AM Best Creates Pandemic-Related Stress Test for Insurance Firms

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.”