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    Home » Life Risk Industry Resilience Provides Confidence to Market

    Life Risk Industry Resilience Provides Confidence to Market

    Features 10 May 2022Greg WintertonBy Greg Winterton
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    Covid-19 Resilience
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    In public and/or more liquid markets, at the onset of the Covid-19 pandemic, it seemed like everything was correlated; public equities and government bonds all fell sharply as investors sought to liquidate amidst the initial panic. But the panic also spread to the private markets, with private equity portfolio company valuations being written down as investors had to re-model their portfolio company forecasts to adjust to the lockdown environment.

    Insurance company stock prices certainly took a hit. But in insurance circles, the big question was whether the pandemic was going to be so severe – and cause such an increase in population mortality – that it would damage the entire industry, leaving it in potential need of a government bailout akin to the one received by the banking sector during the Global Financial Crisis (GFC).

    Since the onset of the pandemic, however, there has been not one bail out or bankruptcy of a major US or UK life insurance company. Nor has there been much of a discussion about the systematic collapse of the life insurance markets.

    There are two main reasons for this. The first is that the pandemic did not trigger a ‘once in a hundred years’ event. According to medical journal The Lancet, the Covid-19 infection-fatality ratio was less than 1% for ages 59 years and below. It was 2.6% for persons of age 69, rising to 7.3% for persons aged 79. Those are arguably ‘good’ odds for a life insurance company when modelling a pandemic; at those levels, insurance company mortality risk exposure should be manageable. Although the aforementioned fear factor affected all markets in February and March 2020, the realisation that Covid-19 was not a multi-sigma event came fairly quickly.

    “Whilst there was an initial concern within insurers over the potential size of excess claims, this subsided as emerging data showed relatively modest impacts. Around 60% of our UK clients saw no material impact in their portfolio experience in 2020, with no client experiencing deaths greater than 20% above pre-Covid-19 levels”, said Mark Godson, Partner at EY. “Additionally, for some firms, negative experience in their life insurance portfolios was offset by positive experience in their annuity portfolios.”

    The second reason is that the regulatory infrastructure of the life insurance industry proved to be robust enough to withstand the impact of the Covid-19 pandemic. Much of this infrastructure was implemented or strengthened following the global financial crisis, where governments and financial regulators around the world have sought to adjust the capital requirements of banks, insurance companies and other systemically important organisations to better withstand a multi-sigma event. In Europe, the Solvency II framework, brought into force in 2014, targeted insurance company balance sheets specifically. In the United States, Dodd Frank encompassed insurance companies. Both sets of legislation had – and still have – their critics, but Nicholas Bugler of law firm Willkie, Farr & Gallagher in London argues that what’s not in doubt is that insurance company balance sheets are stronger from a resilience perspective than before the GFC.

    “Certainly, that’s the case,” he said. “Purely from the perspective of balance sheet fortitude, the changes in the regulations have ensured that insurance company liquidity reserves are larger.”

    The main challenge in the life risk industry turned out to be the same main challenge in most other industries; the need to adapt to working in a lockdown-based environment. In the life settlement corner of the life risk industry, this was certainly the case.

    “We saw some disruption to our interactions with some brokers, physicians and carriers in the first few months as they transitioned to remote working,” said Simon Erritt, Managing Director at Coventry Capital. “But with the accelerated adoption of things like e-signatures, remote notarization and dedicated carrier contacts, the market is definitely operating more efficiently now than before the pandemic.”

    When reflecting on the importance of the life risk markets to the financial system, it is necessary to consider its resilience in the face of world events. Akin to how a devastating hurricane season is disastrous to catastrophe bond holders, a pandemic, in theory, would be similarly challenging to those holders of mortality risk. Life insurance companies provide trillions of dollars’ worth of cover, and are therefore exposed, during a pandemic, to potentially billions of dollars of risk in the form of premature claims. If the underlying life insurance companies – arguably the most important counterparty in a life risk transaction, whether that be a secondary market transaction like life settlements or longevity risk transfer – fail, individual assets in a life risk investment portfolio would lose a substantial amount of their value.

    But life insurance companies didn’t fail. Whether that’s due to the capital restrictions cushion imposed on insurance companies in the wake of the global financial crisis or whether it’s because, so far, Covid-19 has not been the ‘1 in 100 years’ event, is unclear. It’s probably a combination of the two. And there is still a chance that new, more aggressive strains of Covid-19 might emerge – or, another virus or disease entirely – that provides a systematic challenge to the life insurance company sector.

    That’s not to say that the past two years has been all plain sailing for the insurance industry. The Omicron variant that emerged at the end of 2021 caused yet more disruption to markets and lifestyles, and beyond life risk, property and casualty insurance companies have been hit with business interruption claims.

    For life risk, though, it’s not been anywhere near as bad as it could have been. And what is encouraging for the life risk industry – and the investors, investment managers and service providers that make up the capital markets’ participation in longevity and mortality risk investing – is that, so far, systematic losses have been mitigated.

    “Understandably, many in the Life Risk industry were nervous at the outset of the pandemic,” said Chris Wells, Executive Director of the European Life Settlement Association. “Systematic failure was a real threat and capital requirements had not been truly tested in this manner before. And while the Covid-19 pandemic is not over, and the threat of future pandemics is ever present, the Life Risk industry has demonstrated the ability to withstand these exogenous pressures.”

    2022 - May Volume 1 Issue 1 - May 2022
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