The true cost of business interruption

The publication of Santam’s 2020 Annual Financial Statements give the best indication to date of the impact of pandemic-related business interruption (BI) claims on the domestic non-life insurance sector. The country’s largest non-life insurer reported an “acceptable” performance for the year to 31 December 2020 despite trading in difficult economic circumstances. Gross written premium (GWP) from conventional insurance activities was up 5% to R31.1 billion; but the underwriting margin fell to just 2.5% compared to 7.7% in the prior year. This is well outside the group’s profit target of 4% to 8%.

Selling insurance in tough economic times

Lower than expected operating results and reduced investment income attributable to shareholders resulted in a 47% decline in headline earnings to 1100 cents per share. It comes as no surprise that Contingent Business Interruption (CBI) claims following lockdown were flagged as a major performance constraint during 2020. Low interest rates and fair value losses on financial assets also detracted from the result. Santam Group CEO, Lizé Lambrechts, said that trading conditions remained competitive in a constrained economic growth environment, before adding that economic activity would remain under significant pressure in the short- to medium-term. 

The pandemic and government’s response to it impacted the Santam’s sales and underwriting performance. On the sales front, intermediated business written in both the commercial and personal lines categories was marginally lower in 2020 compared to 2019. Premium was affected by a slowdown in new business acquisition due to the restrictions put in place during level five and level four of lockdown as well as the support provided by the insurer to ease the financial pressure experienced by policyholders. An amount of R310 million was provided as relief to motor policyholders in recognition of reduced travelling during lockdown. 

On the plus side, the group experienced continued strong growth in the corporate property, crop and engineering businesses. The accelerated trend to e-commerce and work-from-home also helped the insurer’s direct business, MiWay, to achieve a 7% improvement in GWP despite offering R40 million in premium relief to policyholders. GWP from outside South Africa grew by 28% to R4.963 billion. “Our employees and business partners have continued to deliver top-class client service amid unprecedented adaptations required in both their working environments and personal circumstances,” said Lambrechts. 

How much has Covid-19 cost the insurer?

Santam admitted that its 2020 loss ratio was adversely impacted by provisions for CBI claims; but added that the impact on its total underwriting experience was partly offset by a benign claims environment that saw no natural catastrophes and lower claims frequencies across several insurance classes due to lockdown. The motor and property classes also benefited from lockdown-related change in asset use; but the latter class suffered a R2.410 billion loss as the impact of CBI pay-outs hit home. 

The question remains: How much, in total, will Santam pay-out to its policyholders for pandemic-related business interruption claims. “The group’s best estimate of the insurance liability and reinsurance asset at 31 December 2020 is R5.3 billion and R3.3 billion respectively,” they wrote. In other words, the total insurance liability to its policyholders is estimated at R5.3 billion of which R3.3 billion could be recovered from reinsurers. But estimating and reserving for 2020 claims was no easy task. 

“The ultimate costs of claims are always uncertain, increasingly so given the impact of the COVID-19 pandemic,” wrote Santam. The insurer warned that materially different outcomes to those assumed were possible and that a level of uncertainty around the estimates of eventual claims costs would persist for some time. The group has, in the meantime, increased its total technical provision for the best estimate of its exposure to policies with CBI extensions from R1.290 billion at 30 June 2020 to R2 billion by the end of the year. The increased provision reflects the outcome of the Ma-Afrika case, the Supreme Court of Appeal judgment on Guardrisk’s Cafe? Chameleon case as well as other findings locally and internationally in relation to CBI cover. 

The 18 month versus three month indemnity debacle

One of the big unknowns in the estimate comes from the upcoming appeal of the Western Cape High Court ruling on the length of the indemnity period applicable to certain policies written by the insurer’s Hospitality and Leisure division. Santam believes there is a reasonable chance that the Supreme Court will overturn the High Court’s 18 month indemnity period ruling. The insurer is adamant the indemnity period in relation to its CBI extensions should be three months. Santam gave insight into the level of uncertainty in provisioning for CBI liabilities by saying that a 10% divergence on its various assumptions could result in a 30% move in its reserving. 

Despite pandemic, Santam settled R21.1 billion in gross claims for 2020 compared to R18.9 billion in the prior year. It is worth remembering that despite the economic and financial turmoil experienced last year, the insurer met its claims obligations without compromising its capital integrity, once again illustrating the value of insurance. “The 2020 results reflect our ability to manage significant external challenges in a considered manner that draws on the depth of our resources, skills and experience,” said Lambrechts. 

What does the future hold?

The premium written by a non-life insurer is closely aligned to a country’s economic growth. It will be interesting to see whether this correlation holds during the wild GDP fluctuations expected in 2020 and 2021. We were surprised, for example, by the 5% improvement in Santam’s GWP in the context of a 7% contraction in country GDP in 2020. What happens to its GWP experience in 2021, with a country GDP growth forecast 3% to 5%, is anyone’s guess. 

The group admits that investment markets are likely to remain uncertain and volatile; that the lower interest rate environment will negatively impact investment performance; and that its various foreign currency investments will introduce volatility to the group. “Despite these economic challenges, we are forging ahead with our Future Fit strategy, having completed the reassessment of its appropriateness during the first half of 2020,” concluded Lambrechts. Santam remains focused on extending its leadership position in South Africa and building a specialist Pan-African insurance business under the Sanlam Emerging Markets brand. 

Writer’s thoughts:
An underwriting margin of just 2.5% would be disappointing in a normal trading year; but 2020 was anything but. One would certainly think that any non-life insurer with significant business interruption exposure would be happy to emerge from lockdown and pandemic with a positive operating result. For an insurer to grow its premium in against the backdrop of a 7% contraction in country GDP is also worth writing home about. Were you surprised that Santam managed to grow its conventional insurance premium by 5% in 2020? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za.