Insurers at the boiling point
Financial impact of COVID-19
At the beginning of 2020, the coronavirus COVID-19 disrupted the world in a manner that hardly anyone was prepared for. A vast amount of resources is required to get through this phase. For insurance companies, this means facing greater uncertainty regarding the management of financial risks on their balance sheet at a time when they are already dealing with the low interest rate environment and major regulatory changes, such as IFRS 17.
The immediate effects of the outbreak of COVID-19 are prominent in everyone’s lives. Businesses of all sizes are temporarily shutting down while employees find themselves wondering whether they can maintain a steady income. At the same time, the rapidly increasing number of infections put healthcare providers under stress. This short article provides a high-level assessment of COVID-19’s effect on an insurance company from a financial risk and client behavior perspective . It begins by analyzing the recent financial markets developments and later relates these to the segments of Life, Funeral and Credit insurances.
The financial markets have experienced their most dramatic downturn in decades, with stock prices plummeting by approximately 20% and interest rates decreasing over ten bps within only two months. Solvency ratios and other risk figures across the insurance market are directly affected. In a reassuring statement, the European Insurance and Occupational Pensions Authority (EIOPA) mentioned that the European insurance market possesses enough solvency to withstand these shocks. Nevertheless, the authority advised to withhold dividend payouts and discontinue share buyback programs.
The past years have been characterized as challenging for the insurance industry due to the low interest rate environment. The impact of COVID-19 on the financial markets adds to these challenges with, among others, widening credit spreads in bonds markets and less liquidity in financial markets in general. It becomes increasingly more difficult to generate attractive low risk returns, resulting in higher reinvestment risk.
To reduce the economic impact of COVID-19, governments of individual countries and economic unions worldwide installed emergency funds. These put further downward pressure on interest rates and upward pressure on expected future inflation. In particular, long-term liabilities such as life and (in-kind) funeral insurances may experience significant increases in value. Another insurance segment that will be significantly affected by the economic downturn is credit insurance. Apart from widening credit spreads that impact their fixed income investments, these insurers will also face large increases in insurance claims as the credit quality of clients’ creditors deteriorates and probabilities of default will rise.
… and increasing expenses
The expenses faced by insurance companies regarding their operations, such as administration costs, are of course also sensitive to inflation. An expected increase on future inflation directly translates into higher estimates of future expenses. This effect is potentially amplified by increased lapses. During the financial distress caused by COVID-19, policy holders may reevaluate their expenditures and decide to surrender their insurance policies, or alternatively, leave them paid-up. The reduced volume in insurance portfolio will reduce the cost base for an insurance company’s operations.
It is clear that the vast economic drawbacks caused by COVID-19 will be felt for at least the rest of 2020. The magnitude of the impact on financial institutions can only be roughly estimated. It can be said that stress is a poor companion for decision making. However, efficient asset-liability management is now more important than ever to manage shocks in the short term and meet liabilities in the long run. Eventually, the goal should be to ensure business continuity and to ultimately service the customers who are dependent on a resilient insurance company.
If you want to know more or talk to us about the coronavirus impact on insurance companies, please contact Martijn de Groot or Lennard Beijering.