Covid-19 has caused severe disruption for insurance companies, not least as they are in the business of pricing risks and a pandemic was thought of as a low probability event. But the economic fallout from the crisis may act as a catalyst for positive change in the industry.
According to Google Trends, the global search term ‘uncertainty’ rose more than three-fold between the end of December 2019 and mid-September 2020. This isn’t surprising: 2020 has unmasked risks and uncertainties that very few individuals and companies considered at the start of the year.
This article discusses how insurance companies, as organisations tasked with quantifying and managing risks, have responded to some of the challenges of 2020. They have not been immune to the effects and are likely to see further economic impacts and repercussions as the situation continues to unfold.
How can pandemic risks be priced?
The underlying premise of insurance is a transfer of risk. Individuals (policyholders) swap a potentially large and unknown outgoing for a known, typically smaller outgoing (the premium paid) with an insurance company. The insurer then pools all the risks together and, by doing so, it seeks to forecast, manage and pay out claims.
The multi-faceted nature of the Covid-19 pandemic has meant that it has affected many lines of business where there is insurance coverage. The affected areas include, but are not limited to, business interruption (for example, disruption to supply chains and inability to operate as normal due to government measures), trade credit insurance (cover for businesses if customers who owe money for products or services delay payment or do not pay at all), travel, cyber liability (due to increased working from home) and event cancellation.
Consider, for example, Wimbledon, the world’s oldest tennis championship held in London every June. The pandemic insurance coverage for the event is expected to result in a £114 million payment due to the cancellation of this year’s tournament (Brodies LLP, 2020). A more extreme example of an insurance payment due to event disruption is the postponement of the Olympic Games in Tokyo, with Jefferies analysts estimating the insured cost of the event at $2 billion (Insurance Journal, 2020).
While many insurers have considered and priced pandemic risk into their insurance risks, the global effects of Covid-19 have led to many risk commentators describing it as a ‘black swan’ event (McGillivray, 2020) – in other words, an event that lies outside the realm of regular expectations (Taleb, 1999).
Pricing a very low probability unexpected event is difficult, as a lack of historical data impedes the modelling of future risk events occurring. With very few pandemics in the last century, pandemic risk falls into this category. With this in mind, it is evident that the pricing of pandemic risk within insurance has not been fully understood and allowed for.
How will Covid-19 affect life insurance?
Mortality and longevity
An immediate and obvious insurance implication of the pandemic for life insurance companies has been the tragic human toll affecting life insurance and annuity coverage.
The pandemic has resulted in a significant number of premature deaths, which has increased the mortality risk liabilities for many life insurance products. But it should be noted that the extent of the effects depends very much on the age profile of the policyholders and also where they live.
It should also be noted that life insurers often provide protection against longevity risk, via life-contingent annuity products. Hence, there may be a reduction in the expected longevity risk of already annuitised annuities from pandemic-related deaths.
These mortality and longevity risks offset each other, to some extent, by acting as a natural hedge. Hence, the net change in pandemic-related mortality liability will differ significantly between life insurers depending on the balance of the product mix that they have underwritten.
Various regulatory regimes, such as the European Union’s Solvency II directive, require that insurance companies manage their solvency capital requirements in line with their risk profile. Hence, there may be discussions with regulatory supervisors in progress, especially regarding assumptions around solvency capital requirements.
Financial markets have experienced significant change and volatility since the markets began reacting heavily to the pandemic in February and March of this year (Campbell, 2020).
As life insurance companies hold significant assets to cover their liabilities, changes in financial markets may have various implications. For example, although equity markets have largely recovered from the significant drops experienced earlier in the year, future volatility and decreases in equity values remain significant threats to solvency ratios.
Furthermore, lower interest rates have repercussions for life insurance companies, as they are particularly sensitive to long-term interest rates. The net effect on balance sheets will depend on the asset duration compared to the liability duration. Life insurers typically have liabilities that are longer in duration than the assets available in markets. Hence the net effect of a long-term reduction in interest rates on balance sheets is likely to be negative.
How will Covid-19 affect health and general insurance?
Health insurers underwrite morbidity risk and hence, there were concerns that health insurers would experience significant additional payouts from an increase in Covid-19-related hospitalisations and treatments.
The evidence to date, which comes from an AM Best commentary, suggests that the Covid-19 impact on health insurance companies has been smaller than expected (AM Best, 2020). They attribute this to the fact that most diagnosed individuals have been able to self-isolate successfully at home rather than being hospitalised. In addition, there has been a decline in non-Covid-19 claims, which has offset the expected impact from Covid-19 claims.
General insurance has also been affected in various ways by the pandemic. For example, travel has been severely disrupted, affecting travel policies. Motor claims have also been affected as various lockdown measures have resulted in an unprecedented drop in the number of road users, leading to a drastic fall in the number of motor claims from accidents. Theft claims have also decreased as both vehicles and vehicle owners have remained at home.
