S&P Global Ratings expects COVID-19's shadow over capital markets will influence U.S. insurers' earnings in the first quarter. However, its effect on morbidity and mortality likely won't have as much of an impact on underwriting performance for the quarter.

The much needed shelter-in-place guidelines used to slow the spread of the pandemic have unfortunately significantly affected capital markets and economic conditions in the first quarter. While conditions in the financial markets have improved in recent weeks, investment portfolios across the three insurance sectors--life, health, and property/casualty (P/C)--have likely felt the impact of equity volatility and weakening credit and debt markets. But outside of investment portfolios, fundamental differences in the liabilities of these three insurance sectors will mean COVID-19 will affect their underwriting results differently. We expect U.S. health insurers to likely report better-than-expected underwriting results, life insurers to face a serious test to their hedging strategy, and P/C insurers' underwriting performance to be the least affected of the three in the first quarter. Our outlook on our ratings in the sectors remains stable for now.

Mortality, Morbidity, And Capital Market Through March 31

COVID-19 attack/infection rate: 0.1% as of March 31

The first case of COVID-19 was reported in the U.S. on Jan. 20, 2020. Since then, the illness has spread across the U.S., infecting about 186,000 individuals (or about 0.1% of the U.S. population) as of March 31, and over 550,000 (or about 0.2% of the population) as of April 14, 2020.

COVID-19 mortality: 0.01 excess deaths per 1,000 as of March 31

The first death in the U.S. from this pandemic was reported on Feb. 29, 2020. As the illness spread further, almost 4,000 people (0.01 excess deaths per 1,000) died from this illness at the end of the first quarter. The number has significantly increased since the end of quarter, with almost 22,000 (about 0.07 excess deaths per 1,000) deaths as of April 14, 2020.

Chart 1

Table 1

Equity markets: Volatile, down 20% for the quarter

Equity markets were extremely volatile this quarter. The VIX (Chicago Board Options Exchange's Volatility Index) was especially high, reaching 82.69 in the middle of March. Although the VIX has fallen since then, it remains high relative to the beginning of the year. Additionally, in terms of absolute levels, the S&P 500 was down about 20% for the quarter.

Chart 2

Debt markets: Spreads widened and fallen angels rose

The current conditions have resulted in wider bond spreads. But markets seem to remain open for new issuances. U.S. insurers have issued about $15 billion of senior notes and $4 billion of funding agreement-backed notes issued of issuances by U.S. insurers this quarter.

Chart 3

The debt markets also saw a higher number of fallen angels ('BBB' rated companies that have been downgraded to speculative grade) during the first quarter. About $237 billion in rated long-term debt was downgraded to speculative grade from 'BBB' ratings, although roughly three-quarters of this was largely concentrated in three major issuers: Ford Motor Co., Occidental Petroleum Corp., and The Kraft Heinz Co. (See "'BBB' Pulse: U.S. And EMEA Fallen Angels Are Set To Rise As The Economy Grinds To A Halt," published April 8, 2020.) However, we don't expect these three large issuers to materially affect results given most insurers follow strict investment risk-management policies that limit single obligors and asset concentrations.

A Deferral Of Nonemergency Medical Services Will Drive Positive Earnings For U.S. Health Insurers

We believe most health insurers' underwriting earning to be better-than-expected this quarter. The significant deferral of elective or discretionary medical services will support medical claims trends for the quarter.

However, COVID-19-related claims will rise further in the second quarter. In addition, several health insurers are waiving cost-sharing related to testing and treatment of COVID-19. However, the attack/infection rate through the majority of the first quarter doesn't indicate a meaningful strain on medical claims. This can of course change if containment efforts fail, resulting in increased severity and spread of the pandemic in the second quarter.

Although underwriting income will continue to be the primary earnings driver for U.S. health insurers, impairments to insurers' investments can hurt earnings. However, at this time, we expect improved underwriting earnings to more than offset any investment impairments in the first quarter.

What about the remainder of the year?

Liquidity, declining payroll employment, and COVID-19 claims will be our focus areas for health insurers for the rest of 2020.

