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Asset Management CultureMarch 26, 2020

AM Best Creates Pandemic-Related Stress Test for Insurance Firms

Pension risk transfer market likely to slow because of downturn.

Global credit rating agency AM Best is developing a COVID-19 pandemic-related stress test for insurance firms’ balance sheets to determine the impact that the economic fallout of the coronavirus will have on their risk-adjusted capital levels, investment portfolios, and reserve adequacy, among other aspects of the risks they carry.

“The COVID-19 virus is unique in its scope and complexity of potential losses, and the uncertainty regarding the near-term impacts further exacerbates the situation,” AM Best said in a statement. “Consequently, the direct and indirect effects of the outbreak may not be understood fully for some time.”

The firm said it will send a questionnaire to rated insurance companies to determine how their operations have been affected by the pandemic, which lines of business they expect to be negatively impacted most, or if they expect any overall assumptions or forecasts to change. AM Best said it will also seek results of each organization’s own stress tests, which are typically considered when assessing each rating unit’s enterprise risk management framework.

The stress test follows previous crisis-related stress tests AM Best has conducted after events such as the Sept. 11 terrorist attacks or the eurozone debt crisis. The firm said that the volatility and uncertainty in the financial markets created by the pandemic are more likely to hurt the balance sheets of life and annuity insurers than those of property, casualty, or health insurers. As a result, it recently downgraded its market segment outlook on the US life/annuity segment to negative from stable.

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AM Best said it expects the financial effects of the pandemic will significantly hurt the life/annuity industry’s ability to quickly progress with expensive innovation efforts. However, it said that some factors that should lessen these negatives include the industry’s strong capitalization and improved liquidity; stress testing that has better prepared the industry for downturns from economic and pandemic-type events; and credit spread widening to help offset some of the interest rate decline.

“Carriers with less capital, questionable liquidity access, and limited business profiles or outsized exposures to at-risk sectors such as energy, retail, and travel, will feel the negative economic impact faster and more deeply than most of the industry,” AM Best said.

Additionally, the recent financial turmoil is likely to put a damper on the pension risk transfer market, which set new records in 2019, as new deals will not be as economically feasible. This is a result of the combination of declining interest rates and pension funds’ deteriorating funded status that will be caused by the market downturn.

“The pension risk transfer market will also likely slow with the funding status of pensions facing pressure,” AM Best said. The firm pointed out that funding has seen two significant drops since 2000 from the dot-com bubble burst and the financial crisis and, it said, “the current pullback should put this business on pause as well.”

However, AM Best said the insurance industry should be more resilient to financial market downturns today than it was during the 2008-2009 financial crisis, which put heavy attention on liquidity risk.

“At this time, rated companies are expected to be able to meet their commitments, despite the rapidly evolving situation,” AM Best said. “With these coming stress tests, access to liquidity, as well as the laddering and maturing of debt securities within the capital structures of insurance companies, will be additional areas of focus.”

Coronavirus Crisis Is ‘Crushing’ Global GDP Growth

Fitch Ratings slashes global growth forecast nearly in half to 1.3%.

By Michael Katz

The financial impact of the coronavirus is “crushing global GDP growth” according to Fitch Ratings’ most recent economic forecast, which has been cut nearly in half from what it expected just a few months ago.

In its latest quarterly Global Economic Outlook, Fitch slashed its baseline global growth forecast for 2020 to 1.3% from its December forecast of 2.5%, which would leave global gross domestic product (GDP) for the year $850 billion lower than previously expected. And the firm says this could very easily fall even further if more pervasive lockdown measures are implemented throughout all the G7 economies.

“The level of world GDP is falling,” Brian Coulton, chief economist at Fitch Ratings, said in a statement. “For all intents and purposes we are in global recession territory.”

In its report, Fitch said the shock to the Chinese economy has been “very severe” and its GDP is likely to fall by more than 5% during the first quarter alone.

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“Falling GDP in China is virtually unprecedented and, in the near term at least, these numbers are worse than most previous hypothetical ‘hard-landing’ scenarios,” the report said. And although the sharply falling number of new COVID-19 cases in China portends a strong economic recovery during the second quarter, Fitch says the delayed impact of supply-chain disruptions, and lower Chinese demand on the rest of the world, “will continue to be felt profoundly for some time,” particularly in the eurozone and the rest of Asia.

Additionally, Fitch said the rapid outbreak of the virus outside China has led to sharp declines in travel and tourism and the cancellation of business trips and vacations worldwide. It also pointed out that other large advanced countries have enacted large-scale lockdowns similar to those seen in China. It said these countries are likely to see sharp declines in GDP in the coming months.

“The interruptions to economic activity seen in China—and now in Italy—are on a scale and speed rarely seen other than during periods of military conflict, natural disasters, or financial crises,” the report said. “The risk is that we shortly see these abrupt interruptions happening simultaneously across all major economies as the global pandemic spreads.”

Despite an expected recovery in the second quarter in China, Fitch’s forecasts that growth in the country will fall to 3.7% for the year, and it expects Italian and Spanish GDP to drop 2% and 1%, respectively. It also forecasts US GDP growth to be just 1% in 2020 compared with a pre-pandemic outlook of 2%.

However, these forecasts were finalized prior to announcements that full-scale lockdowns would take place in other major countries. Now that lockdowns have occurred in France, the United Kingdom, and several US states, it’s likely the firm will eventually downgrade those figures even further. Fitch said that because of the speed at which the crisis is evolving, it will update its global economic forecasts with a much higher frequency over the coming months than its usual quarterly publication cycle.

Fitch said escalating lockdown responses across the major economies would mean that the chances of an even weaker GDP outcome are very likely. It said a downside variant to its baseline forecast shows GDP in Europe down by more than 1.5%, US GDP down by nearly 1%, and Chinese growth falling to just over 2%.

“The uncertainties here are huge,” Coulton said, “and we are really only at the beginning of the process of trying to understand the full impact of the crisis on the world economy.”