Actuary Ofer Brandt explains the possible implications of the Corona epidemic on the insurance companies and how intelligent risk management can assist in coping with it
The World Health Organization last week declared the Corona virus to be a pandemic. German Chancellor Angela Merkel estimated that there is a good chance of 60%-70% of Germans being infected by the virus. This is based amongst other things on mathematical models showing that for every known case of infection there are four additional cases that have not been reported.
Such a rapid outbreak and spread of a virus last happened worldwide in 1918, during World War 1. This is known as the influenza epidemic, also known as Spanish influenza epidemic, which left 50 million dead. We are of course nowadays in an entirely different situation with regard to health system deployment, technology and the capabilities at our disposal for dealing with such an epidemic. It is estimated that at the time, the insurance companies paid, in present day terms, around 20 billion dollars in claims.
Whether or not the German Chancellor’s forecast is realized, in Germany or elsewhere, the insurance companies are expected at this time to be needing to cope with the movement of the figures on two fronts – on the one hand big claims and on the other hand the financial implications – that is low interest and low yields.
What types of claims could the insurance companies need to cope with?
Each of the insurance companies has its own business mix and thus the impact of each of the businesses depends on its share of the insurance company’s portfolio as a whole.
- Credit insurance – According to the Moody’s rating agency, the world’s three largest credit insurance companies, Atradius, Coface and Euler Hermes, could be hurt by multiple claims in view of the expected world recession and bankruptcies in various industrial sectors. Atradius expects 2.4% increase in 2020 in the number of companies worldwide running into financial difficulties.
There are three credit insurance companies in Israel that could be facing claims due to the slowing in business activity; Clal Credit, owned jointly by Clal Insurance and Atradius, ICIC, owned jointly by Harel and Euler Hermes, and Coface Israel – an international credit insurance company which has been active in Israel in recent years.
The credit insurance companies need to evaluate their exposure to industries in the economy in the various industrial sectors and give it expression accordingly in the actuarial provisions in their financial reports. In addition, prudent risk management requires a re-evaluation of the insured sums at which the insurance companies will be prepared to insure the various businesses. This would worsen the financial position of the insured companies and impact negatively on economic activity in the economy as a whole.
The tougher the measures taken by the Israeli government in extending the isolation of the population, in an effort to limit the spread of the virus, so will negative impact on businesses and recession grow, exposing the insurance companies to a growing number of claims. The situation is at the present time unclear and will take time to become apparent.
- Business insurance – The insurance companies insure a large number of small, medium and large businesses against loss of profits caused by the risks defined in the business policies, including fire, burglary, theft and so on. The policies do not damages deriving from diseases and epidemics. Thus, it is unlikely that the financial difficulties and loss of profits affecting businesses as a result of Corona will form the basis of claims payments by insurance companies. At the same time, in times of continuing economic difficulties, two phenomena could be expected to occur, which need to be given due attention. The first one is difficulties in the payment of premiums by the insured businesses, which could result in cessation of the insurance coverage, with an accompanying drop in premium revenues of the insurance companies. The second phenomenon is an increase in crime rates, such as burglaries and arson, resulting in damages that are covered under the policies and the payment of claims. Crime can come from a number of directions, and this being the case, the insurance companies will need to examine carefully the claims being filed, including the possibility of “insurance fraud”, which could extend claims handling times.
- Foreign travel insurance – The insurance companies were quick to adjust the terms of the insurance coverage in the policies being marketed, so as to reduce exposure to trip cancellation or interruption of vacations, thereby coping with claims in this direction. Due to the cessation of flights to and from Israel, the insurance companies can be expected to report a significant drop in premium revenues.
- Motor insurances – Motor insurances cover insureds, amongst other things, against property damage and bodily injury resulting from road accidents. As economic activity contracts more and more, the daily use of vehicles also decreases. The reason for this is the move by increasing numbers of workers to working from home, as well as the closure of leisure and entertainment facilities with people spending more time after work at home. Thus, a decrease in accident claims payments can be expected.
- Work disability insurance – Insureds, within the framework of pension plans, are insured against work disability, whether under managers insurances or under pension funds, in the event of being unable to work as result of accident or illness. Insofar as a Corona virus infection not being expected to result in extended illness making it impossible to work, there is on the other hand a known behavioral phenomenon related to economic recession. This situation could have a direct impact on the scale of claims: a deepening recession and an increase in the number of unemployed leads to an increasing tendency of work disability claims, justified or otherwise. This being the case, the insurance companies and pension funds will need to closely monitor the development of the claims and examine whether they are indeed justified. In general, it can be expected that as the recession deepens, so the insurance will be paying more claims than in the past.
