The current circumstances are having a dramatic effect on business, particularly in the insurance sector. Bradley Chadwick considers the impact of COVID-19 on insurance intermediaries, their lenders and investors.
Lenders to and private equity (PE) owners of insurance intermediaries will be acutely aware of the impact that the COVID-19 situation is having on insurers, whose products their intermediaries are dependent upon. I think John Neal, Lloyds of London CEO, and Huw Evans, the Association of British Insurer's (ABI) Director General, sum this up best:
John Neal has said that the coronavirus pandemic is likely to be the most expensive event in history for the insurance industry, and that payouts to customers could be higher than USD 50 billion. He believes this is compounded by the fact that insurers are also likely to have to refund some premiums because of the general downturn in business1.
The ABI estimates that as of 28 April 2020, excluding those made through Lloyds and the London markets, there will be £1.2 billion in claims made as a result of the outbreak. This is primarily across business interruption, travel and event insurance2.
While these views and the daily updates on the likely impact that the situation will have on insurers is essential reading, we're not seeing corresponding analysis of what the impact will be on insurance intermediaries or the intermediary market generally. While our understanding of the consequences of the pandemic is evolving, I have some initial thoughts on what this may mean for the intermediaries and their lenders and investors:
Short-term loss of revenue
Reduced economic activity as a result of the coronavirus outbreak will almost certainly reduce revenue during both the quarantine and the down-turn that now seems likely to follow. While the most-severe loss of revenue will be experienced by managing general agents (MGA) and brokers specialising in products such as credit insurance, individual and multi-trip travel insurance, events insurance and aviation insurance. The wider sector will also experience a loss of income as the economy falters.
Some insurance intermediaries will not only lose future revenue, but may have to refund premiums already written. This will include intermediaries whose product premium is based on economic metrics, such as turnover or payroll, and intermediaries whose policyholders will seek mid-term adjustments (MTAs) or cancellations for policies not required during lockdown. An example is fleet insurance where the insureds' cars are not being used as anticipated and where the insurer is willing to provide MTAs because loss development will be favourable. The loser in this scenario is the MGA or broker who experiences a loss of revenue.
Claim levels may be such that those MGAs whose binding authorities include an underwriting loss ratio “profit share” component do not earn the contingency cheques they had expected. This can be a material part of income structures such that its loss could be detrimental to insurance intermediaries’ liquidity positions. Meanwhile, third-party administrators specialising in handling claims associated with areas where insured loss volumes are down, such as auto, are experiencing a reduction in volume and revenue that may impact their business.
Reduction of binding capacity
Given the level of projected losses in the market, insurers will need to consider how best to deploy their underwriting capacity. I'd expect this to include an analysis of lines of business and distribution channels so as to support decisions about what products to sell, at what level and through which distribution channels. It is probable that there will be insurance intermediaries who will be winners and losers in this re-alignment, and in the worst cases intermediaries may have their binding capacity restricted, non-renewed or withdrawn.
Operational resilience for insurance intermediaries
The current climate has shone a spotlight on the resilience of both insurers and their vendors: software, call centres, third-party administrators, MGAs, brokers, etc. As insurance regulators had already issued multiple consultation papers on operational resilience3, the current situation may accelerate the regulators and insurers focus on this. Insurers will look at their distribution network and service providers to identify who was unable to perform policyholder critical functions and why not.
It is possible this will lead insurers to make changes to vendor audits and vendor-selection criteria. It is also likely that insurer and regulator focus on operational resilience will, in turn, pose challenges to some insurance intermediaries whose operations and IT systems may not be as resilient as the standards set. In these circumstances, intermediaries will need to invest to ensure systems are sufficiently robust. This investment will require both liquidity and management capacity at a time when both may be scarce.
Defending claims against their own business
Given what we've seen in recent years with the cottage industry around PPI re-dress claims, it is possible that similar activity may spring up for policyholders to claim for alleged mis-selling of insurance policies that did not provide the cover the policyholders thought it did. We've seen early signs of this with policyholders banding together to bring collective coverage disputes.
An early indicator of what may follow is the Hiscox Action Group. Initial action is being taken against the insurer themselves, however, insurance intermediaries who sold the policies that are in dispute may well be caught up, either through claims from the insurer or from the insured.
While I've focused on the headwinds there are some tailwinds and mitigations, which I should highlight:
There may be a hardening of the insurance market, with a resultant increase in premiums and commissions earned by the insurance intermediaries
While helpful, these tailwinds won't be a panacea for those insurance intermediaries hardest hit by the pandemic. It is, therefore, worth considering what lenders to and PE holders in intermediaries could be doing now to prepare for and mitigate downside risk.
Advice for stakeholders of insurance intermediaries
Firstly, early engagement with the management teams of the insurance intermediaries to understand how they see their business being impacted by each of the head and tailwinds outlined above, as well as those not identified by this short piece. Use these discussions to both model the impact of scenarios on covenants and liquidity, as well as to look externally and consider relationships with insurers and any risk to your binding authority. Those of you familiar with the Boston Consulting Group (BCG) matrix should expect that the carrier will be categorising its intermediaries into stars, cash cows and dogs, and will be intent on supporting the stars and cash cows, while dealing with the dogs
It is also important to engage with insurers early, which should include dealing head-on with any operational resilience challenges, actual loss ratios experienced/projected versus the insurers expectation, and the expected impact of any lost revenue on your business and how robust your business is. In my experience, an authentic and transparent discussion with your insurers about challenges and remediation can deliver dividends.