Welcome to part three of our special series with EY on the economic response measures to the Covid-19 crisis. Click here for part one, and here for part two. In this edition, we discuss the effect on the global insurance industry, including the immediate and longer-term consequences for operations and technology, looking at the challenges and opportunities brought by digitalisation. We’ll be examining the financial health of the insurance sector as a result of the volatility in financial markets and the recession. What can be said of the significant strain on capital, liquidity, and investment strategies? We provide pointers on how the insurance industry can work with customers, governments and regulators in contributing to economic recovery and societal good. We investigate, too, the outlook for innovation, new methods of winning and serving customers and worldwide insurance consolidation.
Joining us is Simon Woods, EY’s global response leader for the Covid-19 repercussions on the insurance industry. Simon is the leader for insurance strategy for the Europe, Middle East, India and Africa region and a veteran of the sector, having been at EY since 2014, and in the 15 years before that covering insurance in various investment banking positions.
Listen to the recording, or read the transcript below.
David Marsh: Simon, insurance companies are facing major challenges in many areas. What has been the crisis response, first of all, in the fields of people, operations and technology?
Simon Woods: The immediate response was on ensuring people were safe, ensuring that they were able to work from home and that business operations were up and running in a remote environment, with customers looked after. Within days of lockdown, there were massive amounts of calls coming in, particularly in areas like travel insurance. Some customers have had call centre issues and have had to recapture operations from India. Generally the insurance industry, whether in the US, Europe or Asia Pacific, has responded very strongly and has had no major issues from the people or operational perspective.
DM: Do we now see an effect in terms of medium-term challenges as companies face the next wave of the crisis?
SW: We see a range of more complex issues for insurers to focus on. There are six themes prevalent among chief operating officers and HR departments. First: safe return to the office. The lockdown continues in many parts of Europe and in the Americas. And we’re seeing different attitudes on who should go back to work, who wants to go back to work, and how to do that and in a logical and safe way. Allied to that is the second question: the future operating model. People have been quite surprised about certain things that have happened positively regarding working from home. The question is: Do I need the same office footprint I have today? Can I have a more flexible, agile workforce? How do I draw positive lessons from the lockdown? That leads us to the third point, the theme of digital and technology adoption, and, fourth: organisational agility: How do I become a more agile, responsive organisation? Fifth: As the COO, how do I deliver return on investments? We’re seeing a lot of focus on big projects. Some of them are being delayed, some of them being deferred, but the critical thing for the business is to deliver on the projects and on the returns. At the same time, and sixth, we’re seeing a focus on strategic cost reduction, incomes are coming down across the sector and people have to know what is their cost base, and also their capability set, in the future.
DM: The insurance industry has sailed into quite a storm, in many ways. They are now taking action to meet the consequences. Some of the responses must have been things that different companies were thinking about doing anyway. And the extreme nature of the crisis speeds up innovation in some sense.
SW: A lot of our clients would agree that this has accelerated some trends we’ve seen for some time. At EY, in February, we ran our next wave ‘vision of the future’ in insurance, in commercial and specialty lines. When this came out, I felt it was a bit like science fiction. And then we revisited it, three or four weeks ago. And we realised that a lot of what we had forecast as the state of the industry in 2030 was actually happening now.
DM: Which kind of companies are doing well – and less well?
SW: It’s very much about digital and tech adoption. Insurers that have pivoted to become a more digital organisation are much better placed. We’re seeing usage-based insurance pick up, while some of the traditional sales channels fall down. Face-to-face distribution is a major issue for many insurers. The people with a multichannel approach, and the ability to sell services and distribute their products through digital media, are doing much better than those who rely more on traditional business models.
DM: Companies are being hit by a combination of three things. One is a big increase in pay-outs for all kinds of things from travel insurance to events. Second, premium income may have taken a hit because of the fall in consumer incomes. Third, on the investment markets, many companies will have been badly hit by the downfall in equities. There may have been a partial recovery, but they still have to cope with negative interest rates in many core areas. What can companies do about this array of financial challenges?
SW: There are three waves. One is immediate: the fall in equity values, the widening of bond spreads and the further fall in interest rates. That creates a solvency problem for companies. It’s not necessarily a cash problem, but it’s a mark-to-market effect. Many insurers have weathered that pretty well. There’s been some regulatory forbearance, too, to avoid procyclical behaviour. We’ve also seen insurers raise equity and debt as markets recovered in the immediate aftermath of the mid-March turbulence.
