Anatomy of a long-term care rate increase
This paper provides guidance for insurers on how to prepare clean, efficient rate increase filings and to help carriers work with regulators to incorporate the information they seek.
The scope and breadth of the coronavirus (COVID-19) represents an unprecedented shock to the world’s economies, communities, and societal norms. The rapidly evolving nature of the crisis very potently demonstrates the continuing importance of considering future pathways, potential consequences, and how best to respond.
The previous article1 began by stating: “the global coronavirus pandemic is very clearly a rapidly evolving, complex, multi-factor event with significant downside potential over both the immediate short and medium-longer terms”. This article further explores the virus under the lens of a set of key principles we believe are fundamental to effective emerging risk analysis:
Firstly, the present situation would not be in any way accurately described as an event for which the only impact is a direct near-term shock to mortality and morbidity rates. Beyond the infections and deaths, in past weeks, markets have responded turbulently with dramatic falls in equity prices, credit spreads widening significantly and sovereign yields falling to new lows. Most firms have already had to respond to the increasingly strict social distancing measures, which present challenges in terms of both staff and customers. As an unfolding risk event, the crisis can today be characterised by demographic, market and operational risks that have already crystallised.
Looking forward, the only aspect that can be reliably predicted is that the multi-faceted nature of the crisis will continue. From a demographic perspective, in the UK it is widely acknowledged we are perhaps a few weeks behind other European countries in terms of infections. It is an unknown whether the newly announced measures will be effective or are, in fact, being introduced too late. Furthermore, assuming current or increased social distancing measures prove impractical or undesirable to enforce beyond a few months, there are expectations of a second significant spike in infections towards the end of the year. And over the longer term, even with a vaccine (which estimates suggest will take 18 months to develop), the virus could establish itself as an ever-present threat in much the same way as seasonal flu. On a more positive note, researchers are already making good progress with advances in testing, which would potentially allow those who have already had the virus to be identified and returned to work quickly and safely.
Further market falls and sustained volatility should also be anticipated, and initial hopes of ultimately seeing a “v-shaped” recovery in markets appear to be fading fast. It is far from certain that the economy will be able to pick back up where it left off once the virus infection rate subsides and mitigating measures are phased out. There is also the question of whether the coronavirus was the sole cause of the severe market falls or instead triggered a crash that was already primed and waiting to happen, with the risk being obscured and delayed by macroeconomic measures such as depressed interest rates and quantitative easing. In the latter case, fundamental economic weaknesses will need to be addressed in addition to stopping the virus before we can return to economic growth. In the intervening period, we can anticipate a dramatic drop in corporate investment spending as well as increased default rates and company bankruptcies. The effects of the virus might have a lasting impact on factors such as the size of the workforce and consumer demand.
Operationally, the option of working from home will not be practical for certain industries, and with recommended or mandatory social distancing measures in place, many firms will find it extremely challenging (in some cases impossible) to maintain their business-as-usual capacity and capability. Others firms that transition to remote working will nevertheless face their own challenges, not least of which is the need to be mindful of the potential for reduced staff productivity, engagement and morale.
Whatever the type of business, the direct challenges to maintaining the day-to-day functioning of business will need to be managed alongside an increased exposure to existing operational risks. Likelihoods of occurrence will, in many cases, be materially elevated. For example, malevolent cyber actors may view the spread of the coronavirus as an ideal opportunity to launch a targeted or wide spread cyberattack and empty offices/facilities, remote working and supplier restrictions over an extended period all raise the prospect of operational failure.
Furthermore, every firm’s ability to respond to and recover from the occurrence of any operational risk events will also be materially impaired. Existing post-event mitigation and recovery plans will (almost without exception) be designed around incidents lasting a matter of weeks, not months or longer. And they will invariably rely on having people on the ground and readily available outside resources and expertise, replacement equipment and cash to meet a significant, short-term spike in expenditure. None of these can be taken for granted. Firms will need to reassess both their assumptions regarding the availability and efficacy of recovery measures and their own internal definition of what constitutes “recovery”.
From the preceding discussion on the occurrence of multiple coincident risk events across demographic, market and operational risk types as a result of the coronavirus, it naturally follows that the impact to firms will be felt both financially and non-financially.
Asset values will be depressed, liabilities will become more onerous and inward cash flows will become much less certain - with this latter factor becoming an increasingly critical factor to the survivorship of firms the longer the situation persists.
Operational performance will be hit by a range of factors such as new legal restrictions and regulatory requirements, staffing issues, changes in working arrangements and supply shortages. Not all firms will face the same challenges and to the same degree. Some of these factors will undoubtedly play to the strengths of those firms with operating models that are well suited or are better equipped to adapt to the new environment, such as online retailers with robust logistics and supply chains.
Changes in corporate reputations will be driven by the approach taken by the firm and by the wider industry to which it belongs in response to the crisis. In the UK, supermarkets have been criticised for not acting quickly enough to limit the panic buying of certain items. On the other hand, the Royal Mail (now a private company) will almost certainly benefit after its staff voted to serve as an “additional emergency service” during the crisis. The degree to which the virus exposes existing flaws (or strengths) in the business model or a firm’s operational resilience will also have an effect on reputation.
