As protection insurers offer promises way into the future to pay out in the event of death or ill-health, it is essential that they remain in business to honour any claims that arise.
They are consequently subject to stringent solvency regulations, which consider their assets and liabilities/capital position for both the present and the future.
An insurer is solvent if its assets exceed its liabilities/capital requirements but in practice it will always aim to hold more reserves than the minimum required.
Steven Graham, technical policy manager at the Institute and Faculty of Actuaries, says: “Solvency assessments are tailored to the risks that an individual insurer faces, with those selling life assurance being exposed to the risk that there are more deaths than expected and those selling critical illness being exposed to higher-than-expected morbidity rates.”
Investment returns are a big issue as well as claims because if investments plummet it can have a major impact on solvency.
Capital reserve requirements
While some investments like gilts are used specifically to match claims, reserves are spread around a broad range of asset classes, and insurers may also use hedging techniques to offset risk.
The current prudential regulatory regime in the UK is still the EU’s Solvency II Directive, which requires insurers to have enough capital to survive a 1-in-200-year event, and little is likely to change because of Brexit.
Charles-Marie Delpuech, associate director, insurance practice at S&P Global Ratings, says: “The UK government has launched a review of the regulation but we do not anticipate developments in the UK's solvency framework to significantly depart from the existing Solvency II framework.“
Underwriters, who work out the terms that policyholders are to be offered at outset, also play a key role in the risk equation.
They assess medical and lifestyle information provided on application forms and, when they consider it necessary, can request GP reports or even medical examinations. They also pay great attention to population-based morbidity and mortality tables produced by actuaries.
When underwriters feel that risks are above average they can impose premium loadings or exclusions or, in extreme cases, decline applicants altogether.
Premium loadings are typically between 50 per cent and 400 per cent but can be higher, particularly for young people with cancer.
These tried and trusted methods of keeping strong reserves and mitigating risk have been vindicated by the coronavirus pandemic because the rating agencies are not citing issues with solvency.
The pandemic effect
The Moody’s Investment Services Insurance -- Europe 2021 Outlook report states that: “The impact of coronavirus on European life insurers has been limited as the virus mostly affects older people, who are typically not insured.”
Indeed, there is more concern about the potential impact of ultra-low interest rates and other investment risks, which affect insurers of all types.