In this article we discuss potential implications of the COVID-19 pandemic on the best estimate assumptions and capital modeling under solvency II for life insurers. The observations are more applicable to life insurers but can also be relevant for reinsurance.
Our conclusions are based on our experience on the insurance market in Luxembourg in autumn 2020 and might not be relevant if circumstances change and new data is made available.
Building and reviewing Best Estimate (BE) assumptions has to follow the EIOPA guidelines(eiopa-bos-14/166 en) in terms of consistency, appropriateness, materiality and proportionality. Most companies perform experience reviews of BE assumptions using experience data which is monitored on a regular basis, commonly on a monthly or quarterly basis.
In the light of the current COVID-19 situation, we observe impacts on recent past and expected future experience. It requires insurers to pay more attention to regular routine with experience studies. Insurers would need to assess if the existing frameworks and practices are applicable in this fast changing reality that the coronavirus crisis has triggered.
In the following sections, we take a look at what insurers should ideally look at per different risk factors.
Mortality
Actuaries in life insurance companies will need to determine the impact of COVID-19 and whether it is required to revise the mortality assumptions.
In Luxembourg, the direct impact of COVID-19 on insured life mortality rates is not expected to be significant due to the type of products exposed in the market, mainly savings rather than protection products.
However, insurers should consider correlation in death impacts, both positive and negative. For instance, deaths due to complications and lower road accidents respectively, to name some. In the same line, they should take into account that potential adjustments to mortality may need to be age-group specific. It is observed that the population is affected differently, namely, high mortality rates increase with age.
Morbidity
Immediate and long-term effects of COVID-19 should be monitored when it comes to morbidity rates. COVID-19 impacts are of different kinds:
Economic, e.g. rising unemployment, business closures, increase in debt, etc
Social, e.g. psychological impacts due to the lockdown and,
Medical, e.g. limited access to healthcare and delayed treatment due to social and government restrictions.
Another major event we’re all observing is the occurence of a second infection wave—and eventually a third one, and the uncertainty around both vaccine treatment and vaccination strategy which could lead to an extension of the crisis and, thus, to slower economic recovery and financial distress (Institute, 2020).
Lapse
The effects of a pandemic such as COVID-19 can be uncertain on the lapse of policies. For instance, policyholders may hold on to their existing life insurance covers. However, the deterioration of the economic environment and the business climate could force policyholders into “lapsing” their contracts because of the economic situation they are going through.
Conventional pricing models use risk factors that are based on traditional data sources such as demographic data—gender, age, occupation and address. These conventional models don’t fully identify and capture unusual policyholder behavior patterns affecting the decision-making process that eventually leads to early lapses.
Life insurance policies—e.g. With Profit savings (WP) and Unit-Linked (UL)—need to be closely monitored because of the possible impact of dynamic lapses (that should be separated from structural ones) as policyholders are more likely to react to a decrease in their equity portfolio than to other (macro) economic factors.
Premiums
Some life insurance products offer long-term guarantees which can extend to the horizon of human life. Insurers should also consider the effect of the COVID-19 crisis on the policyholders’ behavior when it comes to the (deferred) payment of the premium.
Companies need to either reflect these changes in their future assumptions or explore new scenarios to identify the impact of timing of premium payments as this will also impact ORSA underwriting scenarios. The financial reporting mechanism may also need to be reviewed in order to reflect these changes in premiums.
Claims Management
Claims management is an important building block in the operation of an insurance company. Good performance, in this case, depends greatly on the operational efficiency of the insurer in terms of how it adapts to new working habits—remote working, for instance—and the availability of resources to handle any claims increase.
One major impact of the coronavirus-related governmental measures is some policyholders’ difficulty to visit their treating doctors and other specialists with the same frequency in case they couldn’t use any other new consultation method like video-consultation.
This would probably induce a sudden increase in specific health-related claims once the government measures are eased. As a result, insurers’ capacity to handle claims can be put to test. A key point to note is that actuaries will need to coordinate with other functions to adjust their assumptions accordingly.
Reserving
A pandemic like COVID-19 will surely impact the claims reserving process of life insurance companies that may need to review it due to possible changes in IBNR, future premium payment and lapse rates. This will indirectly shed light on the accuracy of reserving and forecasting models and their capacity to adapt to changes in the claims management process.
The Best Estimate assumptions are required to be unbiased. So, COVID impacts will force actuaries into more flexibility when forming both actuarial and financial assessments through stress testing multiple scenarios which, in turn, could help companies make efficient decisions using the available insights/data to date.
To some extent, life insurance companies are likely to increase their reserving margins to their local GAAP provision. By doing so, they can cope with the unfavorable variations from various demographic and economic factors.
Communication
Companies will need to communicate impacts arising from changes in best estimate assumptions to relevant stakeholders—Board of directors, external or strategic investors, auditors—particularly when these impacts could affect long term profit margins.
Any changes in Best Estimate Liabilities (BEL) and views of Present Value of Future Profit (PVFP) are to be disclosed as part of Solvency II reporting process. These changes would certainly be closely monitored as part of regulators’ duties.
Other considerations
Although individual impacts might be critical per se, they can affect insurers more severely if considered all together. On top of the key factors discussed above, one can mention a few others that can be critically important for certain portfolios:
Understanding customer needs and new behavioural aspects which might affect customers actions (e.g antiselection);
Potential change in both new business volume and profile, and the impact of the latter on pricing and allocated expenses;
Significant impact on the risk-free rate, effective yields and risk premiums;
Possible impacts on asset volatility and also on liquidity premiums when calibrating economic scenario generators;
Possible changes in expense management as well as maintenance/acquisition expenses allocation.
A final reflection
Life insurance companies are facing a big challenge and their operating models could be put to the test.
They should make quick adjustments to successfully address the shift to virtual (remote) environment activities, and also to pay close attention to evolving policyholders’ habits in terms of needs and guarantees.
All this, without losing sight of the solvency and operational risks that emerge in a crisis such as that of COVID-19. After all, their financial resilience over the long term depends greatly on it.
Most importantly, the actuarial function will need to show its ability to swiftly propose practical action plans to meet the changing risk appetite and embed solvency management strategies intended to hedge an onerous and capital-intensive market.
What we think
Pavel Kostyuchenko, Head of actuarial services & Director at PwC Luxembourg
At PwC Luxembourg, we believe that the actuarial function could play an important role in the strategy of the company in the post-COVID19 era. In fact, actuarial function enables actuaries to contribute as a better business partner to help meet company-wide goals. This means better utilising processes and technology so that actuarial staff can spend more time on value-added planning and analysis and provide more robust decision support.
