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The CRO’s role in a crisis: Estimating the impact of COVID-19

Risk & Analytics|Insurance Consulting and Technology|Reinsurance
COVID 19 Coronavirus|Risk Culture

By Chris Bird , Stas Eratt and Dave Ingram | June 5, 2020

Do you know how COVID-19 will impact your company’s financial plans and performance for the remainder of this year?

The question has come down to you, the chief risk officer (CRO), and the executives and board want an answer as soon as possible:

“How does COVID-19 impact the company’s financial plans and performance for the remainder of this year?”

You set to work. The first step is to understand how the balance sheet and solvency position have moved since the end of the year. With the extreme levels of volatility in market values, some firms are on weekly, and even daily, monitoring and reporting schedules.

The focus should be on the solvency position: What it appears to be now and how it might develop over time. Given the great level of uncertainty it would be sensible to consider this by using a range of top-down scenarios.

The starting point

The starting point is to determine how capital and surplus levels have moved since year end. Firms at risk of breaching the required capital for their desired ratings or their risk appetites should be planning remediation strategies to strengthen their positions.

Consider the various ways that the crisis could play out, so that you can mitigate its effects and develop a strategy that is resilient to the uncertainty and equally those crucial actions that must wait for the situation to become a little clearer, such as re-calibrating models, correlations, dependencies and so on.

Movements in asset values have been extreme, and asset classes that have sometimes provided diversification, such as equities and fixed income, have been positively correlated at times. This does not mean that you have to worry about re-calibrating models just yet. That is something that can wait until later in the year. Companies should also be re-valuing future cashflows to reflect the changes in yield curves since the end of last year.

Estimate the insurance event impact

The exact impact of COVID-19 on insured liabilities is going to take some time to estimate, and the impact on your business needs to be considered at a bespoke and granular level.

In addition, it is still the very early days of this rapidly developing pandemic event. There are still a large number of uncertainties that would stop you (and other companies) from developing a reliable point estimate of the impact, such as:

Key uncertainties

Premium volumes

  • Energy premium tied to oil prices and level of demand
  • Aviation related premiums due to reduced demand
  • Reduced premiums due to reduced activities

Business interruption (BI) and contingency (event cancellation)

  • Extent of claims for BI due to government mitigative actions such as lockdowns and social distancing policies  
  • Policy wordings and effectiveness of wordings in having intended impact:
    • Physical damage trigger
    • Explicit pandemic exclusions
    • Coverage for named perils only

Employment practices liability

  • The propensity for those employees who are made redundant to claim wrongful termination or discrimination

Directors and officers (D&O)

  • Propensity for lawsuits to be brought against D&O in respect of statements made to the market about their response to coronavirus.
  • Claims arising from incorrect or misleading regulatory filings
  • Extent of company bankruptcies.

Investment returns

  • Eventual level of interest rates
  • Reaction of stock market to returning economic activities
  • Level of Credit spreads 
  • Amount of default activity

General liability (includes nursing home professional liability) 

  • Propensity for plaintiffs to bring lawsuits alleging companies were negligent in the transmission of coronavirus 
  • The ability for plaintiffs to prove negligence by the accused

Mortgage

  • Future unemployment rates and impact of economic downturn on home prices 

Political risk, credit and surety

  • Severity of economic downturn
  • Extent of government support provided to businesses

Personal travel

  • How quickly the demand for holidays returns 

Workers compensation

  • The number of claims brought by healthcare workers, who are most at risk of contracting COVID-19

The business plan and scenario testing

Once you think you’ve got some idea of your current position, turn your attention to the future outlook. With economic activity crashing, the premium estimates in the business plan are probably looking unrealistic now. But with so much uncertainty about how things will play out, how can you come up with a credible revised plan? Our view is that you do not need to. Instead of trying to predict what will happen, consider the what could happen.

The objective should be to not only assess risk but also work out future strategy and risk mitigation measures. This requires a top-down, holistic approach where possible impacts on different functions (e.g. sales, claims, business planning, reserving, reinsurance, operations) are considered.

You can probably conceive of two or three scenarios of how the crisis could develop. For example, that society quickly gets a handle on things or that lock-downs drag out until the end of the year. So, rather than trying to create a single plan, we recommend that you look at each of these scenarios and then try to construct a high-level plan or forecast for the business in each case. This has great value as management can then prepare for the different eventualities and develop a strategy that is resilient to the uncertainty.

For example, for each scenario, the finance and capital teams can make projections of the level of capitalization and solvency. In parallel, there can be similar projections of rating agency capital requirements. Together, these projections can inform capital management strategy. For instance, to address questions such as should we continue to pay dividends? Or, do we need to raise additional capital?

When constructing the scenarios, it is important to test the resilience of the risk management framework and capital adequacy beyond just the current crisis. This will require consideration of extreme and stressed scenarios. While risk to investments is the area that is likely to be impacted most by the current pandemic scenario, the stress tests should also consider other events (e.g. windstorms) that could happen later in the year and further test the durability of the framework.

Evaluate the alternatives

No one can accurately predict how the crisis will play out. Instead, we recommend that you consider alternative scenarios for how the situation could evolve, estimate the corresponding impacts, and then identify the management actions that you would plan to take in each case.

Taking these critical and informative steps will put you in a position to make more considered and informed decisions, including responding to regulatory interest in what the COVID-19 upheaval might mean for your existing economic models.

Later in the year

It’s possible that the pandemic will cooperate and follow one of your scenarios. But experience so far suggests that this is not very likely. It’s more probable that you will be updating the scenarios one or several times before the year is out.

Certainly, one of the considerations going forward is whether to streamline the scenario testing process and expand the set of scenario tests being performed given the need (both internal and external) of more regular reporting and the amount of new information being reported. Automation of scenario testing along with the whole process around capital modeling and reporting function is the latest trend that we see insurers looking to implement.

No one knows when or exactly how the COVID-19 crisis will end. But by taking these actions, you will be much better prepared for a range of scenario – and to answer the question, “How does COVID-19 impact the company’s financial plans and performance for the remainder of this year?”

Authors

Senior Director - Technology Program Management 
Insurance Consulting and Technology

Director – Risk, Insurance Consulting and Technology

Head of Willis Re ERM Advisory

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