Lessons from past recessions

Like so many other sectors of the economy, insurance has not been spared from the ravages of COVID-19. 

They say history repeats itself, but the jury is still out as to whether the learnings from previous crises will help us through this one.

Fiona Gillespie, macro strategist and assistant vice president at Swiss Re, says the world hasn’t faced a pandemic of the scale of COVID-19 since the 1918 Spanish flu, in which 500 million people were infected and an estimated 50 million-plus people died.

But Gillespie says the environment today is too different to draw strong analogous conclusions from other crises to determine the potential economic outcome from COVID-19, although historical precedents can offer some guidance on how to handle the situation.

‘In particular, containment measures and fiscal spending [addressing the short-term impacts but also longer-term growth] are vital ingredients to manage the sharp downturn and subsequent recovery,’ she says.

Using past crises as lessons for the insurance industry has its challenges.

Professor Monica Keneley, director of teaching at Deakin University Business School, says: ‘First, insurance is not a generic industry. It is composed of a series of different markets, so it would be difficult to generalise about the impact. 

The effect on short-term insurers will also be different to that of long-term insurers.’

Keneley says the current situation comprises both demand shocks and supply shocks. 

Demand for insurance will be affected by people’s ability to pay, which is dependent on their incomes, she explains. 

And supply will involve the ability of insurers to supply a product at a price that is attractive to consumers — something that will depend, in part, on their returns on investment portfolios.

‘This is not something that you would expect to see and is different from other events,’ says Keneley. 

‘We have not witnessed the sudden cessation of economic activity before. Even during the Great Depression of the 1930s, it was a slow decline. This means we are basically in uncharted waters as far as impact and time to recovery go.

‘We are also starting from a weaker base. The bushfires [in Australia] will have had a huge impact on insurers and their liabilities.’

2008 GFC: A MIRROR IMAGE

Stephen S. Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, warns against looking at the 2008 global financial crisis (GFC) to find remedies for the current COVID-19 situation.

‘What worked 11 years ago won’t work today,’ he says. ‘The COVID-19 pandemic is the mirror image of the global financial crisis. The policy response needs to be crafted accordingly.’

The GFC was, first and foremost, a financial shock that took a severe toll on the real economy. 

It was sparked by the depreciation in the United States’ subprime mortgage market and developed into an international banking crisis with the collapse of investment bank Lehman Brothers in September 2008.

By contrast, says Roach, COVID-19 is a public-health crisis and the financial repercussions for the real economy are a secondary shock.

Swiss Re group chief economist Jerome Haegeli believes COVID-19 has already thrust the world economy into recession. 

‘This recession operates at an elevated speed, being twice as fast as the economic downturn brought on by the 2008 financial crisis,’ he says, adding that Swiss Re research shows that the global economy is considerably less resilient compared with pre-2008.

Still, some of what may happen with COVID-19 has been seen before. 

For example, a 2003 Swiss Re sigma report that examined economic crises in emerging markets like Mexico, Argentina and Asia observes: ‘Generally, a financial crisis brings about a dramatic drop in demand for insurance. 

'For example, Thai motor premiums declined by more than 20 per cent due to the financial crisis of 1997, while in Argentina life insurance premiums plummeted by 25 per cent in 2002.

‘However, insurers are more affected by falling asset values and high claims costs.’

2002 / 03 SARS OUTBREAK: A NEW RISK MODEL

Back in 2003, Edi Schmid was chief underwriting officer of Swiss Re’s Asian business and was based in Hong Kong when severe acute respiratory syndrome (SARS) hit.

‘For Swiss Re, SARS really sharpened our focus on pandemic risk management,’ says Schmid, who is now chairman of the Swiss Re Institute and Swiss Re’s group chief underwriting officer.

‘In 2006, Swiss Re started developing our own pandemic model. 

'The model allows us to undertake stress tests on our portfolio in a similar way to large natural catastrophe risks. In turn, this information informs key business decisions, such as setting our risk appetite or managing our capital.

‘Since 2006, the model has evolved. It has been constantly improved and updated as new knowledge has emerged.’

Currently, the model statistically analyses 50,000 different pandemic scenarios to see what the impact of a certain strength of pandemic might be on a modelled portfolio.

So, can it predict COVID-19’s financial impact?

‘The answer is no,’ says Schmid. ‘The final impact of the COVID-19 pandemic remains uncertain and will be unique in terms of insurance impact, lives lost and its impact on the global economy.

‘We need to be extremely careful about making assumptions, drawing conclusions or extrapolating from the model to the current specific situation. For example, the underlying populations used in the modelled scenarios are different from the general population.

‘In our model, the results are based on an insured population and not comparable to the statistics we read in the media, which might be based on a percentage of the total population or a percentage of people known to have the disease.’

1918 SPANISH FLU: A DEADLY REMINDER

Like COVID-19, the deadly Spanish flu outbreak of 1918 spread around the world with alarming speed. 

But unlike the current pandemic where the risk of death increases with age, the Spanish flu struck down many young people, particularly those aged from 15 to 34. The impact on the insurance industry was also different.

‘The 1918 Spanish flu pandemic caused some strain, but mostly because reinsurance in the US was still then quite primitive and, of course, it was a much larger shock and took more younger people,’ says Robert E. Wright, Nef Family Chair of Political Economy at Augustana University in the US.

Steven N. Weisbart, senior vice president and chief economist at the New York-based Insurance Information Institute, explains: ‘In 1918, in addition to the very old, the virus struck unusually strongly at people in the prime working years, triggering benefits from both individual and group life insurance.’

While noting the contrasts, Weisbart is concerned COVID-19 may still behave like the Spanish flu.

The Spanish flu swept around the globe in three phases. The first was in the northern hemisphere spring of 1918 and although it infected widely, it had a relatively low mortality rate.

The second phase occurred in the following autumn, during which the infection spread more rapidly and proved far more deadly. 

The third phase was in the first half of 1919 and while less severe than the second phase, it still resulted in hundreds of thousands of deaths.

‘If COVID-19 follows a similar track to that of the Spanish flu, the current outbreak would turn out to have been a mild phase,’ warns Weisbart.

If this scenario is correct, he says the first phase will soon taper off and we should prepare for a more virulent phase that might manifest in the second half of 2020.

‘Failure to do so would mean we’ve learned nothing from the worst global pandemic in the last 100 years.’