pandemic.”

With businesses more connected than ever before, through digitisation, these connections have evolved to create new pathways for opportunity and risk to flow at speed, he says.

“The resulting ‘connected economy’ is however prone to events which can cause business interruption, loss of revenue and financial ruin—or create opportunities for market development and business growth—in ways not known before.”

Basi argues that as a result, decision-makers need a deeper insight into business flows, especially their connected exposure, so that they can operate successfully, sustainably and be resilient to failure.