Pandemic – an NDBI risk too far

Garry Booth asks: If the private sector is unwilling and unable to provide businesses with pandemic NDBI coverage, how can this gaping protection gap be bridged? And could a solution be extended to other systemic risks? When businesses large and small went into lockdown across the world’s developed economies, they looked to their property insurance providers for a much-needed cash injection – only to be disappointed. In a bitter row fuelled by lawyers and public relations experts, insureds took their claims to court in the hope of persuading supervisors that their insurers had a legal obligation to pay for their non-damage business interruption (NDBI) losses. Insurers argued that business interruption insurance contract wording was always intended to respond to local events and not the mandated closure of businesses such as happened in lockdown. Amid unprecedented public outcry, insurers declined to pay out on the majority of pandemic claims presented to them. In the UK, the Financial Conduct Authority reacted to the ensuing tsunami of legal actions (including several class actions) by fast-tracking an industry test case before the UK courts on behalf of policyholders. In an unparalleled court action, the High Court sought to bring clarity to some 370,000 policies with more than 50 insurers that were subject to dispute. The High Court’s decision in September was appealed by insurers and a Supreme Court hearing followed in January 2021, finding that, except in rare circumstances, cover is restricted to policyholders that were mandatorily closed. However, the new ruling also found that the original High Court judgment was too narrow in its interpretation of denial-of-access wordings – not entirely letting carriers off the hook. From Australia to North America, litigation between insurers and insureds has led policymakers and industry strategists to the same conclusion: pandemic-related business interruption risk is systemic, being characterised by widespread and simultaneous financial losses. Furthermore, it is largely linked to government decisions to introduce mandatory lockdown measures. Insurers opt out In short, pandemic risk is impossible for underwriters to model and price, and meaningful limits are unavailable in the face of such loss accumulation. As such, pandemic risk is beyond the capability of the private insurance sector and the role of the state must be extended to help provide pandemic risk transfer – and not simply making emergency cash handouts as happened in most OECD countries. As Jad Ariss, managing director of the Geneva Association, put it: “It is a tragedy that businesses, particularly SMEs, have suffered so much financial loss during the pandemic as a result of the lockdowns, which were beyond their control. The public sector had to step in with multitrillion-dollar emergency relief measures. Governments and insurers must work together on how to close the massive protection gap exposed by Covid-19, with governments as the leading players.” Mr Ariss was speaking at the launch in April this year of a report from the Geneva thinktank that examines four possible ways for governments to become involved in pandemic risk schemes, three with the help of insurers: Mandatory or voluntary direct insurance offered by the government and administered by private insurers Government reinsurance, backstopping mandatory or voluntary private-sector coverages Mandatory social insurance. The association discarded “post-event financial relief with no pre-event dimension whatsoever” on the basis that it foregoes any benefits from pre-event risk mitigation and preparedness measures. Each of the other potential solutions discussed in the report points to a valuable role for the insurance industry to act as absorbers of limited risk, professional distributors and claims managers, and/or experts in risk assessment, mitigation and prevention. With mandatory (or voluntary) direct insurance offered by the government and administered by private insurers, government insurers would not only collect premiums but also be able to borrow funds in case payouts exceed accumulated premiums, the Geneva Association argues. The government insurer could market policies directly to insureds or, alternatively, through third parties such as banks, insurers and intermediaries. The same options are available for claims settlement and payment. Is backstop best? Government reinsurance that backstops voluntary private-sector coverages is an option that is already in use for other types of catastrophe, notably terrorism but also flood and windstorm. European examples include the French Caisse Centrale de Réassurance, Spain’s Consorcio de Compensación de Seguros, the UK’s Pool Re, the German Extremus scheme, as well as nuclear industry pools in several countries. In the case of pandemic, governments could provide reinsurance to insurers that sell pandemic coverage to businesses prior to a pandemic event, the Geneva Association points out. Variations on this theme have already been mooted in several markets (see table). The reinsurance coverage would