Three key ways the pandemic is reshaping insurer business models

"I expect the insurance industry to continue to protect itself against its obligation to pay by means of exclusions and policy wordings, but also to consider the longer-term implications of such actions.” Stephen Tu, vice president – senior credit officer at Moody’s Investors Service.

· Beleaguered investment portfolio returns will drive riskier investment
· Enforced remote working experiment accelerates shift to digital
· Greater digital working helps 'expense-heavy' incumbents
· Pandemic brings increased focus on corporate social behaviour

As lockdown drags on, analysts and businesses are looking ahead, keen to know what the world’s ‘new normal’ will look like when we all emerge from our homes.

Consensus decrees that the COVID-19 pandemic is a defining global event but how long-lasting or far-reaching will the impacts be for the resolutely resilient financial service providers?

Researchers at Moody’s Investors Service say that in the long-term they expect the outbreak and its effects “will fundamentally reshape many aspects of the macroeconomy, business life and consumer behaviour”.

“The crisis has accelerated existing disruptive trends and is causing a rethink of conventional habits, potentially reshaping business models, consumer preferences and competitive dynamics,” says Stephen Tu, vice president – senior credit officer at Moody’s Investors Service in his report on global financial institutions, published May 19, 2020.

Tu and his team have identified three key areas where they expect to see an enduring impact.

Depressed rates and falling profits

Interest rates will remain severely depressed as government actions to contain the spread of the virus have resulted in severe economic contractions. Many corporations are feeling the pain as revenues, and in turn profits fall.

“The deflationary effects of a reduction in aggregate demand coupled with the decline in oil prices will keep interest rates depressed for the near future, from already low levels before the crisis,” says Tu. “Central banks have aggressively cut policy rates and implemented massive asset support programs, continuing to push investors and speculators toward riskier behaviour in pursuit of returns.”

For insurers, lower interest rates will drag down investment portfolio returns, Tu says, which is expected to drive them to invest into riskier securities or more illiquid asset classes.

“The impact of low rates will likely be greater in regions where we expect the yield curve to remain relatively flat coming out of the crisis, such as the euro area; and where recent declines in short-term rates have been larger, notably the United States, where banks are also heavily deposit-funded.”

There is some positive news. In contrast with some prior crises, governments in developed nations are increasingly supplementing “easy monetary policy” with fiscal stimulus schemes. These can come in the form of temporary emergency payments or universal basic income paid directly to those affected to prevent mass-scale bankruptcies and reduce economic hardship.

But Tu adds a note of caution: “These actions have partially filled the considerable gap left by reduced consumer and business activity but the longer-term consequences are highly uncertain, severely limiting visibility over longer-term inflation and interest rate trends.”

Faster shift to digital

Enforced remote working has certainly helped drive recognition of the value of digital processes and service.

Moody’s Tu says that for financial services, “social distancing has created a surge in demand for online commerce, contactless payments and digital cash transfers”.

It does not require a great leap of imagination to see that customers who are newly converted to novel ways of working and shopping may not return fully to their old ways in a post-lockdown world, especially as the threat of a second wave of infection remains high. In addition to reduced physical interaction, digital processes and services have also shown they can offer greater functionality and improved user experience.

Tu says: “Financial institutions whose offerings lack digital functionality will either suffer more rapid franchise attrition as customers seek to replicate their needs elsewhere, or they will be forced to enhance their product offerings very quickly.”

Service businesses that have been able to operate remotely are also not expected to completely revert to pre-pandemic ways of working. Tu says that once they consider improvements in digital efficiencies and cost savings, not least in rent and business travel, they are likely to allow and enable greater remote working.

“For a number of technologies, the experience of social distancing has encouraged a sufficient number of new adopters to reach critical mass for that technology to flourish and begin to accelerate. Examples include digital collaboration, contactless payments, teleconferencing, online grocery shopping, to name a few. In these instances, the typical technology adoption cycle, often represented by an ‘S’ curve, has taken a sharp step upwards since the coronavirus outbreak, possibly leading to accelerating growth in the years to come,” Tu adds.

This unplanned work-from-home experiment benefits financial firms in particular as they are often “expense-heavy information-based businesses”. Tu says most of their work can be done remotely, so potential cost savings are considerable. This is good news for incumbents as savings from this shift are expected to increase as the trend progresses. Tu adds that this presents incumbents with “an opportunity to close a portion of their costs gap with online-only digital challengers”.

However this same accelerated shift to greater technology use also poses risks to incumbents. Tu says that the convenience and universality of tech companies like Alphabet Inc's Google unit and PayPal for online business transactions or Venmo and Apple Pay for contactless payments will be hard for incumbents to replicate.

Increased focus on corporate social behaviour

The global health and economic crisis has touched everyone. With such far-reaching consequences corporate social behaviour, and firms’ ability to help rather than hinder a recovery, has come under the spotlight. Tu says that prudential regulations exist partly to balance the natural profit-seeking tendency of firms with the need to maintain financial stability and the wider social good.

Through the lens of the pandemic, the balance between these two forces has shifted in favour of the greater social good. One example of this shift in emphasis is already playing out for the insurance sector. It has come under great pressure from certain governments and societies to pay coronavirus-related claims that are not covered by existing language, such as business interruption insurance. Insurers have also been asked to accept delays in premium payments without canceling coverage and to provide other means of financial relief to their customers.

He adds: “Some insurance companies are responding to societal and competitive pressures by refunding profit from expected lower loss rates back to their clients, and extending pandemic risk coverage beyond their contractual liability.”

For this pandemic, Tu says he expects the insurance industry “to continue to protect itself against its obligation to pay by means of exclusions and policy wordings, but also to consider the longer-term implications of such actions”.

Tu adds: “Ex-gratia payments may become an option in some cases to preserve customers’ perception of the relevance of insurance, and to avoid harsher societal or regulatory-led business repercussions. “Further ahead, we anticipate governments will seek to partner with insurers to set up insurance schemes that will cover losses in future pandemics. Governments around the world have already partly or entirely transferred health, retirement or natural disasters coverage to the insurance industry.”