DM: And beyond the immediate solvency issue…
SW: Among the two longer-term issues, one is loss of income, either due to falling premium volumes or lower returns on investments. Regarding return on investment, that is a question about reinvestment risk, as opposed to an immediate fall of income. Many insurers have matched assets with liabilities and have locked in income – as long as there are no defaults. Beyond that, much depends on how severe is the recession. How long does take to get back to normal? What does that mean for the health of insurance companies: the affordability of premiums, but also their investment books? What is the likely default and downgrade experience?
DM: Can you see some trends in different jurisdictions – in America, in Europe and in Asia?
SW: Let’s look first at segments. In the P & C business – property and casualty, non-life business – people are a lot more bullish and optimistic about future growth prospects, particularly in places like the London market. It’s the same in some areas of reinsurance where we’re seeing rate-hardening: the price of risk is rising due to a shortage of capital. In the life insurance business, we’re seeing a bigger drop off in new business. And with low interest rates and the fall the markets, it’s much harder to see that market recovering with new business.
DM: The people in life are a bit more dour?
SW: The velocity of the life business is much lower than that of the non-life business. Liabilities are much longer, typically 20 to 30 years. It takes longer for those books to turn over. The ability to reprice and re-invent yourself on the P&C side is a lot easier given the shorter-term nature of the business.
DM: And the geographic variations?
SW: We see different responses depending on the state of lockdown. Across Asia, particularly in China, there’s been almost a return to normality, with some really interesting things in the Chinese insurance market regarding innovation, new ways of servicing customers. That’s slowly drifting westwards. The Anglo-Saxon world tends to be more immediate, in terms of their responses, whereas the European model is more cautious. That reflects the ability to adapt your business model. In continental Europe there is a greater need to consult with staff, and this applies more prevalently than elsewhere to other sorts of regulation.
DM: Negative interest rates on government bond markets are probably here to stay. Has that had a particular impact on the European business? A lot of people are worried about whether some smaller insurance companies, or even bigger ones, may have solvency problems?
SW: I’m sitting in Switzerland where we have the lowest negative interest rates in the world. The question is really one of asset-liability management, rather than negative interest rates per se. When I was in investment banking, before I joined EY, I was in risk management. Whenever I tried to sell interest rate derivatives, people were telling us that rates couldn’t go any lower. And yet, for the last 15 years, they have kept on falling.
DM: And now?
SW: Negative interest rates are not a surprise in Europe, whereas they would be for the US where rates have been a lot higher. Many insurers are now ready. And the regulators in Europe have been quite focused on ALM. That’s a key point of Sovency-2, with asset and liability matching. So in the short term, we’re not expecting negative rates to cause solvency problems. The bigger issue is the ability to sell your product. A lot of traditional life insurance coverage in Europe relies on guarantees. It’s very hard to provide cost-effective and meaningful guarantees in the current interest rate environment. Even a zero guarantee, which most people would not put a lot of value on, is very expensive at the moment.
DM: What are the big issues for insurance companies in the recovery phase? You’re very keen on the ‘social purpose’ of insurance.
SW: The first thing to remember about insurance is it works quite differently from banking. Very simplistically, banks lend money to individuals, and that’s paid back and there are some defaults. By and large the money flows, and then there’s a loss later. Insurance operates the other way around. Everybody pays a premium. And some people have a loss event in the future. Insurance suffers relative to banking in terms of ability to inject a lot of money into the economy quickly. And it’s very hard for the insurance industry to provide cover retrospectively. That’s one of the big debates now, regarding business interruption cover. There is a view that – even though the contractual terms excluded pandemic risk – insurance companies should have paid claims. That’s a huge issue – and is tied up with a perceived erosion of trust in the industry.
DM: So what are the options for the future role of insurance industry?
SW: Clients are very optimistic. Working with the industry, regulators and governments, we see three different potential models. The first one is using the insurance loss-adjusting mechanisms to get money fast to people – to pay claims effectively through the network of agents, in a way that is complementary to the banking channels. The second is to provide risk cover for essential get-back-to work or get-the-economy-going types of businesses, for example, underwriting vaccine supply chains, providing trade credit or whatever. Third, more grandly, there’s talk of pandemic risk insurance or PRIA which is a very similar concept to post-9/11 terrorist cover, which was called TRIA in the US. This provides some kind of government- or country- backed fund, so, in any future pandemic, there would be funds available.
