Covid-19 – predicting the impact on reserves for general (re)insurers

Published by Nasir Shah on

Estimated reading time: 8 minutes


Following our previous blog on 13 March 2020, which looked at Covid-19 through the lens of insurance company accounts, there have been further developments. 

In this blog, we consider the impact coronavirus could have on the liability side of a general (re)insurer's balance sheet – its reserves. We will also be releasing a liability-side blog for life and health (re)insurers soon.

General points for general (re)insurers to consider about Covid-19

  • A number of companies are treating the Covid-19 pandemic as they would any other catastrophe for the purposes of monitoring claims experience, reporting and seeking to quantify the uncertainty. Treating it in this way enables these companies to enact a playbook which is largely written and has existed for many years.  
  • (Re)insurers should reassess whether their reserves are sufficient, given their exposure. The impact on each firm depends significantly on the risk profile of the business, including types of insurance product underwritten, reinsurance arrangements and level of free reserves. The risk profile may differ between the short and medium terms.
  • Inevitably, Covid-19 provides a degree of uncertainty in the level of reserves held. To illustrate this uncertainty, scenario analyses should be carried out to assess the assumptions and findings from an exposure-based review.
  • Insurers should expect Covid-19 to lead to a surge in claim numbers for some lines of business; e.g. travel insurance, business interruption and trade credit. Claims paid will depend on each policy’s terms and conditions, with many not resulting in any payouts. However, insurers should be careful when handling these claims, especially where policyholders have an expectation that claims will be paid, to avoid potential reputational damage.
  • Generally, there is a higher likelihood of an increase in return premiums where these clauses exist; e.g. if ships are not allowed to sail due to ‘lockdown’ measures. This would need to be accounted for in the reserves.

Specific considerations for some main lines of business

The summary below covers some of the specific considerations for some of the main lines of business affected by Covid-19. Our focus is primarily on the short term, the outcome for which is uncertain. 

How Covid-19 may impact reserves in...

We expect many firms may need to increase their reserves for travel insurance in the short term.

The travel industry is severely affected by coronavirus, with flight and hotel cancellations across the globe. Insurers will have to pay claims where cancellations were in line with terms and conditions. However, we have seen that many insurers have avoided claims through a strict interpretation of their terms and conditions; e.g. abandoning travel to countries where the government hasn’t advised against travelling to those countries. Note that policyholders can try and recover their money under contract frustration which would avoid making an insurance claim.

The decline of travel activity in the coming months may bring some reprieve to travel insurers as the frequency of claims begins to dip, due to new coronavirus exclusions placed on new policies or through amendments to existing annual policies. However, it is noted that there will be a significant fall in exposure (and revenue) for insurers in this market.

Reserves for credit insurance will likely need increasing, depending on the underlying exposure.

We have seen many firms reporting financial difficulties, citing coronavirus as either the main cause or a contributor. The UK government has promised financial help for many firms and individuals. However, the extent to which this support will be sufficient and whether it is received at the right time is yet to be seen, with a number of high street chains in the UK already going into administration. We expect short-term credit insurance claims to increase as liquidity issues arise from the lack of transactions. 

Suretyship insurance could also see an impact as firms may technically default (e.g. delay payments) on their obligations to try and preserve cashflow.

In the financial crises of 2008 and 2009, trade credit and suretyship loss ratios saw a spike to regions of 85% and 87%, with an average of 52% between 2006 and 2018*.

The extent to which commercial property reserves are sufficient will depend on the underlying policies.

There could be a short-term reduction in the frequency of commercial property losses due to reduced property usage (for ‘non-essential’ businesses) in the short term. However, this will not affect perils due to nature and is probably more likely to exacerbate perils due to vacancy like fire and theft. Furthermore, there may be an increase in the number of repair claims; e.g. machinery in need of repair following weeks (or months) of not being used. In addition, reporting delays are possible due to commercial properties being left vacant where a ‘lockdown’ is in effect.

Currently, we do not expect many firms to need to increase their business interruption reserves. However, growing pressure on insurers to cover business interruption losses could see a change in this position.

Most business interruption policies cover the consequential loss of earnings due to property damage caused by perils such as fire and flood. Such traditional policies do not typically cover losses from notifiable diseases. Businesses may choose to add this as an extension and, where these are added, policies usually specify the list of diseases covered. The cost of new diseases would be prohibitive (due to the uncertainty associated with a new disease) and it is not possible to list all new diseases as, by definition, they are unknown. 

