Trend Watch - Scenario analysis and pandemics

Scenario analysis continues to play a vital part in operational risk management and measurement and is used extensively to evaluate exposures to high-severity, low-frequency events given the relative scarcity of loss data compared with other risk types, such as market or credit risk.

I don’t believe anyone could have envisioned the degree to which COVID-19 has impacted businesses worldwide and everyday-life. The various lockdowns currently in place across the globe are unprecedented and signify one of the true costs of globalisation for what is a particularly infectious disease. Therefore, just how accurately were firms able to foresee the pandemic and to what detail were potential impacts and scope assessed?

Trends in the scenario assessment data

ORIC International have analysed anonymised scenario assessment submissions (S00022 – Human Disease/ Pandemic) from Phase One of the Scenario Assessment Service. Whilst it should be noted that the level at which the scenario was run varies between Business Units and Group, the scenario storylines provide a useful indication as to what the firm has considered.

Analysing firstly the scenario storylines themselves, we found:

100% of submitting firms identified there would be a level of business disruption, whether that was loss of staff from the office, a need to work from home or an inability to provide services at full capacity.

40% of firms specified explicit timelines, i.e. how long they thought either staff illness or the entirety of the pandemic itself would last – this assumption will have influenced significantly the anticipated costs and varied greatly between scenarios.

30% of firms quantified likely mortality or infection rates be that globally or regionally (inc. specifying the percentage of the work force affected).

20% of firms identified wider economic factors including a likely decrease in the use of airline travel and the possibility that the pandemic would majorly influence a regional or global recession.

Most firms had considered work from home arrangements and in some cases assumed this to be 100% effective with little to no disruption. Interestingly, no firms had explicitly referenced how increased work from home demand may affect system infrastructure and the need for expenditure on physical assets such as laptops, screens etc.

In terms of the direct impacts assessed, the majority of firms as you’d expect listed a P&L impact including increased overtime/ recruitment costs to cover a reduced workforce. Other costs considered were business resumption/rectification costs, claims leakage/compensation payments, marketing and communication costs and increased hygiene and sanitation costs.

It will be interesting to establish over the upcoming months whether firms with presence in specific geographic regions, perhaps those more susceptible to epidemics and pandemics, were better able to assess and foresee some of the likely effects of a global pandemic which have come to pass over the last few months.

What about mitigating factors?

The two mitigating controls identified within the pandemic scenarios were:

  • Business interruption policies and life cover

  • Business resiliency plans and testing remote working

Just how effective some of these mitigating controls are likely to be in the long term (particularly insurance) should provide some useful food for thought for firms.Business interruption policies have already found themselves in the headlines recently with the FCA stating in their letter to insurance CEO’s that “most policies have basic cover” and “do not cover pandemics, and insurers have no obligation to pay out in relation to the COVID-19 pandemic”. Therefore, the extent to which firms’ business interruption policies cover pandemics or indeed whether they were ever intended to include pandemics at all, will be a useful indicator to the effectiveness of this particular mitigation.

On the upside, there has been a general sense from most firms that the shift to remote working environments has been incredibly successful and on the most part seamless. There is no doubt that COVID-19 may have a significant effect on the way businesses operate in the future and there is a feeling that many of the questions around working from home will have now been answered in terms of productivity and practicality which may influence a shift in business/employee working expectations in the long-term.

Looking Forward

As we know, everything is easier in hindsight but the insurance and investment management industries will have plenty of lessons learned once the COVID-19 pandemic has passed. The event could well be an indication of things to come with increasing population densities, expanding cities and globalisation all contributing to an increased likelihood of widespread disease and pandemics. The data compiled over the upcoming months should continue to feed into scenario assessments of the future and the interconnectedness of risks should always be a key consideration in any impact assessment. This is particularly important when firms consider third party suppliers (inc. overseas third party suppliers). Where appropriate firms should also continue to seek input from other parts of the business, specifically where there is specialised knowledge in order to produce a thorough assessment.

Given the increased scrutiny the industry can expect of firms’ stress and scenario testing as a result of COVID-19, ORIC International is keen to support members in reviewing and validating not just their scenario universes, but also the approach taken to consider the different impacts associated with each scenario. As mentioned above we have the scenario assessment database that contains nearly 1,000 unique and anonymised member scenarios. The storylines, frequency and impact assessments can help firms challenge their own assessments and consider whether their scenarios sufficiently address the different aspects of severe yet plausible events. In addition to the scenario assessment database we will also look to discuss best practice approaches through the scenario working group throughout 2020, taking into account any lessons learned from the COVID-19 situation.

If you’d like further information on the data discussed in this analysis, or if you’d like to participate in the scenario assessment work moving forward please contact Ciaran or Shahine.

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