Stock Market Comment: Insurers brace for spike in claims

• Coronavirus-related disruptions to be a massive hit to the economy

• Insurance claims expected to rise significantly in 2020

• Tredit credit insurers at risk as some sector stop completely

• Rate cuts lower yield on portfolio, dividends at risk as well

• Coface (COFA.FR), Allianz (ALV.DE) and AIG (AIG.US) on watch

Coronavirus outbreak has caught markets off guard. While the situation poses a threat to almost every branch of the economy, there are sectors that are more exposed than others. Retailers, restaurants and airlines are perfect examples. However, there is also a group of companies that may be set for a very challenging year should all the contingency measures remain in place for longer - insurers.

Coronavirus will be a massive hit to the economy

Countries all around the world are stepping up their efforts to contain the spread of novel coronavirus. While such measures are good for public health, they rarely have a positive impact on the economy. Calling off flights and closing borders have a massive impact on the tourism sector while shutting down shopping malls and restaurants is likely to cut household spending. Needless to say, shutting down production plants is not helping economic activity either. Monetary and fiscal stimulus measures will ease negative impact to some extent but it cannot be avoided. Apart from that, the virus is lethal in some cases therefore unless the spread is contained it may shrink the labour force.

So far, both US and European insurers are underperforming the broad market. Data for S&P 500 and Euro Stoxx 600 insurers sub-indices was used and normalized to broad market peak (February 19). Source: xStation5

Trade credit insurers to be impacted significantly

Insurers are heading for a very challenging year as claims are likely to rise. Insurance policies rarely include protection against pandemics therefore early estimates did not point to a spike in claims. As the time passed, things began to look increasingly poor for insurers who offer protection to companies, like for example trade credit insurers. Trade credit insurance protects companies against inability to collect receivables from counterparties due to the latter's default, insolvency or bankruptcy. As one can imagine, potential recession triggered by a coronavirus pandemic may lead to many of such events, especially among retailers and airlines, and those are likely to spill over to the other parts of the economy.

Apart from airlines and restaurants, the entertainment industry is also likely to feel the pain as big events are being cancelled or postponed and people are reluctant to buy trips and vacations. Munich Re, the German reinsurance company, said that in case all major events it covered this year were cancelled, claims could reach €500 million.

Coface (COFA.FR) is the French insurance company specializing in credit insurance for businesses. Share price dropped over 60% during the previous couple of weeks and approached low from mid-2016. Note that this is an all-time low therefore breaking below would leave the stock in uncharted waters. Defending this level could be the last hope for bulls. Source: xStation5

Portfolio income decline to weight on the future outlook

In spite of a spike in claims, trade credit insurers are also likely to see smaller income from their investment portfolios. Insurance companies allocate a bulk of their investment capital to instruments deemed “safe”, like for example government bonds of developed economies. Most major central banks slashed rates causing yields to drop. However, yields were relatively low for some time already and, given how good the economic outlook was in years prior to the coronavirus outbreak, some insurers increased exposure to corporate debt. Significant recession risks made such bonds were risky investments.

Outside of the bond market, insurers are also investing in equities. Such investments are long-term in nature but spike in claims may call for some liquidation to meet commitments. Given current market circumstances, it would likely mean booking a loss. Income from equity portfolios is also likely to decline as there is a high chance that dividends will be cut, at least in some sectors.

Allianz (ALV.DE) has significant exposure to the credit insurance market through its subsidiary Euler Hermes. The German insurer erased 60% of the post-crisis upward move and is testing the support zone at €120. This is an important long-term price zone for the stock as it stretches all the way back to mid-2003. Defending this zone would be a significant boost to the bulls. Source: xStation5

Summing up, insurers are set to be hit by a double-whammy this year. On one hand, claims are likely to rise amid company’s defaults and insolvencies. On the other, investment portfolios have been greatly hit by recent market sell-off, deteriorating capital position of insurance companies. At the same time, actions undertaken by central banks and potential cuts to dividends will decrease yield on the portfolio making things even worse as we go into the future. It is hard to estimate the impact of the coronavirus outbreak on the global economy, especially as new preventive measures are still being undertaken in major economies. Having said that, insurers may be set for another wave of selling later on in the year in case quarterly reports show bigger-than-expect jump in claims.

AIG (AIG.US) is the US insurer, who received a government bailout in the aftermath of the global financial crisis. The company has lost almost 70% in value during the ongoing stock market rout. The ongoing rout has brought the price down to the support at 78.6% retracement of the post-crisis upward move ($19). Note that this zone is also marked with price reactions from 2010 and 2011. Lower wick of this month’s candlestick offers some hope. Source: xStation5