We are already seeing evidence of additional risks crystallising as criminals take advantage of others’ misfortune. Cyberattacks are exploiting a thirst for updates on the situation by putting malware onto news sites. Criminals are targeting offices and stores left empty as people work remotely. Human ethics would make you hope that these additional hardships would not happen, but sadly, they do happen.
Even experts can be expected to miss or underestimate the impact of situations such as the one we find ourselves in today. The clock starts when perceptions take off and these typically lead to actions that are not yet informed by factual or complete information. It can also be the case that the event takes longer to fully “end” than we might want or expect; prevailing fear, caution, and vulnerability mean that it takes time after the root has gone for things to return to normal. Finally, the new “normal” may be very different from the one that we accepted and expected before the arrival of the virus.
A range of factors - the scale and speed of the spread of the virus, the existing fragility of the global economy, regional populism and geopolitical tensions, the ever increasing dependence on technology, international supply chains - will mean that the evolution of the crisis is unlikely to follow any previously seen path.
One only has to look at how governments are trying to manage the direct (health) and indirect (economic) consequences of the virus, to see that individuals and businesses face not only extremely choppy but also completely unchartered waters.
Last week’s UK budget, which included a £30 billion package to tackle the coronavirus, was this week quickly replaced by measures requiring tenfold that initial budget. These measures include loan guarantees, business interruption loans and business rate holidays for businesses as well as mortgage holidays for consumers. And yet these latest steps may just be the tip of the iceberg; there is already speculation regarding the need for regular cash payments directly into citizens’ bank accounts and the prospect of mass nationalisation through the temporary state ownership of UK businesses. From the perspective of monetary policy, further rate cuts, a resumption of quantitative easing programs and weaker or suspended banking controls can be expected, almost irrespective of how effective they might actually be expected to be in combating the economic slowdown. Individually, none of these things are beyond the imagination and several might reasonably be expected during any period of adverse economic conditions. However, many of these measures may have never been implemented in practice (either at all or to this extent) and certainly not in combination.
The steps taken to limit the spread of the virus and the consequent strain on health and emergency services, which include bans on mass gathering and blanket quarantine, will feel completely alien to those living under liberal, democratic regimes. These measures have the potential, particularly as they become ever stricter, to elicit patterns of behaviour and changes in attitudes (at both individual and group levels) that are quite unlike anything we have seen before - certainly not during peace time. Despite frequent and repeated reassurance from the UK government, industry bodies and individual retailers regarding the ongoing resilience of supply chains, consumers have already cleared the shelves of toilet rolls, cleaning products and dry goods. As the quarantine continues from weeks into months, more unusual and untested secondary measures may need to be introduced by governments to ensure that the quarantine remain effective and yet limits the damage to individual and collective well-being.
The first, second and higher order impacts of the fiscal, monetary and civic measures and the dynamic way in which they emerge will be new, demanding creativity and shared insight to explore and prepare for. In particular, the duration of the new way of living has the potential to change some behaviours permanently, such as how we work and travel.
Much has already been written in the past week about the degree to which the coronavirus has revealed the greater difficulty in dealing with a crisis that stems directly from being part of a highly globalised and interconnected world. More still has been written about the threat that the virus poses in terms of halting or even reversing the future path of globalisation. This is certainly true over the short-term thanks to efforts to contain the virus, but also perhaps more permanently so, as countries rethink the balance of benefits and costs related to their reliance on global systems, supply chains and relationships. However, in the here and now, very little can now be done about the former and the future for globalisation is a much wider topic.
For today, as firms consider the range of potential scenario pathways that still lay ahead, it is critical to recognise the influence that prevailing complexity and interconnectedness will have on the speed and manner in which things will evolve. Governments may change tack without notice, people may change behaviours quite suddenly and in unforeseen, radical ways, new dependencies and relationships are likely to emerge and existing ones could fall away.
We should recognise that the pandemic will very probably (or already has) exposed pre-existing issues at a country level, in terms of its economic, infrastructure and political systems, but also at industry- and firm- specific levels. Knowing and acknowledging that these issues were there could have led forward-thinking firms to better anticipate and prepare for developments. A strong emerging risk process would, for example, have helped a firm to think through what it would do in the event of a world recession irrespective of the exact trigger.
The pandemic also uncovers the fact that underlying weaknesses are not necessarily independent. The coronavirus is exposing multiple defects at the same time. The consequences may turn out to be terminal for companies or entire industries previously thought to be profitable and resilient, but it should not have been impossible to identify the common causal risk drivers critical to a business.
However, the purpose of setting out some of the principles of effective scenario analysis at the beginning of this article is not to pretend that, by adopting them, the specifics of the current scenario could have been accurately predicted or adequately prepared for. Today’s circumstances are unprecedented. Rather, they are presented here to remind firms that considering multiple different eventualities and dynamics and preparing response plans for each of these will be essential for navigating the next few months and years.