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For Capstone Project Part 3, imagine you work as a financial consultant. You have learnt that your new client, an insurance company, risks becoming cash poor because of the increased amount of insurance payments caused by the COVID-19 pandemic.

ovid-19 has caused severe disruption for insurance companies, not least as they are in the business of pricing risks and a pandemic was thought of as a low probability event. But the economic fallout from the crisis may act as a catalyst for positive change in the industry.

According to Google Trends, the global search term uncertainty rose more than three-fold between the end of December 2019 and mid-September 2020. This isnt surprising: 2020 has unmasked risks and uncertainties that very few individuals and companies considered at the start of the year.

This article discusses how insurance companies, as organisations tasked with quantifying and managing risks, have responded to some of the challenges of 2020. They have not been immune to the effects and are likely to see further economic impacts and repercussions as the situation continues to unfold.

How can pandemic risks be priced?

The underlying premise of insurance is a transfer of risk. Individuals (policyholders) swap a potentially large and unknown outgoing for a known, typically smaller outgoing (the premium paid) with an insurance company. The insurer then pools all the risks together and, by doing so, it seeks to forecast, manage and pay out claims.

The multi-faceted nature of the Covid-19 pandemic has meant that it has affected many lines of business where there is insurance coverage. The affected areas include, but are not limited to, business interruption (for example, disruption to supply chains and inability to operate as normal due to government measures), trade credit insurance (cover for businesses if customers who owe money for products or services delay payment or do not pay at all), travel, cyber liability (due to increased working from home) and event cancellation.

Consider, for example, Wimbledon, the worlds oldest tennis championship held in London every June. The pandemic insurance coverage for the event is expected to result in a 114 million payment due to the cancellation of this years tournament (Brodies LLP, 2020). A more extreme example of an insurance payment due to event disruption is the postponement of the Olympic Games in Tokyo, with Jefferies analysts estimating the insured cost of the event at $2 billion (Insurance Journal, 2020).

While many insurers have considered and priced pandemic risk into their insurance risks, the global effects of Covid-19 have led to many risk commentators describing it as a black swan event (McGillivray, 2020) in other words, an event that lies outside the realm of regular expectations (Taleb, 1999).

Pricing a very low probability unexpected event is difficult, as a lack of historical data impedes the modelling of future risk events occurring. With very few pandemics in the last century, pandemic risk falls into this category. With this in mind, it is evident that the pricing of pandemic risk within insurance has not been fully understood and allowed for.

How will Covid-19 affect health and general insurance?

Health insurers underwrite morbidity risk and hence, there were concerns that health insurers would experience significant additional payouts from an increase in Covid-19-related hospitalisations and treatments.

The evidence to date, which comes from an AM Best commentary, suggests that the Covid-19 impact on health insurance companies has been smaller than expected (AM Best, 2020). They attribute this to the fact that most diagnosed individuals have been able to self-isolate successfully at home rather than being hospitalised. In addition, there has been a decline in non-Covid-19 claims, which has offset the expected impact from Covid-19 claims.

General insurance has also been affected in various ways by the pandemic. For example, travel has been severely disrupted, affecting travel policies. Motor claims have also been affected as various lockdown measures have resulted in an unprecedented drop in the number of road users, leading to a drastic fall in the number of motor claims from accidents. Theft claims have also decreased as both vehicles and vehicle owners have remained at home.

Other impacts

Global lockdown measures from governments attempting to contain the spread of coronavirus have also led to a complex myriad of second and third order effects, which have been difficult for insurance companies to predict in advance.

One example of these unforeseen risks affecting insurance companies is reputational risk. The insurance industry already suffers from a poor customer reputation (ProActuary, 2019), and the crisis has brought to light the many epidemic/pandemic exclusion clauses for coverage, such as travel insurance and business interruption, of which customers were often not aware.

The Actuary magazine, for example, recently reported that two-thirds of brokers believe that the industry's reputation has been damaged during the Covid-19 crisis, citing a lack of pro-activity and confusion around legislation and policy wording on some of the major issues (The Actuary, 2020) .

As an example of policy wording confusion, consider the aforementioned Olympics insurance payout. The summer Olympics scheduled for June this year has now been postponed until July/August 2021. But it has transpired that many of the policies taken out only cover a cancellation and not a postponement.

On a final note, it would be remiss not to point out some positive actions taken by some insurers that have enhanced the level of trust. For example, many motor insurance carriers have returned premiums to policyholders, by refunding drivers and cutting premiums due to the change in their risk levels.

Description of requirements

• Explained in your own words how the COVID-19 pandemic has influenced insurance companies liquidity risks.

• Answered: What advice would you give to your client to avoid or reduce liquidity risk?

Submitted 3 paragraph minimum

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