Writing a piece on the fate of the life insurance industry at a time of international emergency seems a strange thing to do, but Life companies operate in a uniquely social setting and concerns will inevitably be raised about their ability to fulfil their obligations to policyholders in the current environment. Life insurers do not quite operate on the front line of this crisis, but they will certainly play a supporting role in their dealings with those afflicted by Covid-19, their families and policyholders - many of whom will be facing personal and economic situations which have changed immeasurably. Life companies are distinct from many other types of corporate due to their social reach. Most are keenly aware of their obligations to the public, spending vast amounts on Social Purpose research, marketing and financing activity, sitting as they do at a midway point between big business and society at large.

Life insurers will also be key to rebuilding efforts following this crisis. Besides playing a central role in social infrastructure investment, financing the construction of everything from classrooms and student accommodation blocks, through to airport car parks or wind farms, life companies are premium, investment grade financiers. They are the largest single group of bondholders across almost any indices of public companies, supporting the economies and governments of the developed world at a time of fiscal and monetary inflection.

Investors have quickly exited the life sector in recent weeks, as concerns about the impact of Covid-19 on life company balance sheets have grown. Across the leading life companies, share prices have fallen away by up to 50% as common sense dictates that pay-outs across the Mortality, Critical Illness, Health and Income Protection spaces will inevitably rise as a result of the virus. But, whilst it’s true to say that the financial obligations of life companies will rise as a consequence of the current emergency, the true impact will be felt by their investment portfolios. In a recent report, ratings firm DBRS identifies three areas of financial impact:

(1) Increased claims costs, including death and disability claims, health and drug related expenditure;

(2) Adverse movements in the financial markets, including declines in bond yields, equity markets, and real estate, reducing profitability; and,

(3) Business interruption and potential impact on revenues;

Although the backdrop to this crisis continues to change apace, the industry consensus seems to be that liabilities will be well managed by what is now a well-capitalised, highly regulated and fastidiously stress-tested industry. The exhaustive prudential rule-book processes which have been undertaken over the past 10-20 years, resulting in Solvency 2 in Europe, the Asian C-Ross framework and Equivalence based processes stretching from the Middle East to the US represent perhaps the most rigorous ‘bullet-proofing’ of corporate activity by any sector in living memory. Solvency 2 stress testing on Mortality alone, requires life insurers to allow for an annual increase in Mortality of 15% without any meaningful decrease in regulatory capital. The Solvency 2 rulebook also allows for an increase in post-event disability and morbidity payments in the year following such an event of 35% and 25% respectively. This seems not to be the behaviour of Corona at all, where death versus recovery is fairly prompt and recovery seems to pass immunity. There seems to be little chance of a life insurance company breaching this metric.

My good friend Erik Vynckier, Partner of insurance fin tech company Insurtech Venture Partners, points out:

“In the UK, there are approximately 10-12,000 deaths per week as a natural rate, so the increase in mortality as a result of the Coronavirus, though a terrifying human cost, may not materially impact life insurance companies. As we get to the end of the century, the current annualised global death rate of about 60,000,000 will rise to c.100,000,000 – primarily due to population growth and ageing populations. This figure adds perspective to the current crisis. Since the bulk of demand for Mortality protection comes from the working generation of families (typically aged between 30 and 60 years) and the mainstay of demand for Retirement provision in the form of Annuities falls above that age group, the concentration of deaths from Covid-19 at higher ages often do not trigger insurance claims. Therefore, the impact of Covid-19 on insurers paradoxically comes not from mortality but from business interruption, travel interruption, credit protection (on the liability side) and most significantly the crash in the capital markets on the asset side”. 

Further, there are a number of mitigating factors on life insurance company exposures: Firstly, mortality risk has been heavily ceded to reinsurers over the past few decades, who then transfer their risk onto the wider financial markets using quota share, ILS or other risk transfer tools. Secondly, life insurance is a form of Term insurance, meaning that in economic terms, pay-outs are closely related to demography. Life insurance companies are now highly skilled at managing the cohorts and iterations which comprise their mortality books. Thirdly, many multi-line Life companies will be naturally hedged against at least some increases in mortality, by virtue of their annuities books, which decrease liabilities as a result of any increase in mortality. Finally, industry consolidation and the dawn of the global life company in the 1980's have had the effect of evening out different demographic risks across the world.

Investment Portfolios

Although it's impossible to see how far-reaching the liability sided impact of Covid-19 will ultimately be, it seems likely that the pain will be felt on the asset side of the balance sheet. Pain will be felt by any life insurance company in the value of its illiquid investments, which will fall as the economic backdrop deteriorates. Thus, Shareholder Funds operations, or assets held in areas like Real Estate on behalf of With-Profits lines will experience some difficulty.

However, it is General Account investing which could take the force of the blow. This could be most extremely felt in the Corporate Bond portfolios which still represent the largest single asset class of regulatory capital held by the industry. Unfortunately, the low interest rate environment has had the effect of prompting insurers to increase their holdings in Cross-over Credit and other Enhanced Credit categories such as HY-BBB, Emerging Market Debt or Contingent Capital. For a life insurer, bond downgrades are an outcome to be avoided at all (reasonable) cost, since they immediately ratchet up the company's regulatory capital provision in areas where liabilities are close to fruition. Thus, for a life insurance company with a large annuities or block of guarantees maturing, the bond manager must replace ‘lost’ ratings with what he or she can find on the open market.  Vynckier describes the resulting turbulence:

“For people who sit on cash (which is not many), there are now attractive spreads in some IG names.  (But) It will be difficult to actually lie your hands on paper you want as most trading desks are not functioning at the moment and the attitude in the current markets is one of sitting tight on what quality you have.  i.e. the quotes on the screen have no actual healthy offer underpinning the quote”.  

Thus, with few IG names offering genuine, tradable value and very low IG liquidity, bond managers for the leading life insurers are faced with some difficult (and potentially) expensive decisions in order to replete their portfolios in the current flux. The alternative - replacing corporate bond portfolios with sovereign bonds and gilts - at current rates, is hardly ideal...