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COVID-19 Drives Insurers to Revisit Actuarial Models

August 14, 2020

The COVID-19 pandemic has taken a huge toll on people and economies alike. Governments and central banks worldwide have introduced a slew of fiscal measures to infuse liquidity and stability in the market. However, in spite of these measures, the financial markets are expected to remain highly volatile for a significant duration, likely to worsen further due to lowering of interest rates and increasing credit spread gaps as well as risk of mortgage defaults. Insurers therefore need to assess the impact on their solvency margins and IRRs, and re-assess the assumptions around mortality and morbidity rates, operational and financial costs, claims and losses, and so on.  Actuaries must review existing strategies and products and construct new ones to handle evolving risks and their interactions to be able to better model assets and liabilities as well as analyze asset and capital adequacies. Moreover, insurers will have to perform strong scenario testing to identify key assumptions of asset liability modelling with contingent cash flows to mitigate the pandemic induced risks.

Let us examine the varied impact the COVID-19 crisis is likely to have on each insurance line of business:

Life insurance: Insurers are witnessing challenges in the underwriting process due to difficulties in obtaining medical reports of the insureds. There is likely to be a sudden surge in the sale of protection polices due to increased awareness of life risk. Several insurers are restricting life and health products to people in the age groups close to maximum age at entry bracket and also those in close proximity to COVID-19 patients. Insurers are reviewing pricing assumptions to account for the heightened emphasis on tail scenarios and increasing long-term rate assumptions, thereby reducing the ultimate rate. Changes to operational leniency like extending the grace period would amount to changing the liabilities assumptions. Actuaries also need to monitor the influence of lower interest rates on asset liability management (ALM) and the impact on business margins, statutory earnings, and new business sales. In addition, life insurance actuaries are reviewing the mortality patterns of new suicide claims due to increased cases of depression and anxiety.

Health insurance: Most insurers are settling the health claims related to COVID by relaxing the conditions such as waiver of co-pays, special enrollments, premium subsidies, and unpaid employer premiums. Some of these relaxations and special programs are causing increased losses and higher adverse selection risks. Rate filings for new and renewed coverages during any financial year are based on claims expenses over the previous year. These would pose additional challenges for rate finalizations for the upcoming year 2021. Self-insure employers may not have much reserves for unanticipated events such as the COVID 19 outbreak, as a majority of the claims fall below large claim limits. These increased claim costs, assumed at the time of pricing, would cause higher underwriting losses and thereby push insurers toward the risk of insolvency. Apart from high claims costs, actuaries would need to consider related economic effects such as increased unemployment, which is likely to lead to lower enrollments. Health insurers must also consider the potential increase in the use of mental health benefits in healthcare insurance.

P&C or general insurance: The impact of the COVID-19 crisis on some P&C categories such as occupational and auto insurance:

Occupational insurance: Though COVID-19 is not a typical occupational disease but it can be considered in this category for the simple reason that the frontline workers in businesses such as grocery stores, healthcare facilities, essential services, as well as public security and the police are at a greater risk of contracting the deadly virus. Therefore, actuaries need to review the increased losses due to the claims pertaining to COVID-19, such as medical coverage for diagnosis and treatment, income protection, survival benefit payments, and so on. These are bound to have a significant impact on workers’ compensation policies including benefit structures and premium costs.

Automobile insurance: Some of the key indicators impacting Claim Frequency Actuarial models of auto Insurance are amount of vehicle miles traveled, degree of road congestion. Now, claim frequencies are reducing and claim severity would be increasing caused by increasing social distancing, remote working, negligent/rash driving by the few. Some carriers announced refund premiums such as ~25% of credit of premiums which is estimated to be more than couple of billion dollars. These premium refund credits would impact adversely loss ratios of auto lines of business.  Also, it is noticed that other type of claims are witnessed such as increased theft - as most of the vehicles sitting idle in parking garages and more fatal accident claims due to reckless and aggressive driving behavior - given the lower traffic volumes due to less traffic on road.

Retirement insurance: For defined benefit plans, future contributions to these schemes will have to be reviewed considering the erosions of the asset, turnover of members, retirements in the current financial year, freezing of benefit accruals, and so on. Advanced actuarial techniques are used to determine contribution needs. During the current volatile markets, asset smoothing technique will be used to spread the impact of asset volatilities and amortization approach is used to reduce the contribution needs in the short term.

For defined contribution plans on the other hand, the major impact would be felt in terms of reduction of account balances, suspension of employer’s matching contributions, and flexibility to access the pension funds. These would be exacerbated on fund accumulations and final pensions in addition to other reasons such as lower interest rates, minuscule annuity rates, and low average wage index.

The Way Forward

We believe the crisis would be further intensified by other risks such as adverse climate change, catastrophic perils, extreme weather, earthquakes, and wildfires. However, the reduction of car and air traffic could help in reducing global carbon emissions and this is one of the positive outcomes of the pandemic that could effectively offset the wide range of adverse impacts.

It is no surprise that the pandemic will have far-reaching effects on the insurance industry, but the finer nuances of the impact are still emerging and the lack of sufficient data at this moment may make it difficult to measure the impact in entirety. Actuarial researchers are building models to measure various parameters of this pandemic such as speed, spread, and severity. Actuaries would be redesigning the pricing models with provisions to handle high severity claims, increased contingencies, low contributions levels, and so on. Improving the operational efficiencies such as low-cost operations, improved process optimizations, and increased automation would help to de-risk the immediate impacts. The post-COVID time will likely see the emergence of new business models, market segments, and product innovation, which will help define efficient risk strategies and build infallible actuarial models. As companies adapt to the new reality, we believe a host of new opportunities are expected to emerge in the insurance space. These would include holistic coverage in healthcare, 360-degree digital advisory in life insurance through digital fulfillment ecosystem, usage based pricing in auto insurance, a surge in telematics (pay-as-you-drive models) usage in commercial auto insurance, age group based risk models, and creative products for emotional well-being, advanced analytics to capture rapidly changing risk factors.

Sureshkumar Dubagunta heads the Actuarial Advisory and Business Services Practice of TCS’ Banking, Financial Services, and Insurance (BFSI) business unit. He is responsible for building offerings, tools, and frameworks in niche and core actuarial areas and engaging clients’ actuarial stakeholders to deliver these offerings. He and has about three decades of experience in advising and implementing insurance, finance, and actuarial solutions for BFSI organizations. He is a qualified actuary with three fellowships in insurance from the US, the UK, and India, and has an MBA degree in Insurance, Management and Finance from the Institute of Chartered Financial Analysts of India.