- Life insurance – All of the insurance companies have very large life insurance portfolios that have been sold over the years. If the pessimistic forecasts are realized and the number of deaths increases significantly amongst the populations insured by the insurance companies, they will find themselves paying high insured sums, at least until a vaccine is found for the virus. This does not at the present time seem to be the situation, as far as is known to date, with deaths from Corona relating to older ages, from age 60 on. This is whilst the vast majority of insured populations under life insurance policies are far younger. Despite this, the insurance companies will need to closely track the developments in death claims. One of the ways that insurance companies protect the retained risk in cases such as these is via the purchase of reinsurance for catastrophes in respect of deaths from epidemics. Insurers who took out protection of this type will be paying fewer claims compared with those that did not do so.
It will be recalled that a year ago, the Capital Market Authority forced the insurance companies to reduce their life insurance premiums. This demand came on the backdrop of a claim that the insurance companies had not reduced the premiums to the extent expected of them, in light of lengthening life expectancies of the population as a whole and particularly the insureds, which reduced the claims payments.
The Corona virus represents a case of “black swan” which was not expected or foreseen, which reminds us once again that past experience is not necessarily a good predictor of the future. Thus prudence needs to be employed in the pricing of long term insurance policies, entailing obligations of many years in the future, in view of great uncertainty.
- Old age and long term care pensions – According to the existing, limited information, cases of death that have been reported so far were mainly amongst the aged populations and those with medical weaknesses. Here, likewise, if the pessimistic forecasts are realized, the insurance companies and pension funds will being paying old age pensions for a shorter period than expected and will thus be able to report higher than expected earnings. This is also true of the populations to whom long term care allowances are paid. Migdal has the biggest life insurance portfolio and it is thus most exposed to changes in life insurance or old age pension claims. After it, in descending order of exposure, are Clal Insurance, Harel and the Phoenix. Harel has the largest long term care insurance portfolio, which could improve the situation for it.
What are the financial implications for the insurance companies?
- Low yields on the profit participating policies (managers insurances) – this being especially the case with Migdal, which has the biggest profit participating portfolio, Clal Insurance with the second largest, followed by Harel, the Phoenix and Menorah Mivtachim, in descending order. In the participating portfolio, the companies collect management fees that are a function of the investment yields. Losses in the markets in recent months have brought the management fees collected down to zero (creating a future management fees debt), which is a principal and important source of revenues for the companies.
- Low yields in the guaranteed yield policies – under these policies, which were sold until 1990, the insurance companies guarantee a minimum yield to the insureds. The majority of the guarantee, approximately 70% of the portfolio, is attained by the companies via designated government bonds, but the rest of the guaranteed yield needs to be attained by them on the capital markets. The companies at this time are unable to attain the minimum yield, resulting in them incurring a financial loss.
- Risk-free interest curve for government bonds – The risk-free interest curve serves as the basis for calculating the estimate of the size of actuarial provisions in the financial reports of the insurance companies and the pension funds. This is in addition to the setting of the obligations according to fair value in calculating the companies’ capital requirement in accordance with Solvency 2. Since the end of 2019, the risk-free interest curve has continued falling, and to an even greater extent in the recent period, on the back of the Corona outbreak. The falling interest rates mean higher actuarial provisions. This is particularly relevant for long term life and long term care insurance policies. In this situation, it is to be expected that the companies will need to increase their provisions in their first quarter financial reports, and they can be thus expected to report losses and an additional reduction in the available capital within the framework of Solvency 2.
It is to be noted that last week the Capital Market Commissioner, Dr Moshe Bareket, permitted a certain easing in the way that the risk-free interest is used, which should reduce the level of the expected losses deriving from the low interest, but not to entirely negate them.
Prudent risk management needed going forward
Summing up, great uncertainty exists regarding cases of death deriving from the spread of the Corona virus, both with regard to the implications of the recession and the contraction of economic activity on the level of claims being paid by the insurance companies. Whilst the various types of claims will develop so as to enable a re-evaluation of the current working assumptions in the actuarial models, in connection with the financial impacts – that is, low asset yields and interest rates – these are given immediate expression and in big numbers in the financial statements.
At the same time, the insurance companies will be forced to take certain measures, including: increasing attention in the handling of claims and insureds’ inquiries in this period, a close monitoring of developments, consideration of a re-evaluation of working assumptions in the pricing of products and the calculation of actuarial provisions, and an examination of operating expenses vis-à-vis the falling revenues.
The markets have already given expression to these concerns, with the insurance company share prices dropping by tens of percent. The only thing that is left to do is to await further developments and re-evaluate the situation.
The writer is an actuary and a member of the Israel Actuaries Association and the Actuaries Institute in Britain, former Deputy CEO and Chief Actuary at Clal Insurance and currently as a consultant to insurance companies and startups in the insurtech sector and serves as Chairman of the Training Committee of the Israel