The C-word: six ways it will hit insurers – but some positives

“Relative to many other industries such as airline, hospitality, sports, and others, the impact appears to be more muted and indirect. We are in unprecedented territory and surprises are likely to emerge unexpectedly. That said, our perspectives on the industry are - on balance - relatively neutral.” Ravi Arps, partner, and Joseph Scheerer, chief executive officer, Stonybrook Capital

There are six ways in which COVID-19 will impact the re/insurance industry globally. While the virus will undoubtedly throw up further surprises, the industry is relatively well positioned argue Ravi Arps, partner, and Joseph Scheerer, chief executive officer, Stonybrook Capital, in a memo examining the implications of the virus.

The impact of COVID-19 is foremost human in its effects on the lives of people around the globe - many of which are forever changed, write Ravi Arps, partner, and Joseph Scheerer, chief executive officer, Stonybrook Capital, in a memo.

This aspect cannot be underestimated or easily quantified. Over the past weeks, trade publication headlines have made clear that the broad effects of the virus on national economies and industry likely will be severe, evolving, and unpredictable as governments and societies wrestle with how to stem the virus' spread. This, it seems, is the consensus view of how the pandemic will impact the insurance industry: in a manner more subtle than other industries more directly linked to the broad changes sweeping societies around the world.

In this memo, we consider the effects to six aspects of insurance company operations and strategy: (1) claims exposure, (2) operating expenses, (3) premium income, (4) investment income, (5) access to and cost of capital, and (6) mergers and acquisitions.

Claims exposure

The current accepted wisdom is that unless an insurer that offers policies covering specialized domains such as trade credit, business disruption, or travel and event insurance, it is unlikely that this virus will directly impact the likelihood or severity of claims experience. Even in instances where such coverage as business interruption is offered, it is included as a sublimit lower than the policy limit. Life insurance companies may experience elevated claim activities, though may be even more concerned with the interim performance of their investment portfolios (covered below).

Operating expenses

Expenses related to transitioning workforces to virtual environments may pose a challenge and additional expense for many insurers, especially those with legacy systems. However, depending on how quickly the COVID crisis is resolved, any additional outlay may be muted or prolonged.

Premium income

The demand for many insurance policies is relatively inelastic due either to corporate cultural norms or actual regulatory mandates (as in the case for auto insurance). Thus, it is not expected that the crisis will impact much of the industry from a top line perspective. Obviously, this does not apply to policies issued in relation to discretionary purchasing such as event insurance. Nor does it apply to policies related to business activity directly affected by COVID such as restaurants and bars, airlines, and commercial auto - all of which may be suppressed for some period.

Investment income

Ever since the financial crisis of 2008, the insurance industry has operated in a relatively low interest rate environment, forcing many to focus on underwriting performance. However, in search of yield many insurers have increased their investments in both public equities and bonds in the lower tier of investment grade rated debt (e.g., BBB rated bonds). Obviously, the recent sell-off has been an unwelcome event for many Chief Investment Officers. Furthermore, should some of the BBB rated bonds face a downgrade, it may force a portfolio restructuring amidst an uncertain environment.

Access to and cost of capital

Second to the auto industry, the insurance industry has the largest proportion of its debt set to mature in the next five years of any industry in the US. The lowering of interest rate to zero by the Fed on March 15thmay come as welcome news to companies looking to borrow or refinance debt. However, this news is somewhat mitigated by the simultaneous increases in credit spreads have increased over 50% by some measures since news of COVID started to set in. Increase in spreads tend to indicate a tightening of credit availability in addition to an increase in the cost of borrowing relative to "risk-free" treasuries.

Mergers & acquisitions

Mergers activity tends to slow in the context of volatile public equity markets. The reason for this is principals have difficulty determining cost of capital. Cost of capital underpins the determination of equity value. We anticipate a slowing down of both public and private market merger activity at least until the equity markets stabilize.

Summary conclusion

In conclusion, like the virus itself, the economic contagion will likely have some impact on the insurance industry as the equity market sell-off impacts publicly traded insurers in the short-terms, tightens credit broadly, and requires employees to work remotely. However, relative to many other industries such as airline, hospitality, sports, and others, the impact appears to be more muted and indirect. Certainly, we are in unprecedented territory and surprises are likely to emerge unexpectedly. That said, our perspectives on the industry are - on balance - relatively neutral.