Covid-19: what it taught reinsurers in planning for the next pandemic

As with every sector the world over, reinsurance felt the impact of the Covid-19 pandemic and subsequent global lockdowns in 2020.

An unexpected event for which no one was fully prepared, Covid-19 saw the mass cancellation of events, and the overnight shutdown and scaling back of large industry and business operations, while the service industry all but ground to a halt.

The result was a significant amount of cancellation refunds having to be issued, and a flood of business continuity claims being received. Reinsurance was caught off guard, as insurers across the world looked to recover massive amounts of claims from their reinsurers.

According to S&P, the top 20 global reinsurers reported about $12 billion in Covid-19 losses in the first six months of 2020. A recent Reinsurance News survey suggested it could take up to five years to understand the full extent of the impact of the pandemic on the insurance and reinsurance markets.

Greater demand for reinsurance

A 25 January 2020 article by Barnett Waddingham, an independent UK professional services consultancy, says the volatility in claims due to Covid-19 is currently translating into greater demand for reinsurance from insurers wanting to protect their books.

"Increased demand has already led to an increase in reinsurance prices, following the recent soft market, and Munich Re are [sic] predicting further hardening of rates. This has allowed new instruments or new entrants 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'."

For the year ahead, Fitch Ratings predicts increased reinsurance demand due to pandemic uncertainty and increased prices in primary insurance - a trend it expects to continue for the foreseeable future.

The Spanish Flu example

It's against this context that we look to tomorrow and ask ourselves as a sector, how will we respond to the next pandemic or even, further developments as a result of the current event, which is not yet over?

Planning for the future is always rooted in the past, so in answering this question it's useful to look to previous global events for direction.

The Spanish Flu of 1918 is probably the most comparable disaster. Although death toll figures vary greatly from 20 to 100 million, this pandemic is widely considered the most devastating of its kind in recorded history.

While many insurers have since looked to this event for clues as to the possible trajectory and spillover effects of the Covid-19 pandemic, catastrophe and risk modeller, AIR Worldwide, actually modelled a modern-day Spanish Flu pandemic back in March 2018.

The findings were fascinating. Aside from predicting much of what we have subsequently seen play out abroad and locally as Covid-19 has taken root (which was not known almost three years ago), the modelled scenario provided some gauge as to how the sector could plan for this eventuality.

For example, there would be a nearly 90% reduction in the case fatality rate in modern Spanish Flu compared to that of 1918 as a result of modern medical advancements.

However increases in the scale and frequency of modern air travel, and the average age of the population, would increase the mortality rate by 30% and 8% respectively, compared to the actual mortality in 1918.

The exercise further estimated losses of between US$15.3 and US$27.8 billion for US insurance companies alone.

Given that general life benefits paid to beneficiaries in 2010 amounted to more than US$58 billion, these modelled losses represented close to a 48% increase in the total benefits paid by the life insurance industry.

It was observed, however, that the modelled pandemic did not represent a worst-case scenario for pandemic losses, as in the case of drug-resistant pandemic strains and manufacturing difficulties around vaccines - two areas that have been brought into sharp focus in 2020/21.

Pandemic planning

In looking at ways insurers could use this information to inform their planning, it was suggested they aim to better understand the differences between the general population and their insureds in terms of age distribution and prevalence of chronic diseases as predictors of mortality rates.

A more comprehensive understanding of risk can inform a range of planning decisions, such as building and maintaining accurate reserves the model noted.

From a reinsurance perspective, it's clear cover has to change to accommodate such unpredictable risks as pandemics.

In November 2020, Reinsurance News reported on the Prospectus 2021 annual reinsurance conference. Among other pressing questions, the forum asked if the systemic nature of pandemic risk was inherently uninsurable.

David Flandro, Managing Director at Hyperion X Analytics, said the private sector was capable of handling pandemic risk, but not the accompanying government actions.

"I don't believe that pandemic risk is uninsurable," he said during the conference opening. "But one big caveat to that is if the risk is just based on government action, then that is impossible to insure. And if that's going to be the primary driver of the peril, then unfortunately there would have to be some sort of non-commercial public backstop."

He added the private reinsurance sector would need to develop innovative new products to meet the challenges of non-damage business interruption and event cancellation risks.

Peter Giacone, MD and global head of insurance at KBRA, furthered this sentiment, saying the pandemic was insurable provided the industry was able to quantify the risk and separate it into manageable parts. Tailored coverage and quantified risk were key, he said.

While this may be true, quantifying risk is not easy when there is such uncertainty in the markets. I believe this is where analytics has such a critical role to play.

Using models stochastically to capture tail events is absolutely essential. Superior risk selection and underwriting guidelines with adequate risk transfer is crucial for long-term sustainability of businesses. Dynamic risk models can also assist here by providing a quantitative framework within which to make these key underwriting decisions.

Another key consideration in reducing the uncertainty in risk quantification is achieving more contract certainty in wordings of both insurance and reinsurance contracts. This in turn leads to more accurate and risk adequate pricing and ultimately fewer instances of claims litigation.

It's clear that past experience will shape our preparedness for future events, and that advanced modelling tools can now greatly assist us in these efforts. However what remains a little less clear is the exact extent of these risks and the way we as an industry will need to constantly evolve to respond to them. This only the future will show us with absolute clarity, and to that we need to remain open and flexible.