In the 2007-08 financial crisis, insurance giant AIG’s mispricing of credit default swap risks was one of the most dangerous chapters in a drama that nearly destroyed the global economy.
While insurers’ role in the current crisis is yet to be written, it is likely to be more legalistic. The question yet to be resolved, at least for investors in the sector, is whether policy wording could yet leave insurers on the hook for substantial, potentially crushing, claims.
For the UK economy, this question has focused on two policy lines in particular: travel and business interruption.
In the first case, there are already signs that the hit could be large. To begin with, big names including Aviva (AV.), Admiral (ADM) and Direct Line (DLG) have already suspended the sale of travel insurance to new customers, suggesting underwriting is neither functional nor possible amid the growing shutdown of international movement.
That puts any potential buyer of travel insurance in a bind. The coronavirus pandemic is now clearly an enormous threat to any travel plans this year, but as it is now classed as a known and foreseeable event, it can no longer be covered. For example, Direct Line – which had 3.6m in-force travel policies at the end of 2019 – has said that any new trips booked on or after 13 March will not provide cover for any claim caused by the pandemic.
This doesn’t mean travel insurers will avoid an avalanche of claims. In recent weeks, the UK Foreign and Commonwealth Office (FCO) advised against all but non-essential travel to a growing list of countries – including holiday hotspots such as Spain, India, Italy and the US – due to the coronavirus. This is normally a key trigger for insurance policies to pay out, regardless of a policyholder's plans to cancel. On Tuesday, the FCO extended this advice to cover all countries for 30 days, although at this stage it is hard to imagine an extension is off the table.
The Association of British Insurers (ABI) welcomed the FCO’s designation, arguing it “actually provides welcome clarity for our customers and the industry”. Clarity could still mean that a major income-generating activity is currently broken.
One of the most exposed companies in the sector is retiree-focused Saga (SAGA). Although its activities include health, travel, home and car insurance, it normally derives around half of its cash profits from packaged tour and cruise activities.
Things aren’t going well in this department. Last week, the group warned that impacts to its cruise business would hit pre-tax profits by £10m-£15m this year, after it was forced to suspend all sailings until at least May. Analysts at Peel Hunt reckon the hit could be longer and more painful, potentially testing the group’s debt covenants. “A pre-emptive rights issue should not be ruled out in a worst-case scenario that the disruption takes longer than six months,” said the brokerage in a recent note to clients.
Business interruption insurance presents another test for the industry. Until recently, the issue centred on the official classification of Covid-19 as a so-called ‘notifiable disease’, which was confirmed on 4 March. However, there is no consistent approach to the way insurance policies cover pandemic illness.
“Some policies exclude infectious diseases explicitly, while others are conditional upon a public body declaring either that the outbreak amounts to a pandemic or is a 'notifiable disease',” says Ben Hilary, an insurance solicitor at law firm Pinsent Masons.
The claims risk therefore depends on whether a policyholder sought specific cover for the effects of a pandemic, or forced closure by the authorities. Peel Hunt reckons the hit from business claims including interruption, general liability and event cancellation insurance could have a “material impact” on the likes of Beazley (BEZ), Hiscox (HSX) and Lancashire (LRE).
The ABI believes most policyholders will not have purchased cover that will enable them to claim, although the larger the policy, the more likely exceptional coverage will have been sought.
Either way, it is impossible to quantify what these risks might cost insurers. This week, Aviva said it has not yet factored in “any increase in insurance… that may arise from Covid-19”, despite posting a 31 percentage point drop in its solvency coverage ratio to 175 per cent since the end of 2019. Within that drop, just seven percentage points reflect payment of the group’s final dividend, meaning lower interest rates, wider corporate bond spreads, and the sharp decrease in the value of Aviva’s own equity have already had profound impacts on the group’s capital base.
