General Insurance Article - Covid19 and the impact on reinsurance reserving

 By Wendy Kriz, IFoA, Senior Consulting Actuary at Barnett Waddingham

 This is important as insurers are currently projecting a substantial proportion of Covid-19 related claims to be recovered from the reinsurers.

 Aggregation issues are likely to be debated in the courts for many years to come** if the 9/11 court cases are anything to go by.

 Although not directly relating to aggregation of losses for reinsurance purposes, we have already seen one court case: the Financial Conduct Authority’s (FCA’s) Business Interruption test case. 

 The judgement of this case was being taken to the Supreme Court in November 2020. The result of the FCA test case may have an impact on reinsurance but it is too early to say.

 Methods of event aggregation
 Losses can be aggregated for reinsurance claims in several ways: event-based, occurrence-based or cause-based.

 Event-based (or occurrence-based) clauses generally contain the wording ‘each and every loss’, which means the reinsurance treats each event as a separate occurrence with limits of cover and deductibles for each event.

 Cause-based cover is where all claims relating to the same cause can be aggregated for reinsurance purposes.

 The issue under contention here is what constitutes an event. If we look at the 9/11 losses, for example, the court cases were concerned with whether each plane attack was an event or cause, or if the two planes together counted as one event or cause.

 From a Covid-19 perspective, the first and second (and further) waves could be treated as a single event or multiple different events. The decision could benefit or cost the reinsurer or the insurer but this complex issue is product and wording specific.

 The definitions for aggregation are of particular importance for reinsurance as coverage may only be triggered under one example. It is unlikely that full clarity will be available for some time as cases go through the courts. Until then, reinsurers should be aware of their exposures on all bases, have open dialogue with their insureds, and set reserves consistently.

 Other aggregation issues
 Other potential aggregation issues for reinsurance include the below.

 Allocation to year of account – even once we sort out the event aggregation discussed above, we still need to decide how the losses are allocated between different reinsurance policies covering different years. The time period of the event could be defined as the single date at the start of the lockdown or the entire period of lockdown. Each year of account is likely to have a different set of reinsurers with different terms and conditions so allocation to dates and then year of account can be very important.

 Potential clash exposure due to Covid-19 impacting multiple lines. Some lines of business, which may not be immediately obvious, could be impacted by Covid-19 losses. Both insurers and reinsurers should be aware of this potential and monitor all their Covid-19 losses closely.

 Each (re)insurer should consider their own reinsurance program as a whole to understand the aggregations and impact of various decisions.

 Reinsurers’ ability and willingness to pay claims

 Capitalisation and rating
 The reinsurance market is currently well capitalised, so valid Covid-19 claims are unlikely to cause reinsurers to fail overnight. A high volume of losses is expected, although we do not anticipate any large-scale bankruptcies.

 However, the rating of the reinsurance market by Fitch was reduced from stable to negative in March 2020*** but raised back to stable in December 2020^. So insurers should monitor the ongoing situation and consider the impact of reinsurers not being able to pay valid claims.

 Policy wording differences
 Reinsurance usually follows the underlying insurance policy, but in some cases insurers are being forced to pay out non-covered claims. For example in New York, where legislators and lawyers have threatened to force the payment of Covid-19 related insurance claims that the industry states are excluded from policies.

 If reinsurance wording does not follow the underlying policy, there is a potential for incompatibility between the two sets of wordings. For example, legislators could force an insurer to pay out on a policy where Covid-19 was clearly excluded, but their reinsurer would have no obligation to pay out. Reinsurers should monitor insurer expectations and communicate regularly to ensure there are no nasty surprises, for example, if cover is not confirmed.

 Natural catastrophe-like losses
 Covid-19 has led to natural catastrophe-sized losses but does not share the characteristics of a natural catastrophe. Some reinsurers may consider Covid-19 to be a catastrophe loss and some might not. This could lead to coverage issues. All this means that (re)insurers may need to consider the following:

 How the reinsurance is working under Covid-19, as it may not be providing protection against big losses, as the insurer and reinsurer intended.

 Reinsurance contracts are being used against losses they were not necessarily designed for — Covid-19 could be considered a months or years long event, which was probably not considered when the reinsurance contracts were written.
 If the reinsurance contract does cover Covid-19, reinsurers may not be prepared for the large payouts that will ensue.

 Other reserving issues

 Reinsurance exhaustion
 During the first wave of Covid-19, an insurer’s aggregate reinsurance cover may have either:

 been breached; or
 the underlying policy limits may have been reached.
 If either of these events occur, we would see a hike in the claims estimate for insurers, disproportionate to the increase in claims costs.

 Incomplete projections
 Companies may have set their reserves based on the pandemic being over by now^^^. Also, Covid-19 related claims on other classes of business may not have been fully projected in the reserves yet. For example, the impacts on secondary classes such as accident & health, mortgage and credit & surety lines is far less certain.

 Conclusion
 Reinsurers have a key role to play in the management of Covid-19 in the industry as a substantial proportion of Covid-19 related claims are expected to be recovered from reinsurers. We are still living through a live pandemic situation with many potentially unknown implications for the reinsurance industry.