On 5 March 2020, the UK government declared Covid-19 as a ‘notifiable disease’ and many thought this would have led to insurers covering business interruption losses. However, as Covid-19 was not known until 2019, there are limited circumstances in which its losses will be covered. In some cases policy wording triggers around denial of access to a workplace (which may be open to interpretation) or losses due to supply chain disruption might apply. Quantifying these losses may be difficult and, in some cases, may reach the policy limit.

In the US there is also growing pressure on insurers to payout for business interruption losses as a result of Covid-19, where this is not explicitly covered in the terms and conditions. This is exhibited through a growing number of lawsuits** which is having a knock-on effects for UK (re)insurers and where certain states have proposed legislation for retrospective cover***. Insurers are pushing back, citing that retroactively changing policy terms and conditions could threaten the entire financial stability of the insurance industry and significantly undermine insurers’ ability to pay other types of claims^. Whether insurers are forced to payout and whether the US government provides any funding for this is yet to be seen.

The extent to which marine and aviation reserves are sufficient will depend on the underlying policies.

Marine insurance claims typically cover losses due to physical damage. While it is unlikely a ship’s hull will be damaged as a result of coronavirus, short-term losses could be incurred. This could happen, for example, if a shipment of perishable goods is delayed because the ship is quarantined or if a discharge port is closed as a result of ‘lockdown’ measures. Furthermore, with lower economic activity there will be less demand in the short term for shipping and with many ships not in use this could lead to increased claims for repairs in the short term.  

Aviation insurance will be similarly affected with significantly less demand for commercial flights and air freight.

The extent to which liability reserves are sufficient will depend on the underlying policies.

Some liability policies could see a short-term reduction in claims; e.g. less customers in ‘non-essential’ shops will reduce the likelihood and number of public liability claims.

However, the medium-term risk associated with some policies is likely to increase. For example, there could be increased Directors & Officers insurance claims due to poor management decisions made in a time of uncertainty. There may also be increased employer liability claims where appropriate health and safety advice and equipment were not provided to employees working from home. 

There may also be secondary claims through general liability; e.g. where an insured is sued for losses incurred by the claimant because an employee was spreading Covid-19 during the course of business.

In the short term, we could see an increase in claims activity for cyber insurance.

With employees working from home on a colossal scale and an increased use of technology for work, education and entertainment while travel restrictions are in place, there is a lot more scope for cyber attacks, including data breaches. Equipment used in home working (e.g. routers) are likely to be less secure than those maintained by businesses.

The extent to which personal motor and household reserves are sufficient will depend on the underlying policies.

Some perils could see favourable experience. For example, motor policies should see a reduction in claims as more people work from home. Also, with more people staying at home, the number of theft claims on home contents insurance policies is expected to reduce in the short term.

On the other hand, policies that cover accidental damage at home could see an increase in claims in the short term. Policy wording is important here as some terms and conditions may exclude home working from cover.

We expect firms may need to increase their reserves for events insurance in the short term, where pandemics are covered.

While we do not expect many events insurance policies to cover coronavirus losses, we have seen that Wimbledon^^ is one of few events insured against coronavirus. We have also seen other events covered in certain circumstances; e.g. wedding insurance sold by some providers. However, we recognise that a large number of policies will not likely have pandemic cover.

Conclusion

Changes in claims will depend on the line of business and the exposure of the business. We expect some of the most materially affected lines to be travel insurance, trade credit insurance and events insurance. Non-property-damage business interruption losses presents a unique challenge to the insurance industry. 

We continue to monitor developments in the US with knock-on effects for UK (re)insurers, regarding retroactively amending policy terms and conditions and whether governments will reimburse such insurance payouts.

In assessing whether reserves are sufficient, (re)insurers will also need to consider policy wording, as it is not always clear how general (re)insurer’s reserves will change due to the possible opposing effects of Covid-19 within the same line of business. 

It is vital that actuaries seek to quantify the uncertainty in their reserves and that this uncertainty is adequately communicated to the senior management of the firm.

With regard to reserving, we may be able to help you estimate the potential impacts of coronavirus on your reserves or provide temporary expertise as you think through the issues. We may, of course, be able to assist in other ways as well.

For more information about any of the topics discussed, please contact your usual Barnett Waddingham consultant or get in touch.

Nasir Shah is a partner at Barnett Waddingham, supporting a range of general (re)insurance companies across a wide variety of areas.

Avinash Nandlal is a consulting actuary within Barnett Waddingham's Insurance Consulting team, providing advice and support to general insurance clients.

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