Underwriters hoping for sustained pricing momentum in 2020 face conflicting dynamics as the fallout from Covid-19 hits clients’ exposure bases and budgets at the same time as mounting pressure on both sides of insurer balance sheets makes the push for rate even more of an imperative.
As carriers assess lines of business exposed to coronavirus losses, the broad consensus is that the claims burden for the insurance industry from coronavirus is more than manageable.
Despite a big impact in relatively niche areas like event cancellation and recession sensitive lines such as trade credit and mortgage insurance, core property and casualty lines look to be relatively unscathed – as long as the industry can stave off political pressure to pick up uncovered or excluded economic losses.
There are sure to be exceptions, with some sources pointing to D&O as an area of major concern, reflecting the dramatic market cap losses experienced by many corporations during the crisis.
But rather than the direct impact of coronavirus as a driver of claims, the broader industry’s attention is on the financial markets crisis and looming threat of a recession and what impact that has on the dynamics of demand and supply for insurers and their clients.
“This is not so much about the pandemic but the financial crisis that’s ensuing: the drop in yield, volatility in the credit market and what happens to the global economy,” a top reinsurance executive told The Insurer.
And a senior US insurance executive added: “Most of the industry is looking at it from the standpoint of exposure bases dropping being the really big issue as opposed to this being a coverage thing.”
Exposure base down
The effective shutdown of a wide range of businesses and industry segments across large areas of the developed world – including swathes of corporate America virtually grinding to a halt – will be reflected in a sharp economic downtown.
P&C industry growth is largely tied to GDP, with the exposure base clients are looking to insure the main driver of premium volume for insurers.
That will inevitably plunge, at least in the short term, with many upcoming renewals already contemplating extensions or cancelation of policies as a multitude of businesses dramatically cut activity or lay dormant.
Many of those that do fully renew will do so with a big adjustment for lower exposure bases.
A wide array of sectors will be significantly impacted, from hospitality to aviation, and marine to construction as whole industries are caught up in the economic freeze.
The devastating impact particularly on small businesses means that many buyers in that segment will not be around when it comes to their renewal.
Loss trends have not reversed
“It means a lot of premium is going to evaporate. So carriers will write less business, because it’s not there to write. But the losses are still coming through. All this is going to put further strain on the profitability of the insurance market,” said a senior underwriting source.
In areas like casualty that have seen significant deterioration in prior-year underwriting reserves in the last month, the challenge of underlying exposures and premium volumes shrinking is likely to be acute for insurers.
Although accident year loss trends may be positively impacted in some lines such as commercial auto where the economic slowdown would be expected to directly impact claims frequency, recently deteriorating prior-year loss trends are not suddenly going to go into reverse.
With reserves running thin, carriers are counting on the harder pricing of the last year or so earning through to premium to keep ahead of loss trends.
A cut in the exposure base and knock on impact of lower premium volume if pricing does not adjust means that underwriters will need to continue trying to pull the lever on rates to stop underwriting margins from narrowing further.
At the same time, the financial markets turmoil means that the industry’s capital base is on course to end the first quarter significantly lower than it started it.
Insurer book value hit
Analyst estimates vary, but in a note last night, JMP Securities’ Matt Carletti said he currently calculates that mark-to-market headwinds will have depleted book value for the sector by around 13 percent as spreads have increased and equity markets fallen – even factoring in yesterday’s record rally on Wall Street.
“No default risk…and then insurers’ prime focus will be on the numerator not the denominator: namely, maintaining adequate rate and volume”
Industry capital is a good proxy for supply, albeit that in the absence of major capital depletion, the harder underwriting market that began to accelerate this time last year was driven by the appetite of carriers to deploy capacity in areas where they were feeling pain.
So supply of capacity was already reduced in many segments of US commercial insurance before book values were hit in recent weeks by the coronavirus sell off.
Volatility in the market means this could all turn around pretty quickly. Indeed, over the past 48 hours there is a growing optimism that the actions of central banks and the Federal Reserve will – in effect – have the result of acting as a backstop on the majority of (re)insurers’ vast credit portfolios.
As holders of assets until maturity, insurers are concerned about default risk. No default risk (because of government actions on corporate debt) and then insurers’ prime focus will be on the numerator not the denominator: namely, maintaining adequate rate and volume (all the more necessary in our soon-to-be negative yield environment).
Reinsurance and retro factors
But there is also the potential impact of higher reinsurance costs which in turn include the impact of higher retro costs for those reinsurers who use it heavily.