kick in for losses above a certain threshold and up to a designated limit. As for the direct insurance option, a major pandemic would probably require governments to borrow to raise funds, as well as to tax in order to service the debt, the paper points out. In contrast to backstopped private-sector coverage, the distinguishing feature of the social insurance concept is mandatory participation. The Geneva Association paper also points out it involves a higher level of solidarity and more uniform non-risk adequate pricing. With pandemic risk, participants would be required to make pre-event payments, for example through a special tax or levy. Benefits from such a scheme would be capped at a relatively modest level of potential losses, in line with the typical objective of social insurance to provide modest coverage for broad segments of the population. Corporate insurance buyers not surprisingly lean towards the backstopped public-private risk transfer option. Earlier this year, Ferma president Dirk Wegener wrote to the European Commission in support of public-private initiatives, which he said would increase financial resilience for the bloc’s economies against future pandemic risks. “Many European businesses face inevitable and sometimes severe financial losses as a result of the pandemic event. Insurance provides little if any cover for these risks, and insurers are introducing more exclusions and tighter conditions as policies renew,” Mr Wegener said. “We do not expect this to change. Pandemic risk, like climate change and cyber risk, is systemic. It is beyond the capital of the private insurance market to provide material capacity for transfer of risk.” Ferma’s view is that public-private partnerships for pandemic risk would be on a national basis, but the EU should help member states. “It could, for example, provide expertise, such as modelling and rate setting, and startup costs. There is also potential for additional EU support such as an EU backup layer, possibly via the European Stability Mechanism, allowing the convergence of all national systems to a European standard,” Mr Wegener wrote in his letter. Eiopa weighs in At the time of writing, the European Commission was exploring its options, helped in part by the European Insurance and Occupational Pensions Authority (Eiopa). In a paper out for consultation until the end of March 2021, Eiopa examined three mitigating aspects of the NDBI protection gap around risk prevention and risk transfer. In the latter category it discusses the role of capital markets in risk transfer and, extending the brief, also pooling of different perils for addressing systemic risk. Eiopa cautioned that capital markets investors won’t be as receptive to pandemic risk as they have been for well-modelled windstorm or earthquake property events, saying: “Progress on pandemic risk modelling and pricing will be needed… Public-private solutions for a leveraged pandemic fund may be a relevant option to consider in order to involve investors in a shared resilience solution.” On pooling generally (and it doesn’t say whether or not this would be backstopped), although the diversification benefit from pooling is not clear, multi-peril solutions can provide opportunities for addressing the risk of “following” events, developing common prevention measures, as well as addressing the opportunity cost of separate peril solutions. “The option to introduce future-focused multi-peril solutions should be considered going forward, to address systemic risk. The next crisis is unlikely to be the same as today’s, so we should improve our tools having in mind future challenges ahead,” Eiopa said. Black swan solutions Eiopa is not alone in thinking that the global economy will be disrupted again in a way that business and wider society is not sufficiently prepared for. Plausible systemic risks could include a cyber disruption, a climate change event or apocalyptic meteor strike. Pandemic Re, the London market project formed to find an industry solution for covering future pandemics, envisaged extending the UK government-backed terror mutual Pool Re into a vehicle that could help pay potential [systemic] losses that are outside the insurance industry’s capital. “One possible option is to turn Pool Re into a holding company where the surplus is held, and then form subsidiary companies – such as Pan Re, Cyber Re, even Climate Re,” Pandemic Re’s chairman Stephen Catlin suggested. Lloyd’s made a similar pitch with another government-backed pool it dubbed Black Swan Re. Policymakers’ wheels grind exceedingly slow however, and little progress has been made on industry proposals in Europe and around the world. Meanwhile, Eiopa has said it is analysing the feedback it received and “liaising with the European Commission regarding next steps”. That leaves risk managers and insurers alike watching the horizon for whatever the horsemen of the apocalypse next have in store – and hoping that the lessons learned from lockdown will make them better protected against it.

Pandemic – an NDBI risk too far

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