Each line of business can affect the insurer in a different way, for this reason we try to look at the Coronavirus through the special lens of the insurance company accounts. This approach may help brokers, MGAs and customers to catch the underwriting implication of the products that they sell / buy.
In detail, we try to look into the P&L and financial strength of an insurance company.
In terms of P&L, the insurers may expect that the profit will reduce in the short term but the outcome strongly depends on the risk profile of their portfolio, the policies underwritten and the expenses structures. The investment strategies also play a key role in determining the final result.
Each of the components mentioned above can be explored in more detail in order to underline the main exposures that an insurer needs to manage in this difficult period.
One of the elements that the insurance company can directly control is the expenses structure. Indeed, the operating expenses will increase in the short term because different systems for business continuation need to be adopted. Like many other industries, insurance is testing working from home approaches which increase uncertainty on productivity and effectiveness of the staff. More uncertainty, as many risk managers know, will increase the expenses. The risk that insurers will face, from this point of view, can be categorized into the operational risks. As operational risks, the insurers need to consider also the impact of a possible business function that can be seriously affected, by shut down, because of the spread of the virus across the staff. We can call this risk key function risk. As a direct consequence, a key person risk for the leader of the function can arise, putting at risk the relationships and the reputation of the business. Moreover, if the insurance adopts outsourcing, another source of risk needs to be considered because a lack of resources in the external partner will be a cost in terms of worser service to the customer (e.g claims delay). In addition, the closure of the office will increase all the operating expenses.
The global spread of the virus is forcing the government to adopt extreme measures that have a very strong impact on the economy. Indeed, the UK is under lock down status, which means limited economic activity that will result, at least in the short term, in reduced premium written. This view can be simplistic unless we refine the reasoning.
Above we discussed the operational issues that can arise from the pandemic situation. The issues can be extended to the fact that key functions risk may create problems in the execution of underwriting contracts. Furthermore, different factors need to be considered such as demand, supply and premium rates in the short term. The demand (volume of sales) can be variable across the products with Travel Insurance, Event Insurance and Business Interruption as the best candidates to be claimed in the Coronavirus outbreak. From the supply and premium rates side, the insurers need to react quickly to the market by reviewing the policy wording and the premium. The biggest issue in this situation is the conflictual position of the insurance company. Indeed, if from one side the market would increase the demand for some products, the insurer needs to control the cost of claims by excluding or limiting the coverage for Coronavirus. Consequently, the increase in demand would be compensated through the risk management actions taken by the insurers.
In general, the premium rates are likely to increase for new and renewing policies due to a riskier environment.
The claims will likely increase though the dynamic depends on the different line of business.
It is reasonable to think that the crisis will mostly affect travel insurance, trade credit insurance, business interruption insurance and income protection insurance. Specific characteristics need to be analysed like sum assured, age and geographical exposure. It’s important to outline that the insurance policy does not necessarily result in paid claims. Everything depends on policy wording. An interesting perspective is also given if we look at the Directors & Officers policies. In times of uncertainty, like the period we surely are now, many claims arise from poor management decisions.
Solvency and Financial Strength
The immediate impact of the pandemic will be in reducing the insurer solvency and financial strength. The value of the balance sheet assets will suffer by the downturn in the investment. Indeed, the equity markets have lost, on average, more than 20% of their value across the globe and different asset classes. From the actuarial point of view, the less value in the investments, thus in assets, will be compensated by the increasing reserves, if the insurers think that the claims experience will deteriorate. Moreover, the risk capital is calculated with a prudential approach, that leads to an effective impact less than initially imaginated. The coronavirus spread will affect the actuarial models that insurance adopts by incorporating one more rare event that will modify the models’ parameters.
FOCUS ON ONE PRODUCT : Business Interruption
As illustrated in the previous paragraph, different products will be involved by the coronavirus spread. The one that is most related to the business environment is the Business Interruption Insurance which will be discussed in this section.
The loss of income due to closures, supply chain disruptions and broken ordinary activities will reasonably induce the business to seek a Business Interruption insurance, the issue here is if these policies cover the COVID – 19 outbreak.
Business Interruption Insurance covers a business for loss of income during periods when they cannot continue their activity as usual due to an unexpected event. In this case, the insurance will compensate, under certain conditions, the business for any running costs and/or shortfall in profits as the result of the event. In general, the coverage is valid for lost income resulting from :
- Damage to the policyholder’s own property ( traditional business interruption
- Damage to the property of a customer or supplier or a suppliers’ supplier ( contingent business interruption )
The main point that needs to be considered is if the coverage above includes the Coronavirus case, that is, if the Coronavirus-related loss constitutes property damage and if this damage plays a role in the loss of income.
