By now, previous year’s annual financial statements have been approved and signed off, and most short-term insurers will have a clearer view of the uncertainties they initially anticipated when the Covid-19 pandemic started.
Some of the larger players in the market will have highlighted concerns over both the resilience in their operations and their financial performance through the pandemic. Today, consensus appears to be that there are vast opportunities for premium growth, investment in environmental, social and governance (ESG) factors, innovation and digitalisation as the global economy recovers post-pandemic.
This positive outlook aside, we must remain aware of the emerging systemic risks in areas like climate change and increased cyber exposure. Based on our market observations, here are some of the considerations that you should be thinking about presently.
The impact of volatility on the income statement
The motor class of business benefited from government-imposed lockdowns which resulted in premium discounts. Insurers experienced a lower claims frequency as their insureds spent less time on the roads. In addition, the premium holidays enabled insureds to retain their cover despite tough economic conditions. On the negative side, the industry has experienced lower new business volumes and higher lapse rates which has put pressure on premium volumes.
Business interruption (BI) and income protection claims have severely impacted on insurer and reinsurer income statements. As a reinsurer, Munich Re has played a critical role in ensuring that we share our expertise with our clients to limit their exposure to unexpected and unpriced risks. Exclusions such as the physical damage provision within our cedants’ wordings is one example of this. We have, in addition, hosted various workshops regarding the impact of Covid-19 on short-term insurance policy wordings.
The pandemic is not the only elephant in the room. Extreme weather events such as the disastrous April 2022 KwaZulu-Natal floods are becoming more frequent in the context of climate change. These floods have not only led to severe property damage but sadly resulted in many lives being lost. Our role is to assist our cedants with risk mitigation, with exposure to weather-related catastrophe being a key focus area. Beyond traditional reinsurance, we are also engaging with our cedants to explore event-driven solutions such as loss portfolio transfers, parametric solutions and insurance-linked securities.
Balance sheet resilience
Short-term insurers’ balance sheets have, to a large extent, remained resilient through the pandemic. The most significant impact has however, been the increase in liabilities due to Covid-19 related reserving.
Commercial players were faced with uncertainty regarding the validity of BI claims as well as the ultimate settlement amount for such claims. We saw increased settlement delays due to time-consuming court challenges as well as a shortage of claims assessors to assist with complex claim types. The uncertainties underlying pandemic-related reserving have somewhat stabilised and we expect to see some of insurers’ reserves being released in coming reporting periods.
On the asset side, the financial industry is faced with volatile equity markets, low-interest rates, exposure to currency, and credit risk. Many insurers are now looking for alternative solutions to optimise their balance sheets for today’s volatile market movements. These assets are largely protected from this volatility through hedging and asset liability management. From a management of liabilities point of view, reinsurance can offer cedants a combination of prospective as well as retrospective structured solutions, depending on the cedant’s needs.
Interrogating the SAM one-in-200-years’ event
Resilience post-Covid-19 has raised many questions regarding the appropriateness of the standard solvency assessment and management formula. According to Prudential Standard GOI 3.1, insurers are required to conduct an own risk and solvency assessment (ORSA) annually or whenever the insurer’s risk profile changes materially.
Each cedant will therefore have to assess whether there have been changes in their risk profiles consequent the 2020/2021 Covid-19 pandemic, exposure to the looting that affected parts of Gauteng and KwaZulu-Natal in July 2021 or the recent KwaZulu-Natal floods, for example. Changes following an environmental, social and governance (ESG) implementation into an organisation’s strategy would also necessitate a review.
The ORSA assists management in monitoring regulatory capital, refining business planning and strategy, defining capital needs and having a full view of its risk profile, risk tolerance limits and impacts on business strategy. Insurers should also consider the operational risk of working from home and increased reliance on IT system against the backdrop of cybercrime (hacking of vulnerable systems) and the potential loss of value in assets which impacts the solvency capital requirements (SCR) modules.
Short-term insurers have shown resilience during the Covid-19 pandemic. The industry SCR coverage ratio decreased due to the exposure to volatile market movements, increases in reserves and lapses together with operational risks. However, we need to note that Covid-19 is not a scenario that qualifies as a ‘shock’ within the standard formula. In fact, the secondary effects of the pandemic such as volatile equity markets, low-interest rates, exposure to currency, and credit risk do not exhibit a return period that is remotely close to a one-in-200-years event.
This creates opportunities for insurer’s to truly maximise and optimise their capital. Traditional reinsurance reduces your liabilities, hence offers a reduction in the solvency capital required. To truly release some of the funds trapped in the SCR, Munich Re’s structured reinsurance solutions offer loss portfolio transfer and adverse development covers for insurers that no longer have an appetite for the runoff exposures of a specific line of business.
Our aggregate excess-of-loss treaties enable cedants to limit exposure to increasing catastrophe claims due to deteriorating climate conditions. We also have solvency-based trigger solutions for high-growth clients where the cover is triggered once the SCR coverage ratio is below a certain level. These structured solutions are specific to an insurer’s needs and tailor-made on a case-by-case basis.
Our aim is to support each insurer in remaining solvent and maintaining its SCR coverage ratios within its risk appetite. This will enable our cedants to expand their insurance operations within the economic growth cycle and improve their return on equity (ROE) without additional capital injections.
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