The balance sheet impact for primary insurers will be echoed up the chain to reinsurers.
“When you have diminished balance sheets and investment returns then logic says that the capital you’re going to put at risk you’re going to want a higher return for,” said a senior reinsurance broking executive.
It has also been suggested that there could be further tightening of non-traditional reinsurance and retro capacity.
There is already anecdotal evidence of isolated examples of redemptions as some ILS fund investors look to reallocate capital to other opportunities as asset prices drop amid the market volatility.
“Industry capital is a good proxy for supply”
Another upwards pressure on pricing could come as underwriters at insurers and reinsurers look to apply a “coronavirus load” across multiple lines of business, to reflect the evolution in understanding of exposures from the event.
All of those factors point to a pricing imperative for insurers that has arguably intensified as a result of what has happened in the last few weeks.
Falling demand and the ability to pay
But underwriters and brokers are facing a client base whose businesses are now facing a whole different set of challenges – some of them existential – as they come to renew coverage.
The industry’s immediate response has been wherever possible to provide flexible solutions at renewal as their clients try and assess what the crisis means for their immediate prospects and insurance needs.
That includes policy extensions, endorsements, grace periods and other temporary measures.
The reality is that many renewals, when they come, will see dramatic reductions in exposures, at least in the short-term, as the economic freeze hits corporate America and other areas of the developed world.
“It’s going to be a tough pill to swallow,” said a senior insurance broking executive.
“We are seeing clients buy less insurance. It’s not good. That means the fundamentals for insurers… not only did they not change for the better but they actually changed for the worse.”
Insurers are hopeful of avoiding any legislative attempts to force them to waive exclusions on business interruption, for example. But the knock-on effect of Covid-19 on the economy means that exposure bases applied to BI cover will shrink, potentially even leading to premium claw-back on in-force policies.
A recession would also be expected to hit areas like personal and commercial auto – which could be a short-term claims boon, but also detrimental to longer-term growth prospects, and the need to continue increasing premium volume to keep up with prior-year loss trends.
In a note on the impact of coronavirus, JMP Securities’ Carletti added that workers comp will likely be impacted negatively both in the short and long term.
In the short-term wages – the exposure unit for premiums – will contract in some areas of the economy such as hospitality, creating a premium headwind for carriers exposed to those areas.
“Longer term, depending on the depth and length of the recession, other areas of the economy will likely also come under stress and see slower growth or declines in work activity.
“This broader decline in wages/premiums has the potential to increase competition across the sector as companies vie for a shrinking pool of premium dollars, particularly in one of the only lines of business that has continued to show favorable loss cost trends,” he observed.
The impact of shrinking demand on market dynamics could be more widespread, as areas with more plentiful capacity become more competitive again.
“There is already anecdotal evidence of isolated examples of [ILS] redemptions”
The crisis affecting businesses is also likely to have a negative impact on budget, at a time when insurers would have otherwise been gearing up to RIMS with hopes of getting more spend from clients – in the absence of Covid-19.
Instead it is likely that in some instances buyers will be forced to consider alternatives to insurance, whether through the greater use of captives or simply retaining more risk on their own balance sheets.
Despite the shifting dynamics, senior carrier sources spoken to by this publication remain confident that the outcome will see underwriters achieving rate increases even as exposures fall.
“We think premiums will not go down completely commensurate with exposure reductions, so you’ll still see rate increases and a recognition of the exposures going down. We’ll continue to capture rate on lower exposure bases,” said the CEO of a US insurer.
Insurance market fully open for business
Broking and underwriting source have said that despite an expectation of major disruption as carriers, intermediaries and clients transition to new work practices in the Covid-19 shutdown, business activity has been surprisingly stable.
One senior broking executive described it as being “as close to business as usual as you can say, knowing that business as usual was already pretty tough as recently as a few weeks ago”.
“The insurance market is working and renewals are getting done. It hasn’t seized up in any material way. Some things are taking longer but other things are getting done quicker – decision makers at carriers are amazingly available!” they continued.
The executive said there had not been any discernable change in rates compared to just before the Covid-19 crisis took hold.
An E&S carrier executive said that his company had been tracking submission activity and for the most part casualty is registering about the same activity as it did at this time last year.
“Property is ahead of where it was, and the same with healthcare,” the executive said.
He said it was a social responsibility for insurers to continue underwriting business in the crisis, even where there might be concerns over certain classes where there are grey areas over communicable disease coverage.
“If you’re worried then shorten your limits. Society is literally counting on us to continue underwriting business, and to keep our doors open.”