On February 27 Daily Fintech published this article, “Dominoes fall- business disruption and risk management in the COVID 19 environment,” wherein there was a discussion of the indirect effects of the then China-based COVID-19 outbreak, and the estimation of economic damage due to the outbreak being $1 trillion. We now know the effects of the pandemic will be in the many trillions of dollars, and business enterprises around the globe are realizing that business interruption (BI) financial losses due to the outbreak are generally not covered by their commercial insurance policies. This is not a surprising finding since BI cover has the policy need of direct physical loss, which a viral pandemic does not produce. Many implications here regarding coverage gaps and systemic risk, and global application of moral hazard.
Patrick Kelahan is a CX, engineering & insurance consultant, working with Insurers, Attorneys & Owners in his day job. He also serves the insurance and Fintech world as the ‘Insurance Elephant’.
In one month’s time the anticipated BI losses due to COVID-19 increased manifold, became global, and have become difficult to quantify accurately, an apt expression of the unexpected outcome a systemic risk like a pandemic can cause- an uninsurable risk due to those exact criteria.
Business interruption cover is described by Marsh & McClennan as follows:
- We will pay for the actual loss of business income you sustain due to the necessary suspension of your “operations” during the period of “restoration.”
- The suspension must be caused by the direct physical loss, damage, or destruction to property.
- The loss or damage must be caused by or result from a covered cause of loss.”
The problems with the BI cover regarding COVID-19 effects are…all three points. Items 2 and 3 are not applicable due to the outbreak being the cause, and a viral and item 1 sets such wide expectations for the insureds as to be impossible to summarize. Loss of business income? Is that cash flow, ongoing bills, net income reduction (based on what?)
Even in the most direct loss cases, say a fire experienced by a business owner, BI losses are seen differently by the business as compared with the carrier. Again, what constitutes loss of income, and how is the loss indemnification supported and adjusted? BI cases are difficult to wrangle and often are simply negotiated.
If that handling were to occur say, in the U.S. for all the COVID-19’s affected insured businesses, the twenty-five million or so claims would need to be adjusted throughout the decade, would result in indemnity amounting to two to three trillion dollar total severity, would make all commercial carriers insolvent, and result in a consequential insurance catastrophe of loss of the industry.
There is no retrofit that would have the expected effect the insureds would need. Take for example the intention the New Jersey Assembly has in Assembly Bill 3844. The NJ Assembly proposes the insurance industry provide BI coverage to NJ businesses with full knowledge that BI cover does not apply and is excluded from cover. NJ would like carriers to pay the cover through legislated changes to the insurance policies’ contractual intentions, with NJ then reimbursing the carriers in the future for all or part of the payments. Just that one state’s businesses may have BI claims that exceed $100 billion! That is not a reasonable nor a legal option (would surely be challenged if enacted) and would challenge the solvency of the state’s carriers. Ex post legislation is not an answer.
Firms have already initiated legislation in the U.S. for breach of contract, and while most in the industry agree that BI cover is a long shot, the irony is that the claims being made trigger the need for loss and expense reserves, and the initiation of litigation will- absent cases being considered unworthy by courts- require that the respective carriers recognize worst case scenario reserves being placed on their balance sheets- a profitability hit that could be significant due to the volume of potential claims (think asbestos.)
Truly there is not a practical answer to the enormity of the question, so the industry and businesses must be forward looking in anticipation of another like occurrence, whether it’s a viral outbreak, cyber outbreak, or regional natural disaster. Systemic risk effects will occur again, and mitigative actions need to be considered now.
I considered one of many scenarios of systemic risk in the recent article published in InsurTech360, “Rethinking excluded pandemic (and other) risks. The article discusses just one of many loss occurrences- events and conferences, and considers the many aspects of planning, response, potential cover, admin of the response and potential payments for what is for an indemnity product an excluded peril. Future cover cannot be full reimbursement as we have discussed- the indemnity factors are troublesome to adjust. Parametric approaches to shared risk are discussed in the article as is planning and segmentation of the loss layers.
Insurance veteran Mark Geoghegan recently recorded a ‘solo podcast’ on the Voice of Insurance that addressed the topic in depth, and touched on the many issues of BI claims and COVID-19. The ‘selfie’ podcast, unfair-punishment-and-pandemic-re editorialized on the two-edged sword that BI handling by carriers will produce- 1) carriers cannot reimburse insureds for BI claims in that there is no policy cover, and there are not sufficient resources within the industry to do so, and 2) the carriers will still be left as the parties with record levels of capital that will not be applied to the situation, not a good view for the insured public to consider. Mr. Geoghegan walked through some efforts that could be put into place going forward, and some collective global actions that would distribute future systemic risk that would have similar effects as COVID-19. He clearly agrees with the writer that BI indemnity cover remains unreachable, but parametric hybrid products might be a compromise, if there is sufficient global participation by carriers, insureds, and governments. The industry knows that government subsidized products such as the U.S. NFIP flood program are not the answer. In fact there are some influential insurance persons who suggest private parametric plans supported by alternate risk sources are the most effective and stable answer, and not government backing as is found in the U.S. Terrorism Risk Insurance Act (see Dr. Marcus Schmalbach’s article, implement-pandemic-perils-into-tria-no-a-free-market-solution-is-needed ). Dr. Marcus is a knowledgeable proponent of capital markets being a primary force in financing these unique risks.
Mr. Geoghegan suggests that cooperative programs such as might be gained through premium contributions to a global pool of insurance backing for systemic risk response built over years is an option to consider. The pool would also help fund an important initiative going forward- research into causes of pandemic outbreaks, anticipating new viruses, be prepared to respond with strategic supplies, and with several years of global contributions, a substantial response fund that is not indemnity-based and available to all. However, what does that mean? Participation by all countries, carriers, and governments, a daunting task for the best of motivations. And as Mark reminded the listener- memories are short, and large sums of money are attractive targets for raids by cash-short governments. The concepts are provocative and if actionable in small part a sure improvement.
The author had a related thought-provoking discussion this week with Thomas Verduzco-Weisel, Director Central Europe at Symbility – Mobile Claims, a colleague in Germany who has seen the effects of disappointed customers; the chat focused on any actions that might be taken to respond to customer concerns- now.
We settled nothing categorically but did consider some options carriers can take to mitigate the effects of the constant drum beat in the press coming from businesses that have experienced or anticipate substantial BI losses:
- Reduce or suspend premiums based on companies’ reduced operations.
- Coordinate with other carriers in establishing a response fund that can provide direct cash benefits to business customers.
- Extend coverage for risks that are solely associated with COVID-19 actions, e.g., forward-looking coverage for credit risk, health risk.
- Partner with government regarding establishing captives- immediately- for mutual sharing of risk within affinity groups
- Establish help centers for staff to assist in navigating insurance and finance issues
- Look for coverage within policies that were in force at the inception of the pandemic, e.g., cover for civil authority actions in temp closures. Don’t wait for a claim to be initiated, create the claim and contact the insureds proactively
- Know how your product lines will evolve going forward- parametric options, review and retest exclusions, etc. The efforts must be uniform for all like insureds, and reproducible for similar perils. Not taking any action is going backwards.
Plenty of discussion of a problem that has grown into a multi trillion dollar beast, and a challenge for the industry and its customers, and not to forget, governments. Systemic risk from pandemics can no longer simply be a line in the exclusion section of insurance policies, but by the same token cannot be relegated to macro government response. For COVID-19 all players have been guilty of the oldest of risk management dodges- moral hazard. Why bother insuring the outcome if someone else will cover the effects? Well, that time is now gone.
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