Generally, we don't view liquidity as an issue for health insurers, and at this time we remain comfortable with the liquidity of this sector. But recent announcements by some health insurers that seemingly make them the "bankers" to the health care system may pressure liquidity. Some insurers have announced advances to providers and additional grace periods for nonpayment of premiums to full-insured members/groups. We expect insurers to look at sources of liquidity such as Federal Home Loan Bank advances or tap into their revolvers and even capital markets to be prepared for these cash outflows.

As payroll employment declines, we will likely see a decrease in premiums from the fully insured group/employer business. There will be some offset as eligible individuals who may have lost their job and their job-based insurance shift to the individual or Medicaid market. Though these markets may blunt the blow, they won't eliminate the increase in the uninsured rate and a slowdown in expected revenue growth for the full year.

Finally, medical claims from COVID-19 will likely be more pronounced in the second quarter than in the first. As the claims paid catches up to actual reality on the ground, specifically in regions that are most affected by the pandemic, we expect earnings to revert to normal for full-year 2020. Health insurers' full-year profitability may even be somewhat depressed depending on the continued severity of the pandemic and hospitalization levels in the remainder of the year.

U.S. Life Insurers' Hedging Strategy And Potential For Impairments Will Be Tested

Market-sensitive liabilities (such as annuities with living benefit riders) of U.S. life insurers will be tested amid the lower interest rates and volatility in equity markets during the first quarter. We expect most insurers to pass this test, supported by improved hedging practices since the last financial crisis. But this crisis will undoubtedly showcase any weaknesses in an insurer's hedging framework. Insurers that didn't buy adequate protection from an equity downturn or lower rate environment may see negative charges for their market-sensitive liabilities, although the magnitude of those, especially in the first quarter, remains to be seen.

Related to their hedging framework, we do expect more accounting noise in the first quarter as generally accepted accounting principles (GAAP) accounting requires most of these derivate gains/losses to be mark-to-market, even though liabilities are not. Additionally, in volatile markets, the cost of dynamic hedging programs increases, which is something the insurers will have to consider as their hedges expire and they need to do renew their protection.

On the asset side, U.S. life insurers hold over $4 trillion of invested assets on their balance sheet. Impairments on these investments have been low over the last 10 years, but they may increase starting in the first quarter of 2020. We do expect the amount of impairment will be a negative force, but not a major shock to first-quarter earnings.

Insurers with meaningful fee-based income arising from asset management segments may see a decline in related earnings, which is an expected byproduct of a market downturn. However, we don't expect insurers to make any meaningful strategic decisions as a result of the decline in fee income, since the asset management businesses can provide valuable diversification benefits.

And finally, new product sales will likely underperform compared with 2019. As products are repriced to reflect the current rate environment, it will have less attractive benefits/guarantees for the potential policyholders. Additionally, distributors who may be used to undertake face-to-face sales will likely be see a slowdown in their sales process due to shelter-in-place rules. An event like this also highlights the importance of product diversification. We expect diversified insurers to do better in such a slowdown because they are able to pivot to other parts of their product portfolio to offset any weakness in inflows.

What about the remainder of the year?

Reserving updates, fallen angels, and disability and mortality claims are our focus areas for life insurers for the remainder of 2020.

We expect a hit to earnings from likely reserve updates in the second and third quarters of 2020. Under U.S. GAAP accounting, most insurers assume mean reversion, meaning rates will gradually increase over time. But as rates have remained lower for longer, insurers have lowered their long-term rate assumptions and endured earnings hits from related reserve updates. We believe it's likely that in 2020, during the annual actuarial assumption reviews, several insurers will further lower the long-term rate or extend the amount of time it will take to reach their assumed mean reversion levels.

With record high 'BBB' rated bond exposure for this sector, fallen angels can hurt life insurers' investment portfolios. Impairments will likely rise through 2020 if more 'BBB' category bonds fall to speculative-grade. However, we believe life insurers are better positioned to weather this economic downturn compared to the last financial crisis, supported by a relatively stronger levels of capitalization. Additionally, we had applied an asset stress test to the insurers we rate, and we expect the impact will strain--but not break--their strong capitalization (see "When The Cycle Turns: Investment Impairments Will Bend But Not Break U.S. Life Insurers' Financial Strength," May 13, 2019).

We will continue to track mortality and disability claims resulting from COVID-19. There will likely be an uptick in disability and mortality claims in the remainder of 2020, but at this time, the attack rate and mortality rate don't indicate a severe mortality event for life insurers. However, if containment fails, disability and mortality claims could rise later this year. Additionally, increased mortality may be positive for some business lines, such as long-term care insurance or pension risk transfer, that have longevity risk.