DM: What role is played by the regulators here? Who do you talk to regarding new innovative products?
SW: There’s usually a company-level view – often a CEO agenda item. And this is a question for regulators and governments too. A key part of macroprudential stability is the ability, whether in insurance or banking, to provide funding and risk capacity for the economy to get going. There’s a huge amount of engagement among senior regulators regarding the prudential side, as well as the conduct or customer side. We see a lot of focus within European finance ministries on the cost of furlough schemes, the potential hit to tax revenues, and a great desire to get economies going again. The door is firmly open to good ideas, particularly ones that don’t require immediate cash contributions. So we see a coalition of the insurance industry, regulators, and governments to make these things happen.
DM: Is this specifically linked to the fear or the threat of pandemics? After all, pandemics have been with us since biblical times. Or is this more about the threat to society of enforced lockdowns for whatever reason, which could be due to terrorism or natural catastrophes. And then there’s also the effect of other interactions with the globalised supply system. The insurance industry could work together with governments and regulators to make the world a safer place. Can an you give me an inkling of the kind of threats you’re looking at?
SW: People are not so worried about the pandemic per se, it’s much more the societal impact of the lockdown and the consequent financial impact. We’ve spiralled down through a combination of health worries leading to lockdown, leading to economic slowdown. The desire is to reverse that spiral, also by providing confidence on health.
DM: Can you give an example?
SW: Reinsurance can provide support to the supply chain for vaccine production. Providing security on vaccines getting from country A to country B, for instance in maintaining temperature controls, is a highly delicate job – providing cover for that is important. With risk financing comes the ability to borrow money, and you can then restart the economy. Risk coverage for small business owners so they can reopen is another example. We’ve seen that in Switzerland and Germany, where insurers are paying out on business interruption claims to the restaurant industry or the Munich beer gardens, to get those businesses going again. That creates confidence and momentum in the economy. It’s a combination of removing the medical concerns and providing confidence that businesses and people can get going again. That then can help create a safer world.
DM: Synthesising what we’ve been talking about, it seems that there’s three main strands to the successful insurance company of the future. First, get the nitty gritty right, all the things that could go awry – people, operations and technology. Second, without the necessary finance and some powerful systems behind it, even companies with the best ideas will not prosper. And third, there’s innovation and an eye for the bigger picture. Are there companies that combine the best of all these worlds?
SW: The bigger stronger companies are generally better placed, better resourced to invest in the nitty gritty, including in digital transformation, and they have the financial wherewithal to weather the storm. The bigger groups are in a stronger place than the midsized companies. But there is a cost of size, in terms of lack of agility. The market is moving rapidly – not just the financial markets, but also in terms of customer affordability, customer preferences and so on. The winners will come from a combination of the bigger groups with agility to amend their strategy to take advantage of opportunity, and the more agile, digital start-ups with enough financial wherewithal to survive.
DM: And there will be consolidation, won’t there?
SW: Some capacity will come out to the market. We’re already working on M&A deals regarding firms with rating agency and capital challenges. Some really exciting fintech companies are struggling with funding and looking for safer homes. So, yes, there will be consolidation.
Additionally, we must consider the rise of alternative capital, as hedge fund capital comes into the insurance and reinsurance industry. The question is how long that money will stay around given the opportunity to invest in other parts of the market now at higher returns, and also in view of some of the losses that have come through.
DM: Who will be the industry trailblazers in the next five to 10 years?
SW: The more open-minded big players will be the winners. Firms more biased towards non-life and risk products will be able to accelerate out of the problems more quickly. It’s easier to turn a non-life business around, to write better rates and to innovate than for the life companies. In this latter group, there will still be a drag of legacy books particularly in a low interest rate environment, where the guarantees that have been written in the past will continue to be very capital intensive, and drag on capital returns and resources. The good start-up companies will do well, too – as well as the more agile bigger companies.
DM: Perhaps a large company with lots of start-up mentalities within it, that might be the one to go for. That’s a good note on which to end. Simon, thanks very much for talking to me about the insurance industry’s challenging times.
David Marsh is Chairman of OMFIF.