There are many questions that cause anxiety for insurance leaders as they navigate the business implications of the COVID-19 pandemic, including: Will the effects of the pandemic last longer than expected, thereby causing a prolonged spike in life insurance claims? What reimbursement support or relief can the health insurers expect from the federal government for claims related to testing and treatment of the virus? And as people spend more time isolating at home, will a decrease in auto claims frequency be offset by an increase in bad debt expense on premium receivable?
In the face of further uncertainty ahead, there are steps that insurers can take now to mitigate the impacts of COVID-19 on their business. Insurance leaders can look to their CFO and senior financial executives for guidance on critical accounting, financial reporting and operational decisions that can help position the business to sustain through the crisis and thrive in its wake.
Insurers should examine these four key questions to provide some clarity during this uncertain time:
1. What impact can insurers expect on asset quality and impairment?
Fixed income securities and mortgage loans make up a majority of insurance company assets. Current market volatility and a decline in the federal funds rate has caused market value declines on many insurers’ investment portfolios. Here is an analysis on some of the underlying sectors supporting the fixed income asset class.
- Commercial mortgage loans (CML) and commercial mortgage-backed securities (CMBS): This asset class, which was performing well until recently, has abruptly experienced a sharp decline in value. It could be under duress over the longer term as the economic slowdown caused by the novel coronavirus continues. Take the commercial office space sector, for example. Before the COVID-19 pandemic, occupiers were already experimenting with new workplace designs to foster productivity through shared spaces, which was reducing both their footprint and, in turn, their real estate costs. Now, social distancing requirements due to COVID-19 have changed the long-term market dynamics again as companies realize the benefits of remote working on productivity and costs. Compounding the risk to the real estate sector more broadly, the COVID-19 pandemic has accelerated online shopping purchases, putting additional pressure on many brick and mortar retailers to reduce their store footprint. These underlying trends will have a lasting impact on commercial mortgage loans and mortgage-backed securities held by many insurance companies.
- Municipal bonds: March saw a significant decline in the S&P Municipal Bond Index, but this recovered quickly as buyers saw bargains in this asset class. According to BlackRock: “Municipals will experience some stress alongside the U.S. economy. Muni issuers must continue to operate despite revenue uncertainty. Some segments will face daunting financial challenges, and federal support may be insufficient. Issuers with solid balance sheets will need to draw down reserves to meet obligations. Safety net hospitals, senior living facilities, mass transit and airports with limited resources will require funding from the states and municipalities they serve. Non-rated stand-alone projects may experience significant credit deterioration.” Overall, this is considered a high-quality asset class which could have some potential downgrades and credit issues along the way if the COVID-19 crisis or the following recession lasts longer than expected. But the overall credit quality in this sector is expected to remain strong.
- High-quality corporate bonds: These bonds have benefited greatly from recent interventions by the Federal Reserve, such as: cutting the federal funds rate close to zero, opening a lending facility to enhance liquidity in short-term commercial paper markets, and lending directly to corporations and buying investment-grade corporate bonds. In addition, the Treasury restarted its bonds buying program. The Fed is also trying to keep bond markets liquid and functioning smoothly, but the intent is not to rescue the entire corporate bond markets. Issuers with low ratings and certain industries, such as oil and gas, hospitality, entertainment and restaurants, will continue to face downward pressure and may have a difficult time rebounding. This will result in downgrades and credit deterioration over the next several quarters.
These factors will have a direct effect on insurance company investment portfolios, and individual positions with deteriorating asset quality will increase the probability of impairment.
2. How is the NAIC providing relief to the insurance industry?
On April 16th, 2020, the National Association of Insurance Commissioners (NAIC) adopted three interpretations in response to policies impacted the COVID-19 outbreak:
- Interpretation 20-02 provides for a temporary, one-time optional extension of the 90-day rule for uncollected premium balances, bills receivable for premiums and amounts due from agents and policyholders, amounts due from policyholders for high deductible policies, and amounts due from non-government uninsured plans for uncollected uninsured plan receivables. INT 20-02 is available for policies in effect and current prior to the date as of the declaration of a state of emergency by the federal government on March 13, 2020, and policies written or renewed on or after that date.
- Interpretation 20-03: Troubled Debt Restructuring Due to COVID-19, was also adopted.This interpretation clarifies that a modification of mortgage loan or bank loan terms in response to COVID-19 shall follow the provisions detailed in the April 7 “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus,” and the provisions of the federal Coronavirus Aid, Relief, and Economic Security (CARES) Act in determining whether the modification shall be reported as a troubled debt restructuring.
- Interpretation 20-04 offers limited-time exceptions to defer assessments of impairment for bank loans, mortgage loans and investments, which predominantly hold underlying mortgage loans, that are affected by forbearance or modifications in response to the COVID-19 pandemic.
These short-term interpretations are designed to provide temporary exceptions for insurers’ March 31st and June 30th financial statements, but the working group will continue to review the situation and will consider whether extensions or additional interpretations are necessary.
3. How does the CARES Act benefit insurers?
The CARES Act provides significant tax relief for insurers and other mid- to large-sized companies, because it allows for net operating losses from 2018 through the end 2020 to be carried back for five years prior to the loss. This effectively reverses some provisions from the 2017 Tax Cuts and Jobs Act, which had eliminated carrybacks for net operating losses for certain companies, including life insurers.
The CARES Act now allows companies to carry net operating losses to before the effective date of the Tax Cuts and Jobs Act, in addition to being able to use the previously applicable tax rate. This has additional benefits for insurance companies that can take advantage of applicable tax credits as a result of the carrybacks. The CARES Act also allows companies to file for accelerated refunds of excess alternative minimum tax (AMT) credits by allowing them to claim the refund in full for 2018 or 2019.
These legislative changes combine to provide relief for insurers that could potentially be facing a surge in new claims because of the pandemic. Other tax savings opportunities for insurers include payroll tax credits and deferrals and tax-deductible charitable contributions. To determine eligibility for tax relief under the CARES Act, insurers should contact their tax professional for further guidance.
4. How can insurers re-establish internal control policies in a remote environment?
During the pandemic, remote working capabilities have been an important component of insurers’ business continuity plans, allowing them to continue operations while also maintaining the safety and productivity of employees. However, work-from-home arrangements may give rise to other risks, potentially compromising the integrity and security of an organization’s sensitive financial and accounting data.
For example, many employees working remotely may not have the same cybersecurity safeguards as a secure office space. Employees that use their personal devices for work can also expose an organization to increased cyber vulnerabilities. It’s critical that management work with the IT department to re-evaluate the internal control structure and make any necessary adjustments, including ensuring appropriate data retention and privacy practices, as well as confirming comprehensive cybersecurity practices for remote workers.
It remains unclear what impact the COVID-19 pandemic will have on the future earnings and growth prospects for insurers. That’s why it’s imperative for financial leaders at insurance companies to help guide their organization on the path to profitability. A key component of this is advising about all aspects of the applicable relief offered through government stimulus packages. It’s crucial to take steps now that prepare the organization for sound financial reporting and accounting strategies, which can help minimize potential risks to future operations.
