Expert article by Claude Schwarz in the magazine Schweizer Personalvorsorge, November 2020

Coronavirus: A life insurance provider’s perspective

Despite all of the medical advances that have been made up to the present day, life insurance providers are still confronted with the problem of the risk of increased mortality due to infectious disease pandemics. Pandemics will continue to occur in the future, but it is impossible to predict exactly when they will occur or what the effects on mortality and disability rates will be. With this in mind, how can a life insurance provider prepare for the risk of a pandemic?

Over the last few centuries, mortality risk has decreased. However, despite medical advances such as antibiotics, antiviral medications and vaccinations, life insurance providers are still confronted with the problem of the risk of increased mortality due to infectious disease pandemics. Influenza pandemics occur at irregular intervals. The Greek physician Hippocrates described a pandemic as early as 400 BC, and thanks to more precise records being kept since the Middle Ages, we now have relatively good knowledge of pandemics.

A total of 13 influenza pandemics have been recorded in the last 300 years, and these occurred at varying intervals. In that period, the time between two pandemics fluctuated between 2 and 56 years. Based on the historical data, the probability of a pandemic is three to four per cent in any given year. Given that the most recent pandemics occurred in 2009 (swine flu), 1968/69 (Hong Kong flu), 1957/58 (Asian flu) and 1918 (Spanish flu), the current SARS-CoV-2 pandemic conforms well to this model of periodicity. 

Pandemics will continue to occur in the future, but no one knows when they will occur or what the effects will be. So how can a life insurance provider prepare for the risk of a pandemic despite this fundamental uncertainty?

Business continuity management: emergency plans must be in place 
It is crucial (and this applies to all companies), to ensure that company operations can continue even if employees are unable to come in to work due to official restrictions on their freedom of movement. The situation at the beginning of the coronavirus lockdown made it clear that effective business continuity management is essential. 

The global population today is so mobile that a new virus can spread around the world very quickly. Drastic restrictions on freedom of movement may have to be imposed from one day to the next in order to control the spread of a pathogen. In real-life situations, there is often no time to make preparations, which is why emergency plans must already be in place. In the service sector at least, the increasing digitalisation of work has made this aspect of pandemic management relatively easy to handle: employees can work from home via the Internet.

Insurance-specific risks: mortality and disability 

The most obvious risk for a life insurance provider in a pandemic is the risk of death. If a pandemic leads to an increase in mortality rates, the immediate consequence for life insurance providers will be an increase in death benefit claims. Life insurance products usually provide full coverage for both death and disability due to a pandemic virus. On the one hand, providing cover for such risks is precisely the purpose of these risk products, but on the other hand, in the event of a claim, it is often difficult to establish a causal link between the death or disability and the pandemic virus due to pre-existing conditions and infirmities.

Approaches to pandemic risk management for life insurance providers 
As mentioned above, it is at least possible to roughly estimate the probability of a pandemic occurring. Solvency rules require insurance companies to reserve risk capital for the risk of pandemics. This risk capital comes with a cost of capital, which must be taken into account in the premiums for risk products. In other words: life insurance providers need to anticipate the occurrence of pandemics and take the appropriate precautions, which is to say that they need to reserve sufficient capital for such an occurrence. In this way, customers will have cover they can depend on in the case of a pandemic. 

Insurance companies cannot use a strategy of international diversification to reduce the risk they are exposed to by a pandemic because a pandemic is global by definition. Life insurance providers can manage pandemic-related risk in accordance with their company’s appetite for risk and their risk capacity by transferring part of the risk to reinsurers. However, because pandemic risk is difficult to diversify even for reinsurers, there is hardly any capacity for stop-loss insurance (overinsurance), which is very efficient for pandemic-related risk.

Useful modern solutions include mortality cat bonds, which ultimately transfer the pandemic-related risk directly to the capital market. It will be interesting to observe whether the current SARS-CoV-2 pandemic will result in excess mortality that would ultimately lead to defaults of outstanding mortality cat bonds. 

The outlook: risks and opportunities for life insurance providers 
Death benefit insurance is not the only area in which the current SARS-CoV-2 virus can be expected to have a damaging effect. There will also be damaging effects in the area of personal insurance policies – especially daily sickness benefit (DSB) insurance – where claims will become more frequent and expensive due to COVID-19-related illness. Furthermore, it can be assumed that the economic effects of the pandemic will also indirectly lead to an increased claims burden in the area of DSB insurance. 

What is already happening in the area of disability products in the short-term is therefore probably only an initial sign of things to come for life insurance providers in the area of disability pension products: there have already been increasing reports of long-term health damage caused by COVID-19 that could result in disability. In addition to this anticipated increase in cases of long-term disability, the economy will also suffer as a result of the pandemic. This, in turn, could lead to increased pressure on employees, which could result in a marked increase in rates of mental illness and therefore higher levels of disability. 

For life insurance companies, a pandemic brings not only risks but also opportunities. This is because in such times, the population is confronted with the risks of death and disability to a much greater extent than usual. People are also becoming increasingly concerned about the potential financial consequences of being infected with a pandemic virus. For these risks, life insurance providers should flag any gaps in coverage to policyholders and offer solutions in the form of corresponding products that cover the risks of death and disability. Ultimately, this will allow the insurance industry to make an important contribution to building a more resilient society.

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Claude Schwarz
Chief Underwriting Officer