A series of practical papers on Interest Rate Risk Management under Solvency II Part 3: Solvency II hedging
Explore the intertemporal dynamics as hedged liabilities age in Solvency II hedging: Part three in a series.
The 2019 State of the Industry report from the North American Pet Health Insurance Association (NAPHIA) shows continued growth in the pet health insurance market. At the end of 2018, nearly 2.43 million pets were insured in the United States, an increase of 18% from 2017.1 Gross written premium shows similar increases as well, growing to $1.3 billion at the end of 2018. With the population of insured pets continuing to grow, it’s almost certain that the recent outbreak of COVID-19 has the potential to affect the industry. Although a tiger at the Bronx Zoo recently contracted the virus, the good news for insurers is that the Centers for Disease Control and Prevention (CDC) says it “has not received any reports of pets becoming sick with COVID-19 in the United States.” 2 Nevertheless, COVID-19 stands to have an impact on the pet health insurance industry, but at this point, it’s unclear whether that impact is going to be positive or negative.
Since early March, there has been a significant effort to promote social distancing as a result of COVID-19, with most state governments issuing stay-at-home orders. A majority of the United States is being asked to leave their homes only for “essential” needs, which raises the question: is veterinary care an essential need? Michigan is one state that has made it abundantly clear, with its stay-at-home order explicitly stating that veterinary services can only be rendered for the following purposes:
Clearly in Michigan, but more likely across the nation, it is plausible that many individuals are forgoing their pets’ (and their own) routine checkups and addressing minor concerns in order to comply with social distancing. Veterinary clinics are also adapting procedures to provide safe environments for human beings. Besides postponing any elective procedures, veterinary clinics are generally not allowing owners into waiting rooms. Instead, pet owners are dropping off and picking up their pets curbside. Additional sanitation measures are also being put in place for each visit in order to limit the spread of COVID-19.
All of the above would seemingly point to fewer visits to the vet. In fact, data compiled by VetSuccess from more than 2,500 veterinary practices in the United States shows that, from March 25 through April 5, the number of daily veterinary invoices have fallen nearly 19% year over year. As shown in Figure 1 below, daily invoices had actually been slightly higher than last year in the weeks prior. Daily revenue data shows a similar pattern, down about 16% year over year.
Figure 1: Daily invoices per practice
Although not all services would be covered under pet health insurance, it is almost certain that the drop in daily invoices will lead to a drop in claims filed. As it stands today, there is no clear end point for social distancing, and the longer it persists, the greater the chance that claim activity for pet health insurers remains lower than prior years. Ultimately, an unanswered question for insurers is whether a lull in activity now will lead to an increased amount of claim activity once the COVID-19 restrictions ease.
The possible reduction in claim activity is only half of the story to which pet health insurers should be paying attention. Close attention should also be given to the churn rate, the number of policyholders either canceling or not renewing their policies. The near complete shutdown of the U.S. economy has created previously inconceivable unemployment numbers. In the three weeks ending April 4, a record 16.8 million Americans have filed for their first week of unemployment benefits. That number is staggering when compared to the 8.6 million Americans who lost their jobs over the course of two years during the global financial crisis. 4 Many economists are expecting unemployment to peak in the double digits. A recent New York Times article actually estimates that unemployment is already at 13%.5 With widespread unemployment, it is feasible that there will be a number of policyholders looking to cut monthly expenses, which may include dropping pet insurance coverage. Average annual premium for an accident and illness policy in 2018 was $529 per NAPHIA’s report. While this amount isn’t staggering, it may well be considered a discretionary item for individuals looking to cut costs in the coming months.
Will the decrease in claim activity and the additional churn offset one another, or will one have a greater impact than the other? That might depend on who is canceling or not renewing their policies. It’s unlikely that policyholders with a premium of $529 per year, but annual reimbursed vet expenses of $1,500 per year, would cancel their policies. Unless those policyholders stop taking their pets to the vet, doing so would only add expenses to their budgets. It is much more likely that a policyholder who has not used the insurance much, if at all, would cancel the policy. These are the “good risks” with very low loss ratios that insurers would prefer to retain. If insurers begin to lose these policyholders, it leaves them with a riskier and less profitable book of business.
