Ratings Agencies Start to Sound Alarm Bells

The major ratings agencies have been busy revising their outlooks for the major financial sectors and for individual firms in the wake of the Covid-19 pandemic. They have been cautious in their re-assessments but some will make uncomfortable reading for insurers.

As more detail on the impact on individual firms and classes of business become clear it will be inevitable that others with suffer the same fate as the London specialty market – including Lloyd’s – which has been downgraded from stable to negative by Fitch.

There were several factors that weighed heavily on Fitch as it made this decision.

One was the likely impact on the market of the large claims in classes in which London has a major share, such as event cancellation. Alongside this is the huge disruption to sectors strongly represented across the London Market such as aviation.

Fitch also highlighted the difficulties the market will have in conducting business with only around 70% currently placed electronically: “Business transacted in the London Market typically relies heavily on face-to-face interaction and this could be significantly disrupted if the Covid-19 outbreak is prolonged”, said Fitch.

Other agencies have focussed their attention on life offices as they believe they are more vulnerable.

“We consider that life insurance companies are more at risk of negative rating actions as a result of the pandemic than non-life players, because they have larger exposure to financial market risk”, said Standard & Poor’s, although the agency retained its stable outlook for European and North American life insurers. Its immediate concerns were focussed on the Asia-Pacific region which it downgraded to negative.

AM Best took a gloomier view of the UK life insurance market, downgrading it to negative.

“In AM Best’s view, the industry maintains strong capital and liquidity resources, however, key factors that have led to the change in outlook”. These included:

  • Material uncertainty as to the severity of the impact of market volatility on capital positions
  • Pressure on earnings due to equity market declines and the low interest rate environment
  • Increased risk of corporate bond defaults due to deteriorating economic conditions

Moody’s, however, highlighted some of the threats to the non-life sector, warning that governments in Europe and North America were coming under pressure to force insurers to make ex gratia payments to businesses adversely affected by the widespread lockdowns of social and economic activity.

“Insurers face the risk that governments will exert pressure to make ex gratia payments to their clients or make some other form of financial contribution to the resolution of the crisis”.

This will be contested by insurers who are already warning that the costs of claims across all classes in the UK could easily exceed £1bn, according to the Director General of the Association of British Insurers, Huw Evans.

“What insurers cannot do is pay out for claims where customers have not paid for the cover; this is a shortcut to insolvency. We do, however, have to build a better future solution to ensure more widespread business insurance cover for pandemics”, said Evans.

Increasingly, the discussion on how to do this is moving towards a state-backed solution similar to Pool Re for terrorism or Flood Re for flood cover: “The state will have to be front and centre of such an effort, but the insurance industry is ready to talk about how it can be an effective partner in building more widespread protection against pandemics than we have seen with Covid-19”, Evans told the Financial Times.

The ratings agencies’ relatively sanguine view of the impact on the general insurance market was also challenged by Munich Re which became the first major global re/insurer to post a profit warning as a result of the pandemic. At the end of last week it withdrew its previous profit guidance, cancelled a planned share buyback and warned of the level of claims it is facing, which include a significant line in the cancellation cover for the Olympics.

“In the first quarter of 2020, Munich Re’s property-casualty reinsurance segment saw a considerable claims burden from losses in connection with the effects of the significantly worsened Covid-19 crisis. The claims expenditure is due mainly to the cancellation and postponement of large events. Hence, even though work on the quarterly accounts has just begun, Munich Re only anticipates profits in the low-three-digit million-euro range for the first three months of 2020”, said the company’s statement. In Q1 it posted a €633m profit.

So far, insurers have been spared the savage downgrades the ratings agencies have inflicted on banks, especially in Spain and Italy, but that may not last as the economic damage of the pandemic escalates.

David Worsfold