The insurance profession is facing challenges from all sides as it weathers the Covid-19 crisis, as Liz Booth reports
When Covid-19 first struck, it seemed insurers might escape the worst of the battering facing businesses globally. However, it now seems that in fact the sector is facing a triple whammy.
Recently, professional services firm EY warned that, of the 31 profit warnings from financial firms in the UK in the first four months of this year, the non-life insurance sub-sectors issued the second highest number of warnings (six).
Tom Groom, UK head of financial services transaction advisory services at EY, explains: "Covid-19 has resulted in health and economic challenges like none we have witnessed before. The impact on households and businesses up and down the country is already profound and may have long-term ramifications for some. No sector has been immune and we are seeing financial services firms issue profit warnings at a rate well above historic precedent.
"By and large, financial services firms entered this period in a position of capital strength, having significantly built up reserves since the last crisis. This is helping the industry weather the storm and maintain a strong base of financial stability. However, the signs of stress on some of the UK's largest firms cannot be ignored. Financial services firms will continue to monitor the level of warnings coming from the sectors that they lend to, invest in and insure, because what is very clear is that even the most diversified portfolios will be impacted."
THE TRIPLE WHAMMY
Firstly, claims. Back in April, the Association of British Insurers (ABI) said members were paying out more than £1.2bn in claims to support businesses and individuals affected by Covid-19. This covers payments on business interruption (BI), travel insurance, weddings policies and cancelled school trips. Beyond that, the thorny issue of further BI claims remains in the courts.
No sector has been immune and we are seeing financial services firms issue profit warnings at a rate well above historic precedent
And then there was investment income. Originally there was hope of a v-shaped downturn and recovery -- now the experts are not so confident of a rapid bounceback. In The Impact of Covid-19 on Share Prices in the UK, authors Rachel Griffith, Peter Levell and Rebekah Stroud state: "The price index remained pretty steady in the early weeks of the crisis but saw a sharp decline in the weeks following the lockdown in northern Italy and fell to its lowest point in the week following the announcement of social distancing in the UK (down 35% from the start of January).
"As lockdowns have steadily been eased across the world and in the UK, some of this decline has been reversed, taking the overall decline in the FTSE All-Share Index over the period to 21%."
That is bad news for insurers relying on investment income to prop up any underwriting losses.
But finally, the great unanswered question is whether or not insurers will see premium income fall in the coming months. Insureds in many sectors have seen their incomes drop dramatically through lockdowns and even if they pick back up, their turnover this year will be down and, of course, many insurance policies are priced on the turnover sums to be insured.
Added to that, insureds may simply see cutting back on their insurance programme as sensible -- they have less to insure, possibly fewer employees and they need to cut costs as much as possible to ensure their survival.
Although by early July, Swiss Re was more bullish, saying: "The insurance industry is set to overcome this year's Covid-19-induced global economic recession. The sharpest economic contraction since the 1930s will lead to a slump in demand for insurance in 2020, more so for life products, with global premiums expected to contract by 6%, than for non-life covers (-0.1%). However, total premium volumes will return to pre-crisis levels in 2021."
It does add a caveat that the recovery would be sector-specific and not across the board.
Around the world, this triple knock is impacting insurers' confidence and increasing concerns that they will see a fall in income in the months ahead. The regulators are watching closely too.
In the UK, the Prudential Regulatory Authority (PRA) has been continuously updating financial service entities and in early June stressed that while not all its advice was directed at insurance firms, much of it applied equally to insurers as it did to the banks.
And it reiterates: "Firms are reminded to apply sound risk management practices regarding the identification of defaults. Consistent with paragraph 4.13 of SS7/18, the PRA expects firms to have a policy that sets out their definition of default events and processes to identify different types of default events or the severity of distress and likelihood of recovery for an individual asset.
"In the current circumstances, these processes may be used to distinguish between borrowers who are unable to make full payments due to direct Covid-19 related issues that can reasonably be expected to be temporary, and borrowers who are unable to make full payments due to financial difficulty that is likely to be more long term."
The warning is loud and clear -- the regulator does not expect anyone to use Covid-19 as an excuse for not maintaining their capital requirements.
But will insurers find their regular insureds ready and able to pay for their policies? In many emerging markets, there is serious concern that the answer to that is no. Insurers are being urged by their regulators "to think outside the box" and innovate to remain attractive enough to garner premiums. Many predict a wave of mergers as insurers themselves fight for survival.
In the UK and elsewhere across Europe, the role of government is muddying the waters too. Furloughs and loans have kept firms and staff in place -- as those rules change, the question is whether the companies will emerge with their business intact and in a position to bounce back. Or has the government intervention been merely delaying the inevitable?
For example, on 4 June, the UK government announced the establishment of a temporary government-backed £10bn trade credit reinsurance scheme. Since alerting the government in early April to the challenges faced by the profession and the businesses it supports across the country, the ABI has worked with members to evidence the scale of the challenge and the importance of establishing a reinsurance scheme to ensure that the profession has the confidence to continue providing the cover needed by many sectors across the economy.
Lloyds Banking Group plans to refocus its attention on insurance, due to declining banking profits affected by Covid-19, which it hopes should improve its strong position in the UK household market. This could start a trend of increasing strength for the bancassurance channel if Lloyds is seen to be successful.
- UK-listed financial services firms have issued 31 Covid-19-related profit warnings so far in 2020, representing 17% of the FTSE financial services sector.
- More financial services profit warnings have been issued since the start of 2020 than in the whole of 2019.
- Within financial services, non-bank consumer lending showing the most signs of distress.
Aviva's reaction has been just one example of what is happening more broadly. In April it took the decision not to pay its directors' 2019 final dividends, saying: "Aviva remains well capitalised with strong liquidity. It remains too early to quantify the impact of Covid-19 on claims expenses in our life and general insurance businesses, and the potential effect of capital markets and economic trends on our results. Given the change in the economic outlook, we are reviewing all material, discretionary and project expenditure."
Liz Booth is contributing editor of The Journal