Reinsurers grapple with potential BI claims burden

Negotiation in favour of litigation is likely to determine the extent to which reinsurers bear the burden of claims stemming from COVID-19 as they seek to maintain good relationships with clients and avoid any damage to the industry’s wider reputation. But reinsurers could well seek concessions around rate increases and other terms and conditions in return.

This was one of the main points from an interview with Robert Mazzuoli, director, EMEA Insurance, at Fitch Ratings. The interview took place on Intelligent Insurer’s Re/insurance Lounge, an online platform where interviews and panel discussions are available on demand.

Even following one of the most volatile and turbulent periods in the industry’s history, the global reinsurance sector’s capital strength has remained largely unscathed. But Mazzuoli added that Fitch Ratings remains of the belief that losses relating to the pandemic will be an earnings event as opposed to a capital event.

“When the pandemic started, we performed a stress test to see what the impact of the pandemic might be, and whether it may lead to a capital event,” said Mazzuoli.

“However, in the end, it remained an earnings event and while profits were extremely low, the industry did remain profitable.”

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Who will pay, and how much?
The UK Supreme Court in January ruled against primary insurers in a test case relating to COVID-related business interruption (BI) claims. But the resulting extra claims costs to primary insurers should not translate into reinsurance claims large enough to materially affect the credit quality of the reinsurance industry, Mazzuoli said.

He noted that the fact that so many reinsurers were able to raise additional capital in 2020, reassured the ratings agency.

“Companies were able to tap the capital markets where necessary. That gave us confidence that there would not be a negative impact on the credit profiles of the reinsurance companies,” he said.

Despite this certainty over the sector’s overall financial strength, Mazzuoli said, it remains unclear what the ramifications of the Supreme Court ruling will be on the reinsurance sector in terms of the claims burden.

“BI claims have been one of the biggest claims the re/insurance sector has had to deal with, so the question now is certainly who is going to pay how much of these claims? Much of that depends on court rulings,” he said.

“For UK insurers this may be substantial, but we still don’t know how much of these claims can be passed on to reinsurers.”

He pointed out that while the nature of claims will be clear in quota share treaties, great uncertainty remains around other types of treaties, such as excess of loss where the wording in the reinsurance policy may differ from the wording that the primary insurers have used with their clients.

Key to this issue could be the extent to which cedants will be able to aggregate multiple BI claims into single large claims to trigger excess of loss reinsurance treaties on the basis that the individual claims were all caused by the same event.

More to come
Mazzuoli stressed that many of the negotiations that will need to take place around the issue have yet to take place.

“In the January renewal, re/insurers preferred to get their renewals done in a quick and orderly fashion and therefore these discussions were taken out of the meetings. Now we still do not know what the spread will be between primary and reinsurers,” he said.

This means the issue of whether insurers can aggregate BI claims is not yet settled.

“This is a key debate: we are asking ourselves whether BI claims are the result of one common cause—the pandemic—or rather, the multiple lockdowns,” he explained.

“Primary insurers protect themselves for different layers of claims so that they might have protection if claims go beyond a given amount. Depending on what we have, we look at what the protection looks like and how much can be passed on.”

Fitch expects reinsurers to contest this, arguing that claims were caused by separate events.

“The outcome will depend on the wording of each reinsurance treaty and in some cases may involve litigation. However, even with widespread aggregation, we do not expect that the resulting excess of loss payouts would materially weaken the major European reinsurers’ earnings or capital,” Mazzuoli said.

He added that it might take time to see what the ultimate loss may look like.

Reserves
The bigger reinsurers have already set aside reserves which, according to Mazzuoli, should be adequate.

“As of end 2020 more than 60 percent of claims reserves were incurred but not reported,” he said. “This happened because the reinsurers believed that it would be required but there has been no cedant claim yet. This gives us a strong level of comfort that reserves will be sufficient to cover the potential claims even if it takes a little longer to know what the ultimate loss will look like.”

Mazzuoli added that it would be fair to say that policy wordings have already been tweaked to make sure nothing like this happens in the future.

“Where communicable diseases were still included, the reinsurance industry will not offer this type of cover any more,” he said.
The UK has set the precedent for countries that have similar legal systems. “Some more rulings could come in favour of insured clients, but reserves are on a global basis, so the buffers are there,” Mazzuoli added.

Looking at the primary insurance market, there is a political and social question that he feels requires clarification.

“What will happen to all those clients that lost their insurance coverage for BI because of the pandemic?” he asked.

“If we have a systemic risk and the insurance industry cannot provide coverage for policyholders then who is going to provide that protection now?” he concluded.

To view the full Re/insurance Lounge session, click here.