If good risks are canceling policies and offsetting the impact of a decrease in claim activity, an insurer has two courses of action to attempt to keep loss ratios consistent: increase rates or grow new business. Insurers have generally been increasing rates over the last several years already. A review of insurer rate filing activity from February 28, 2019, to February 29, 2020, shows that pet health insurers have increased rates almost 16% in the past year alone. Additional increases during, or immediately after, record unemployment and an impending recession could drive current and potential policyholders away. While increasing rates may lower loss ratios for an insurer’s current book of business, doing so also opens the door for adverse selection, where the good risks continue to leave because their rates are increasing despite not utilizing coverage. In the long run, this would have the exact opposite effect insurers would want.
What about growing new business? New business tends to be younger pets, which often have a lower loss ratio. This could potentially serve to offset good risks that will churn in the coming months in order to cut expenses. The concern here, as stated above, is the record levels of unemployment. Insurers will certainly continue to add new business, but doing so at a meaningful level will be challenging in the near future. The possible silver lining, at least in the short term, is that news stories are popping up across the United States stating that animal shelters have seen a spike in adoptions. The obvious reason is that more people are looking for companionship while being forced to stay at home (and are maybe looking for an excuse to go for a walk). With various insurers offering discounts for shelter animals as an incentive for policyholders to insure their pets, there is hope for new business growth so long as stay-at-home orders continue.
What does all of this mean for pet insurers? The answer is that it depends and, in the interim, it’s important not to overreact to the data. If pet insurers can manage to control the churn of current policies, they may enjoy a lower than normal loss ratio, at least over the next several months. This might result in a push for lower rates going forward, but rate-making is a prospective process. Only if the decrease in claim activity is expected to continue for the next year and beyond should rates be lowered in this scenario.
On the other hand, if churn starts to increase, loss ratios won’t look nearly as good for insurers. They would likely see loss ratios increase as the good risks cancel or don't renew their policies, leaving a less profitable book of business for insurers. In this scenario, rate increases may seem necessary and would serve a short-term purpose, but would only introduce adverse selection in the long run, and growing new business at a time of record unemployment may prove a tough obstacle to overcome. Regardless, insurers will benefit from monitoring which policyholders are churning. With an understanding of which policyholders are leaving, it is possible to revise a rating structure, rather than increasing rates across the board, in order to focus on retaining good risks. Adding or increasing claim-free discounts, analyzing breed relativity factors, rating territories, or considering demographic information of pet owners could serve to more closely align premiums with claims in order to keep good risks from leaving.
12018 GCC Healthcare Industry Report by Alpen Capital. ArabHealthOnline. Retrieved on November 6, 2019, from https://naphia.org/news/naphia-news/naphia-announces-pet-insurance-market-reaches-1-42b-in-north-america/.
2Wamsley, L. (April 6, 2020). A tiger has coronavirus. Should you worry about your pets? NPR. Retrieved on April 8, 2020, from https://www.npr.org/2020/04/06/828517076/a-tiger-has-coronavirus-should-you-worry-about-your-pets.
3Gibbons, L. (March 30, 2020). Non-essential veterinary visits banned in Michigan during coronavirus pandemic. MLive Michigan. Retrieved on April 8, 2020, from https://www.mlive.com/public-interest/2020/03/non-essential-veterinary-visits-banned-in-michigan-during-coronavirus-pandemic.html.
4Kurtz, A. and Tappe, A. (April 9, 2020). Another 6.6 million Americans filed for unemployment benefits last week. CNN Business. Retrieved on April 9, 2020, from https://www.cnn.com/2020/04/09/economy/unemployment-benefits-coronavirus/index.html.
5Wolfers, J. (April 3, 2020). The unemployment rate is probably around 13 percent. New York Times. Retrieved on April 8, 2020, from https://www.nytimes.com/2020/04/03/upshot/coronavirus-jobless-rate-great-depression.html.