Since, the virus can be transmitted either through the air or from touching infected surfaces and making the work location unsafe, some courts (especially outside of the UK) have declared that in such circumstances, that property can sustain physical damage without experiencing structural alterations. ( https://law.justia.com/cases/federal/district-courts/new-jersey/njdce/2:2012cv04418/277072/51/ ). Though there is a precedent, the losses from coronavirus are unlikely to be covered from the traditional business interruption policy because of a non-standardized rule in the definition of “physical loss”.
A large portion of the losses will fall within the, so called, contingent business interruption.
This category, widen the definition of loss and extend the standard property insurance policy through expressly provide insurance coverage for losses caused by communicable or infectious disease without requiring a physical damage property. In addition, the extension can include the losses originating from a civil authority that prohibits or impairs access to the policyholder’s premises, such as forced business closure. The components mentioned above need some clarification. Indeed, a communicable or infectious disease needs to be notifiable to the insurers and this extension requires a specified list of diseases named in the cover. If Covid-19 is not specified, then cover may not apply . However, some covers extensions have a not specified notifiable disease where the Covid – 19 may be included.
In addition, Tapoly has elaborated data from Google Trend to verify what in the market is already perceived. We see that the interest for Business Interruption insurance surging by 623%, in the last three weeks of data recorded, while Professional Liability and Legal Expenses are down , respectively, 9.6 % and 19.77%. Indeed the last two products are pro-cyclical, that is, the demand increases when the economic environment is positive. Moreover, the interest for Medical Malpractice insurance interest is up to a reasonable 33% as a consequence of the medical emergence in the UK, as well as across the world.
HOW THE MARKET PLAYERS RESPOND TO THE CRISIS
Insurance companies have responded very differently across the Uk. Their actions strongly depend on the structure and risk profile of the portfolio.
Axa, the largest insurance company in the world by assets ($US1.011,4bn according to AM Best) has declared that the Business Interruption products will only cover specific diseases named in the policy, thus the COVID – 19 will likely not be included. Moreover, their contracts do not consider the general class of notifiable disease. This approach is adopted by many other UK insurers
It’s important to outline that COVID – 19 was first identified as a notifiable disease by the government on 5th of March. (https://www.gov.uk/government/news/coronavirus-covid-19-listed-as-a-notifiable-disease)
Also Aviva confirmed that their Business Interruption cover did not include losses from coronavirus.
On the other hand, the RSA group declared that the company will deal with coronavirus cases on a claim by claim basis.
Ageas together with brokers, will help businesses to tailor made policies to the current risk environment since the policy wording varies in approach.
Allianz is still monitoring the situation without defining a standard approach to the market situation. The company invites customers to speak with the brokers to understand how to move forward.
Nig confirmed that the Corona Virus is not covered under the Standard Business Interruption cover. Extensions can be applied by specifying a list of diseases.
Zurich declared that some of their products may cover against CoronaVirus without any standardized approach.
Let’s do a resume of the Market Players respond to the crisis:
Insurance company / Market answer
- AXA / No cover for Coronavirus
- Aviva / No cover for Coronavirus
- RSA group / Claim by claim decision
- Ageas / Claim by claim decision
- Allianz Stand by – Claim by Claim
- NIG / No cover for Coronavirus
- Zurich / Some products offer cover
This analysis suggests that the insurance sector has not been prepared to deal with one of the toughest economical and social crises in history. The response seems to not be adequate to the market environment. Indeed in many cases the COVID – 19 disease is not covered. On the other hand, entire countries are shutting down economies and businesses. Who is going to cover the financial losses of these businesses? Who is going to support the SMEs to recover from their increasing costs and decreasing revenue?
In this context, the insurance industry has a great occasion to show the UK, and the world, the social utility of its activity by offering products and services that can help the British economy to limit its losses. Isn’t it the purpose of the insurance activity?
It’s also true that from the technical point of view the situation is critical. Indeed the risk management practice suggests to avoid selling policies related to Coronavirus because of this would have the consequence of correlated portfolios with high loss ratios. The worst case scenario that would disrupt the insurers’ balance sheet.
However, a pragmatic approach can be adopted in order to find a tradeoff between the interest of insurance companies to protect its balance sheet and the businesses to protect its activity. Indeed, the CoronaVirus spread seems to be predictable in terms of geographic and demographic distribution, as well as, in its general trend. The big amount of data and scientific models available can help the insurance industry to calibrate the premiums (e.g increasing) and the policy wording (e.g analysing which part of the business can be covered).
Finally, these actions imply a good degree of risk appetite from the insurance companies.
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