COVID-19 is straining solvency ratios and higher-risk asset strategies, while the prospects for regulatory relief are unclear.
While much uncertainty remains about the financial impact of COVID-19 on the insurance industry, one thing is clear: there will be significant strain on capital, liquidity and investment strategies.
Solvency ratios and holding company liquidity will come under pressure as asset values fall and capital requirements are stressed. Insurers that have adopted higher-risk asset strategies (particularly those featuring illiquid asset holdings) will need to review their investments and manage their risks through the credit cycle as defaults and downgrades come through. Cash flow strains are likely as premium volumes fall and some claims payments are accelerated. Insurers are also expected to contribute to society in ways that have yet to be defined. From a financial perspective, COVID-19 seems like a perfect storm for insurers.
Firms are taking steps to optimize hedging and protect capital. For instance, proactively engaging regulators may help ease capital pressures amid concerns of procyclicality. At the same time, the intense financial challenges must be balanced with the need to serve customers, support employees, and contribute to the economic recovery. In exploring their options for relief and assistance from governments and regulators, insurers can also demonstrate their commitment to reviving the economy and being there for their customers.
This article focuses on the largest and most likely impacts and what insurers can do to navigate them. It also includes recommended actions in several key areas so insurers can push through the immediate-term volatility and chart a strategic path forward to a stable and prosperous future.
A significant and immediate impact on solvency positions
The hits to solvency positions will be significant and immediate for all types of insurers. Lower interest rates, wider spreads and lower equity values are the main threats. While disclosed solvency positions show material buffers above minimum thresholds, some – and perhaps most – carriers will need to take action to maintain solvency. Those actions may include dividend reductions and cancellations.
Regulators will be closely monitoring the positions of individual insurers. They will be keen to avoid procyclical behavior. Whatever form it takes, regulatory relief is likely to come at a cost to shareholder dividends and executive bonuses. That much is clear from the experiences of other industries seeking financial support from government authorities.
In response, insurers will need daily monitoring and reporting of their capital and liquidity positions. Strategic plans and scenarios will need revisions – extensive ones in some cases. For instance, scenario plans will need updating to reflect current circumstances and to trigger capital preservation actions. Various capital optimization and hedging activities can be used to preserve capital. Insurers should look to use all of their tools as they consider how to protect their solvency.
Emerging liquidity pressures from a number of sources
Insurers must mitigate multiple sources of pressure – including premium holidays and margin calls – as they deal with operational cash flow strains. There is also a clear societal expectation that insurers, like other types of companies, should contribute to the broader economic recovery. That’s an expectation that can’t be overlooked. Rather, it can be viewed in terms of long-term brand positioning and the need for the industry to more forcefully articulate its social purpose and value.
All insurers are likely to see a steep drop in new business premiums. Life insurers may also see an increase in withdrawals from savings products. Early redemptions will strain asset liability matching and may force insurers to sell assets below par.
In the face of these pressures, it’s necessary to consider the scope and extent of changes in client and customer behavior and how they will impact liquidity. Proactive communication with regulators, rating agencies and other key stakeholders will also be critical to mitigating the financial damage.
Earnings pressure and evolving credit risk as actions play out
The industry faces shrinking revenue. Life policyholder investments sit at lower levels, with guarantees further in the money, and non-life insurers will see reduced premium volumes. Some commercial segments (e.g., aviation and marine) will be hit harder than others, but all will absorb some damage.
The pandemic will also change product preferences. Certain products will become less attractive, providing a drag on future earnings and capital generation and necessitating new investment in innovation and product development.
Governments are taking unprecedented actions to protect the wider economy, but there are likely to be more credit rating downgrades, and ultimately, defaults. Interest rates are expected to be lower for some time to come. Life insurers with illiquid assets will face particular pressure as investors look through to mark-to-market impacts on the balance sheet.
Collectively, these factors give insurance executives a lot to think about. The review of liquid and illiquid asset exposure can help them identify potential default triggers and covenant risk. They should also prepare for further earnings pressure as revenue shrinks and claims costs are increased for some lines.
Recommended actions for capital, liquidity and investments
Even as insurers deal with the immediate fallout from COVID-19, they can’t lose sight of their longer-term goals or pause the important strategic initiatives that have been underway for some time. Indeed, the crisis has only intensified the need for change across the business and in both front and back offices.
In defining the best course of action, insurance executives should think across several time horizons and acknowledge that decisions made today can help accelerate longer-term change programs. Thus, the following recommended actions are keyed to now (the immediate term), next (the coming months) and beyond (for the longer term).