Global lockdown measures from governments attempting to contain the spread of coronavirus have also led to a complex myriad of second and third order effects, which have been difficult for insurance companies to predict in advance.
One example of these unforeseen risks affecting insurance companies is reputational risk. The insurance industry already suffers from a poor customer reputation (ProActuary, 2019), and the crisis has brought to light the many epidemic/pandemic exclusion clauses for coverage, such as travel insurance and business interruption, of which customers were often not aware.
The Actuary magazine, for example, recently reported that two-thirds of brokers believe that the industry's reputation has been damaged during the Covid-19 crisis, citing a lack of pro-activity and confusion around legislation and policy wording on some of the major issues (The Actuary, 2020) .
As an example of policy wording confusion, consider the aforementioned Olympics insurance payout. The summer Olympics scheduled for June this year has now been postponed until July/August 2021. But it has transpired that many of the policies taken out only cover a cancellation and not a postponement.
On a final note, it would be remiss not to point out some positive actions taken by some insurers that have enhanced the level of trust. For example, many motor insurance carriers have returned premiums to policyholders, by refunding drivers and cutting premiums due to the change in their risk levels.
Are there any silver linings?
Although the pandemic has caused severe disruption and economic fallout for insurance companies, the crisis may also act as a catalyst for some positive change.
Like most other industries affected by the pandemic, insurance companies have been forced to consider how they operate and to focus on becoming more agile and digital.
Enforced working from home has led to a realisation, across numerous insurance companies, that many operations can be effectively undertaken away from the office with employees working virtually while maintaining productivity and a streamlined service. Indeed, regulatory supervisors have been pro-active in encouraging the use of digital channels with initiatives such as encouraging digital service delivery and relaxing previous face-to-face requirements (OECD, 2020).
Remote working has proved to be remarkably effective for many adaptive organisations and a hybrid virtual working norm may emerge in the post-pandemic world (Wired, 2020; Dingel and Neiman, 2020). This may lead to significant cost savings with reports of employers typically saving about $11,000 per annum for every employee working remotely half of the time (GlobalWorkplaceAnalytics, 2020). A new agile, digital workforce may also result in happier, healthier and more productive employees who have less commuting stress, greater location autonomy and a better work-life balance.
Insurance companies have been recognised as ‘laggards’ in the adoption of technology and digital disruption (Raconteur, 2018). This includes, for example, moving systems and applications to the cloud.
Various reasons, such as reliance on legacy systems and paper documents, have been put forward to explain this slow adoption. But the crisis has highlighted how technology adoption can be used to digitise operations and service provision. These changes open up potential opportunities to streamline future operations as well as making significant cost savings, improving security and reducing current and future operational risks.
Finally, the pandemic may even spur technological innovation within insurance product offerings. For example, the demand for telematics device-based insurance within the car insurance market may increase.
‘Telematics’ devices benefit drivers by measuring and feeding back the policyholder’s driving behaviour (including the mileage driven, for pay-per-mile policies) to help determine an appropriate risk premium. The personalised benefit of telematics-based insurance cover has become more evident during the pandemic, as lockdown measures led to significant changes in driving behaviour, especially the volume of miles driven.
The benefits of personalised cover have, therefore, become more evident among some policyholders who may now be more willing to have their personal data being used to provide a more granular personalised premium. This may extend into wearable devices, which are also starting to come to the fore in insurance products.
Covid-19 has undoubtedly affected nearly all businesses across the globe, including insurance companies. The long-term impacts of the pandemic remain uncertain and insurance companies face many changes and challenges, but also potential opportunities as we move towards a post-pandemic world.
Where can I find out more?
- The impact of COVID-19 on insurers: Divya Kirti and Mu Yang Shin discuss the various shocks that Covid-19 has had on US life insurers.
- Regulatory and supervisory response to deal with coronavirus impact – the insurance sector: International Monetary Fund experts Nobuyasu Sugimoto and Peter Windsor highlight the impacts of Covid-19 on insurance companies and discuss the actions regulatory supervisors have taken to support business continuity and fair treatment of policyholders.
- Insurance sector responses to COVID-19 by governments, supervisors and industry: The OECD discusses the various government, supervisor and industry response measures being implemented for insurance businesses due to Covid-19. These include ensuring continuity of insurance services, managing solvency and liquidity risks, and supporting policyholders.
- Impacts of COVID-19 on insurance businesses: Mark Andrews, Patrick Hayward, Mark McDonald and Steve Whitfield consider how Covid-19 will affect insurance businesses in relation to proposition management, distribution management, customer management, claims management and policy administration. They also discuss various activities insurance that businesses should consider for each of these aspects.
Who are experts on this question?
Experts in insurance research in the UK include:
- Guy Thomas
- Angus Smith Macdonald
- Angelos Dassios