U.S. P/C Insurers' Underwriting Profitability Remains Safe For Now, But Investments May Take A Hit

We don't expect a significant impact on P/C underwriting profit and operating cash flows as a result of COVID-19 for the first quarter. Underwriting performance should be in line or better-than-expected for the majority of P/C insurers because of recent premium rate actions and a relatively benign loss environment this quarter. However, investment assets that are impaired will likely strain capital. The magnitude of this effect on capital would vary depending on the insurer's portfolio allocations.

The U.S. experienced a relatively mild winter with limited catastrophe activity, which we believe will benefit operating performance for the sector. However, these positives could be modestly muted by continual headwinds from social inflation trends in casualty lines. Although many personal lines insurers, sensitive to policyholders' growing financial pressure and recognizing the steep decline in lower miles driven as a result of shelter-in-place restrictions, recently announce premium discounts and rebates, this will only hit the books for March and April and will not meaningfully affect first-quarter volumes.

For commercial P/C insurers, given the timing of the COVID-19 impact on business shutdowns, there will likely be a false bias benefiting underwriting earnings and premium volumes due to the economic growth trends and positive rate environment at the tail-end of 2019, although this we expect to be unsustainable for full-year 2020.

While first-quarter results will not tell us the extent of underwriting performance volatility stemming from COVID 19, there is perhaps more certainty on capital and income affected by the record market volatility in March 2020. Over the first quarter, equity markets declined about 20% (see chart 2). The impact on an individual insurer's earnings will vary depending on the size of its equity portfolio (see "Robust Capitalization Makes The COVID-19 Fallout Manageable For North American Property/Casualty Insurers And Reinsurers," March 25, 2020). In addition to equity declines, earnings could take a hit given the impact of widening credit spreads within insurers' fixed-income portfolio, further exasperated from fallen angels that have already occurred in the first quarter.

What about the remainder of the year?

Legislation on business-interruption (BI) coverage, increased unemployment, business shutdowns, and market uncertainty will be our focus areas for U.S. P/C insurers for the remainder of 2020.

As continued shelter-in-place restrictions further stress economic disruption, we will keep a close eye on state legislative initiatives attempting to override standard exclusions in BI coverage. While pandemic risk has long been an excluded cover for BI policies, quite a few states have sought to pass legislation to force insurers to pay for these coverages to specifically assist small businesses. We expect that any sort of action would likely come with support from government resources; however, the timing and amount of support would greatly affect the loss potential commercial insurers would face.

The macro impact on the economy will be the key factor that we will monitor closely, with equity markets remaining highly volatile and certain fixed-income asset classes such as transportation, gaming and lodging, and energy potentially being more at risk. Furthermore, we will be watching the effect on premium volumes and losses with unemployment levels continuing to rise and businesses not only being closed temporarily, but many likely permanently. We expect closed businesses could lead to a decline of 2%-4% in premiums earned and 4%-6% on premiums written. Additionally, we expect combined ratios will rise to 98%-102% for the year. That said, the longer shelter-in-place restrictions remain, the greater the strain we would expect to see on premium volumes and losses.

Our Outlooks On The Life, Health, and P/C Insurance Sectors Remain Stable

Our sector outlooks on all three major insurance sectors remain stable. Although each earnings season can present its own set of surprises, we don't expect first-quarter results will likely lead us to revise our outlooks.

Related Research

• Despite The COVID-19 Pandemic, The Outlook For The U.S. Health Insurance Sector Remains Stable, March 26, 2020
• Assessing The Top Risks COVID-19 Poses To North American Life Insurers, March 26, 2020
• Robust Capitalization Makes The COVID-19 Fallout Manageable For North American Property/Casualty Insurers And Reinsurers, March 25, 2020
• Morbidity Stress Test: How A Hypothetical Pandemic Could Affect U.S. Health Insurers, March 12, 2020
• Amid Coronavirus Outbreak, S&P Global Ratings Looks At How A Hypothetical Pandemic Could Affect U.S. Life Insurers, Feb. 14, 2020
• Ten Things You Need To Know About U.S. Insurers' Long-Term Care Business, Jan. 23, 2020