Reserves and Capital Adequacy – Insurers, Consider the Pandemic Carefully. Your Regulators Will.

The news that A.M. Best is developing stress testing to gauge the impact of COVID-19 on insurers is a timely reminder of the various regulatory capital and reserving regimes under which such exposure could be measured. In addition, in the National Association of Insurance Commissioners’ (NAIC) March 20 webinar on the pandemic, a state insurance commissioner indicated that insurers can be expected to invest more “aggressively” as a response to market volatility. It appears likely that the NAIC and state regulators will be focused on financial-strength implications for the industry arising out of the pandemic.

• At a fundamental level, insurers need to consider the effect on policy reserves for in-force business as well as future pricing.
  • Health carriers seem the most likely to be primarily affected, particularly with mandates from states such as New York that carriers waive cost-sharing (such as deductibles and copays) for certain coronavirus-related services.
  • Life carriers might be affected; the mortality incidence associated with COVID-19 appears to remain an open question that life actuaries will no doubt be monitoring.

  • The NAIC has previously considered pandemic risk in connection with Property-Casualty lines, although it has noted the presence of pandemic exclusions in many of these policies. However, carriers should consider the risk associated with possible legislation, such as New Jersey’s pending A3844, which requires insurers to cover pandemic losses even where explicitly excluded in the policy. In its March 20 webinar, the NAIC noted that workers comp will likely be the Property-Casualty line most affected, followed by liability lines and then by business interruption.

• U.S. insurers subject to the NAIC’s Risk-Based Capital (RBC) standards should note that COVID-19 could adversely impact values in C-1 (asset, or investment, risk), C-2 (insurance, or underwriting, risk), C-3 (interest rate risk) or C-4 (business risk generally). The pandemic’s many repercussions across the economy, workforce, financial markets and other arenas could adversely affect multiple inputs that produce RBC values — both with respect to capital resources on hand and required capital.
• Insurance groups subject to the NAIC’s enterprise risk reporting should consider the following prongs from the instructions to NAIC’s Form F (which sets forth the various enterprise risk management, or ERM, factors required to be reported).
  • Identification of group capital resources
  • Identification of any negative movement in credit ratings or financial strength ratings, at both the carrier and group levels
  • Identification of any material “development” of the group that could adversely affect it
• Similarly, insurers subject to the NAIC’s own-risk and solvency assessment (ORSA) requirements should consider capital adequacy at both the entity and group levels. The NAIC’s ORSA guidance calls on insurers to examine risks “under both normal and stressed environments.” This should include “consideration of risk capital requirements, available capital, as well as . . . rating agency and/or other views of capital requirements.” Under ORSA requirements, insurers should be thinking about how to incorporate current events (such as the pandemic) into their broader risk management policy. The policy should be conducive to ascertaining the “level of financial resources needed to manage its current business and over a longer term business cycle (e.g., the next one to three years).”
• According to the NAIC’s group capital calculation (GCC) that is under development, particular attention should be paid to, in addition to the insurer itself, non-insurers in the group that might be perceived to “pose a material risk to the insurers.”
• Finally, under the International Association of Insurance Supervisors’ (IAIS) incipient group capital standard for internationally active insurance groups, ICS 2.0, pandemics are a type of catastrophe risk, defined as “unexpected changes in the occurrence of low frequency and high severity events.” Insurers should bear in mind that the NAIC is developing a methodology to achieve uniformity with ICS 2.0. This methodology, which will be based on an “aggregation method” of capital adequacy (measuring capital needs and resources at each affiliated entity), might not be the GCC itself but some similar “jurisdictionally-agnostic” standard (in the words of NAIC and state staff at the Fall 2019 National Meeting). Thus, longer-term, insurers will need to consider the pandemic’s impact on their catastrophe risk profiles.