David Priebe offers COVID-19 insights on investment portfolio impact on (re)insurance pricing, pricing momentum amid economic challenges, alternative capital and communicable disease exposures and exclusions in an interview with The Insurer held on April 13. This is Part Three of a three part series.
1. How do you expect collapsing yields and the hit to investment portfolios from COVID-19 market volatility to affect the commercial insurance and reinsurance pricing cycle?
The correlation between lower yields and pricing is well known but there are a couple of important caveats: (1) the impact of interest rate movements takes a few years to materialize fully, given the duration of carriers’ asset portfolios, and (2) capital has traditionally had a greater bearing on pricing.
Global commercial insurance and reinsurance pricing was already on the increase prior to the COVID-19 crisis, although strong capitalization in the reinsurance market saw more moderated increases compared to those in the primary market. Looking forward from here, capital, as well as loss costs trends and reserve adequacy, are likely to have a more direct influence on pricing. The short-term impact of asset portfolio performance is unlikely to be as significant, perhaps with the exception of insurance-linked securities (ILS), where capital availability is more directly impacted by higher credit spreads and the ability to redeploy funds.
Ultimately, the fundamentals of (re)insurance remain strong. There will nevertheless be winners and losers as the market adjusts to the post-COVID-19 environment: carriers with strong capital adequacy, more disciplined underwriting and efficient expense structures will likely prosper.
2. Will insurers be able to maintain the momentum on pricing they need to outpace loss trends when many insureds are likely to be experiencing economic hardship and budget restrictions?
The economic shock of COVID-19 has brought huge challenges to households and businesses, many of whom were already paying more for insurance protection in the lead up to the current situation. However, the key drivers behind these rate increases – including shifting views (and appetites) of risk, higher loss cost trends and deteriorating loss experiences – will likely be exacerbated by the COVID-19 pandemic.
While some lines of business may be impacted more than others, the need to sustain, or even accelerate, price increases in stressed areas of the primary market is clear. Whether these rate rises can compensate for the level of premium slippage carriers will inevitably experience from the collapse in economic activity is another matter. Obviously, pricing adequately needs to account for a lower premium base, but much will depend on how quickly economies can recover.
The industry needs to be cognizant of its reputation during this time, and it is, therefore, pleasing to see some carriers proactively rewarding their customers with premium rebates or discounts as they benefit (in the near-term) from the drop in economic activity and lower frequency of loss.
3. What impact will COVID-19 have on the role of alternative capital in the Property and Casualty (P&C) industry? Does it create additional opportunities or will the ensuing financial crisis lead to retrenchment?
The outperformance of ILS capital during the peak period of COVID-19 market volatility has once again demonstrated the benefit of investment allocations into the asset class. A quick comparison of return between the beginning of February and early March reinforces this point: the S&P 500 was down 23 percent while the Swiss Re Catastrophe Bond Price Return Index fell by just 0.8 percent. This reaffirms the low correlation that ILS has to broader capital markets.
With catastrophe bonds holding their valuations, multi- strategy asset managers have looked to sell such investments to dedicated ILS managers in order to meet investor redemptions and/or rotate into other sectors with high return focus. Secondary market trading was particularly active in late March, and the vast majority of these deals (>70 percent) traded successfully.
The ILS market has, therefore, performed extremely well so far, and issuances that were in progress through much of March were closed with no issues. This bodes well for the significant opportunities on offer going forward, although there are a couple of near-term challenges that the market must meet in order to exploit these. With more than USD 4 billion of capital being freed up in the second quarter of 2020 from existing ILS opportunities, it is crucial that the ILS market remains open and competitive during this period. Equally important, we believe investors should seriously consider supporting pandemic coverage needs that will inevitably follow COVID-19. After all, pandemic risk has a low overall correlation to financial capital markets (e.g., the recent SARS and Ebola events) and can help diversify investors’ portfolios from the most common and frequent financial market risks – namely, recessions, asset bubbles and geopolitical situations.
4. By adding communicable disease exclusions on renewals and new business is the industry in danger of a tacit admission that there was exposure in expiring covers?
While some policyholders and attorneys have attempted to advance this argument, it fails to account for the simple truth that policy wordings change regularly and for a variety of reasons. Each change does not indicate a prior defect. Policy wording amendments, or the introduction of new exclusions, are made to provide clarity and for the understandable desire to minimize litigation. American courts, and the British tradition upon which they draw, have long rejected this line of reasoning, characterizing it as the mistaken notion that “because the world gets wiser as it gets older, therefore it was foolish before.”