Trang Duncanson, Deloitte Life Insurance Partner and Actuary considers some of the specific implications of COVID-19 on life insurers, in particular the need for companies to update their Internal Capital Adequacy Assessment Process (ICAAP) stress test processes to inform the Board on the impacts to profits, capital and to plan a pathway to the restoration of ‘normal’ operating target surplus.  

Dealing with the Immediate Responses

Overall the implications on the following four areas will be the most immediate. 

• Business continuity plans, as more operations will need to be performed remotely, as the established BAU processes and technology systems are impacted. Any offshored processes will need rapid review.
  
• Claims payment is an essential ’moment of truth’ for life insurers as they need to ensure customers are treated fairly and efficiently at this time, and that claims operating staff have access to the systems and tools required.
  
• Capital adequacy will need to be tested to assess the range of potential mortality (death) and illness outcomes, and the immediate impacts on the capital base.
  
• Strategic plans will need to be reassessed and reset under COVID-19 scenarios, including impact to intermediaries and on customer affordability and demand.

While business continuity impacts will be the more immediate concern for life insurers, the focus here is on financial impact considerations for life insurers, in particular on their ICAAP processes.

Ensuring the Restoration and Recovery of Capital

Life insurers will have established ICAAPs in place with an increasing ladder of intervention, with triggers requiring actions as its capital levels fall below certain levels over time. This is supported in the ICAAP via stress and scenario testing, which has been developed over the last five to seven years under APRA’s supervision.

There will typically be established scenarios within the ICAAP considering a pandemic, a recessionary or depression scenario, as well as a China downturn scenario. This suite of assumptions should be revised and updated for the emerging events from COVID-19.

Life insurers must hold regulatory capital for an ‘event’ stress under APRA’s prudential capital standards for insurance risk, which was introduced explicitly in 2013. The minimum requirement is to allow for a pandemic event causing death and illness across its portfolio to a specified level. 

Most life insurers hold only the ‘minimum’ within their insurance risk capital.  It is imperative that the life insurer stress test its existing capital levels for adequacy against the emerging impacts from COVID-19 by considering the following:

• Age distribution of its portfolios - Currently the emerging death rates are particularly high for the older age groups and lower for the 30-55 year ‘working’ age group (the insured aged population). However, depending on the infection rates across the Australian population, the minimum event risk capital may not by itself be sufficient.
  
• Employment mix of its portfolios – insurers with group insurance schemes should test for significant exposure to the particular segments of the working population with high death or illness exposures, such as health care, hospitality and tourism workers. 

Other impacts on the life insurer’s capital base, which should be incorporated in this round of stress testing for COVID-19 include:

• Subsequent morbidity issues – there is going to be an increase in stress related claims as a result of the societal ‘lock down’ that has been enacted across the country. This could result in higher levels of anxiety, stress and mental illness occurring across a broad section of policyholders, in particular those of 30-55 years where there is employment, financial and family pressures exasperated by changes to everyday life. Insurers need to both operationally plan for this in their claims area as well as consider the capital implications of greater incidence and claim longevity for disability income and TPD.
  
• Unemployment rate impacts on income protection portfolios - the closure of the ‘non-essential’ chain of services will increase unemployment rates. There is a past known positive correlation between unemployment rates and worsening claim rates on income protection portfolios, manifesting mostly in lower termination rates and a drop in ‘return to work’ rates. In recent news, unemployment rates in Australia are tipped by economists to increase from around 5% to 10%-15%. Life insurer recessionary scenarios may have already considered these rates and those that are even higher if a depression scenario, where 30% unemployment rates were to occur.
  
• Economic impacts on assets and liability valuations – the large falls in the share-market due to the worldwide economic uncertainty coupled with the forecasted impacts on country by country GDP growth may be prolonged over one to two years. Government bond rates have been reduced, and the liquidity of certain assets such as corporate bonds has fallen.  All these factors point to material short term adverse impacts on the capital base as well as capital requirements through reductions in asset values and increases in the discounted value of liabilities.
  
• Community expectations on life insurers have been heightened post Royal Commission. In this environment, there will be an expectation for insurers to waive any pandemic exclusion clauses, and the cost of this should also be considered in the stress scenario modelling.

There may be some positive assumption impacts that should also be considered by the life insurer in the COVID-19 scenario. These include the impact on risk insurance sales (potential increase in volumes) and potentially some reductions in asset concentration risk charges as asset values fall.

The direct financial impacts on the life insurer are therefore multi-faceted. However, the financial net impact on life insurers will be negative with even greater strain to emerge for life companies over the medium term.

Life insurers are well placed as an industry as they have a comprehensive and established ICAAP process in place.  Notwithstanding this, life insurers will need to urgently test their ICAAP and put in place much more regular solvency reporting to their Boards and APRA.

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