By Wendy Kriz IFoA, Senior Consulting Actuary, Barnett Waddingham
Demand, supply and cost of reinsurance
The impact of Covid-19 on demand for reinsurance is not straightforward. We expect increased demand in some areas as insurers try to manage their exposures. There could also potentially be a reduction in demand where the government have stepped in; for example, in the trade credit market described later in this blog. Overall, Fitch Ratings is currently predicting an increase in demand for reinsurance due to pandemic uncertainty and increased prices in primary insurance. The ratings firm expect this increased demand to be a long-term trend .
Competing impacts on reinsurers
The current volatility in claims due to Covid-19 has started to translate into greater demand for reinsurance from insurers seeking to protect their books. Increased demand has already led to an increase in reinsurance prices, following the recent soft market, and Munich Re are predicting further hardening of rates. This has allowed new instruments or new entrants (for example Index Linked Securities or Private Equity funds) without legacy issues to take advantage of this increase in demand, potentially dampening any increase in reinsurance prices.
Economic issues caused by Covid-19 could lead to large losses in some lines and an increase reinsurance purchase. Reduced claims in some areas (e.g. motor insurance) may lead to insurers purchasing less reinsurance. These competing forces mean that the longer-term impact on reinsurance remains highly uncertain. Insurance Insider has stated that “senior industry sources are sharply divided on the forward trajectory of the reinsurance market, with highly divergent views on the net impact of the forces unleashed by coronavirus.”
New opportunities for reinsurers
Covid-19 also represents an opportunity for established reinsurers and new entrants. Pandemic cover had been offered pre-Covid-19 by reinsurers but with very limited take up. Post-Covid-19, insurers may revisit the value of pandemic cover. Both insurers and reinsurers will need to ensure the terms and conditions are appropriate on this new or expanded product, in the light of the learnings from the Covid-19 pandemic.
Tightening reinsurance terms and conditions
Hardening of reinsurance rates and tightening of terms and conditions was already underway in early 2020. Since the onset of the pandemic this effect has been accelerating as reinsurance contracts are tightened to explicitly exclude pandemic cover in new and renewing contracts. This makes it more difficult for insurers to buy reinsurance protection appropriate for their needs.
Terms and conditions formed an integral part of the ongoing FCA test case for business interruption claims from pandemic losses. (Re)insurers should study the wordings decisions made to ensure their terms and conditions only cover what is intended, approaching consultants where appropriate to ensure they are market consistent.
The effect on investment income
For some time before the pandemic, reinsurers had changed their investment strategy to cautiously invest in riskier and more illiquid assets. This new strategy, designed to generate additional return in a low interest environment, has paid off. Investments in these assets have helped reinsurers weather the economic impact of the pandemic.
However, asset yields are continuing to fall, even in these riskier assets. This will erode some of the increases in underwriting income gained from increased rates. A weak economic recovery could also reduce profitability for reinsurers, leading to a desire to further increase rates. This desire is likely to be stayed by competitive forces in the market.
Trade credit guarantee
On 4 June 202010, the UK Government announced that it will provide guarantees of up to £10 billion to trade credit insurance schemes for business-to-business transactions. The government reinsurance scheme is designed to maintain trade credit insurance coverage and credit limits through the pandemic. The scheme was originally available for nine months from 1 April 2020; in December 2020, the government extended the scheme by a further six months.
With the government providing this cover, demand for trade credit reinsurance is likely to reduce as insurers can choose to use the scheme instead of purchasing reinsurance. However, not all insurers will take up the scheme. Participating insurers will pay 90% of premiums to the scheme, along with other terms to help the government manage their own risk.
Reinsurers offering trade credit cover will need to revisit policy wording to take account of the government backing and also consider the end date of the scheme. Reinsurers’ risk profiles will be impacted, both during and after the scheme, and the state of the market in the long-term is impossible to predict at this stage. Both reinsurers and insurers should therefore consider their options for when the scheme expires in mid-2021, including the possibility of further extension..
Pandemic Re
Pandemic Re is a UK insurance industry proposed public-private risk-financing mechanism for future pandemics, based on the Flood Re model. The proposal is to cover non-physical damage business interruption losses in a bid to make the domestic economy more resilient for future pandemics. Pandemic Re conversations are ongoing and some solutions may evolve in due course, but for now the impact on the reinsurance market is unknown. Flood Re took several years to set up so it is unlikely that a Pandemic Re will be occurring any time soon.
Conclusion
Reinsurance providers have a key role to play in the management of Covid-19 as the effects filter through to a hardening market. The live pandemic situation presents us with continuing unknown implications for the (re)insurance industry. The reinsurance market is likely to be significantly changed in future; Pandemic Re and other government actions may well play a part in this.
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