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Sep 2020

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Reinsurance in the time of COVID-19

Source: Asia Insurance Review | Aug 2020

The coronavirus pandemic has upended human life and economic activity as we know it. At the time of writing, 9.4m COVID-19 cases have been reported globally and unfortunately, almost half a million people have lost their lives to this new virus. The accompanying economic losses are already immense, and while the pandemic is ongoing, there will be much uncertainty over the eventual numbers of cases and deaths. Guy Carpenter’s Tony Gallagher shares some insights.
 
 
Industries and supply chains have been adversely impacted by the lockdowns in many jurisdictions, and the ramifications can be felt across the globe. The Asian Development Bank (ADB) estimates the global economy could suffer losses of up to $8.8tn — or almost 10% of global gross domestic product — as a result of the pandemic. Additionally, as many as 242m people worldwide could lose their jobs with their overall income being reduced by $1.2tn.
 
Insurance plays an important role in helping businesses and individuals recover and overcome crises caused by disaster events. But in the current pandemic the industry’s share of total economic losses is likely to be marginal compared to the magnitude of the event. Due to the systemic nature of pandemic risk it is unlikely that the situation will be different in future pandemic events — unless new forms of public-private partnerships are built that allow societies to be better prepared for similar shocks in the future. While different in magnitude and scale, the currently unfolding COVID-19 event is similar to the SARS outbreak in 2002, in which pandemic coverage was generally excluded. 
 
Collaboration is imperative to mitigate the scale of the financial challenge that confronts the world, clearly suggesting that various stakeholders from the private insurance industry, governments, international think tanks, and others need to come together and pool their capabilities and resources to alleviate the economic pain societies endure when risks such as pandemics materialise. We need to bridge the gap between insured loss and economic loss.
 
Pandemic funding and risk pools
Risks become amplified without proper levels of insurance coverage, often leading to the perpetuation of economic downturns. Insurance companies do not have the resources to provide pandemic coverage, leaving businesses vulnerable to what are termed ‘acts of God.’ The crises that result require a multi-stakeholder approach. A suitable solution could be the creation of a ‘pandemic pool’ similar in function to existing terrorism pools. 
 
The foundation of the initiative should be spearheaded by the respective national government and designed in cooperation with the local insurance industry and international capacity providers. The pool could be administered by the insurance industry, but given the size of the risk in relation to available market capacity, a government back-stop is key along with additional capacity support from the international reinsurance and capital markets. Government participation is vital as it helps in distributing the risk component and in creating a safety net for insureds to provide pandemic coverage. Most importantly, the pool allows for the quantification of risk from a reinsurance standpoint, which means reinsurers can support coverage in a limited nature as the amount reinsured is capped at the total size of the pool. 
 
In the event of a pandemic, the pool funds – premium collected and the funds guaranteed by the government – can be used to alleviate business losses and to stimulate a slowing economy. During normal times, the funds can be invested with the aim of generating returns from other potential growth opportunities. Such a dedicated pool can also help governments plan for pandemic emergencies by helping build an effective safety net when most needed.
 
In this manner, a pandemic pool allows for the provision of affordable insurance cover on what are generally considered to be uninsurable risks. At the same time, a pandemic pool can reduce, to some extent, the fiscal burden on governments that may already be fiscally constrained, in addition to having to invest in healthcare infrastructure and other services. In the absence of future events, over time, the goal would be to achieve a self-funded vehicle; for example through a levy on insurance policies.
 
The effective use of such an approach can be seen in the current discussions about a future pandemic reinsurance solution for the United Kingdom. The country already has a state-backed reinsurance company, Pool Re, which provides terrorism coverage to UK businesses. One option is for insurers to be encouraged to provide a pandemic coverage supported by a state-backed pool. The reinsurance premium collected would be used to fund the pandemic pool and pay for the government’s unlimited guarantee.
 
In such a scenario, governments will need to have the mandate and a fiscal guarantee to kick-start the pooling process. The insurance companies would collect premiums and manage claims payouts. Once the pool has grown to a substantial amount, the funds are reinsured to distribute the risk further. Partnering with a reinsurance company helps the government to maintain a healthy balance sheet and also assists reinsurance companies in providing business continuity during turbulent times. 
 
Impact of the downturn on the reinsurance industry
Government-mandated lockdowns and shutdowns and the resulting global economic slowdown are impacting the insurance industry’s capital and earnings position. During catastrophe events, the liability side of the balance sheet gets impacted by losses. For COVID-19, the impact is on both the asset and liability sides of a balance sheet. We have seen investment returns drop. Profitability is now dependent on the underwriting side of the balance sheet, which is also adversely impacted. In many ways, it can be a double hit for reinsurers. Notwithstanding, the industry is still strong, albeit with higher combined ratios and lower investment returns. 
 
We are of the view that we will see a surge in insurance claims due to COVID-19, both short tail as well as long tail losses. Following SARS, many of the policies in Asia excluded pandemics, which reduced losses to the industry. Globally, discussions on COVID coverage are continuing. 
 
An uncertain time
Given uncertainty in the market, the ability of some insurers to continue taking risks will be tested. Many insurance companies will cease underwriting new businesses and restrict other coverage due to ecosystem inabilities and future market uncertainties. 
 
Meanwhile, small businesses will need to make the difficult choice of either continuing to pay premiums on their existing coverage, or restricting or discontinuing the purchase due to affordability issues. Larger companies, on the other hand, will continue to buy insurance because the purchases are integral to the proper risk management of their businesses.
 
Crises such as the current one warrant the purchase of more insurance, but because premium rates are high, companies may look to reduce their insurance cover. This problem, too, can be mitigated if all stakeholders come together to find solutions. Pandemic pools led by national governments, and administered and supported by the insurance and reinsurance industries, will help societies and economies better manage risk, keeping the wheels of the economy turning and saving jobs.
 
Indeed, new forms of public-private partnerships are imperative, not only in dealing with the financial consequences of pandemic risk, but also in better managing increasingly complex risk landscapes through risk identification, reduction/mitigation, risk funding and transfer. A 
 
Mr Tony Gallagher is CEO Asia Pacific region of Guy Carpenter.
 
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