Is pandemic insurance a contradiction in terms?

The answer could lie in public-private risk-sharing mechanisms and innovation

A fast post-Covid economic rebound is highly coveted by businesses, consumers and the government alike – and cancellation insurance could be key. Although many of us are ready to splash out on holidays, sport events and festivals, we are unwilling to gamble and lose on such things in case – heaven forbid – another lockdown hits.

Cancellation insurance policies, nevertheless, are few and far between. You could, for example, insure against the risk of not being able to visit someone if you, your travel companion or a dependant is taken ill by Covid. But coverage against a national or regional lockdown is non-existent.

To be fair to insurers, providing a cover against fire risk while the house is already burning might not appear commercially sound or even sensible. Understandably, the government’s quasi-guarantee that restrictions will irreversibly be lifted by the summer also falls short of convincing insurers to take on such an immense risk.

Even more so because, a year after the breakout of the pandemic, insurers are still left in limbo about the full extent of their Covid-related payouts. The most contentious cause of this ambiguity is the scope of business interruption (BI) policies.

Business interruption (BI) revisited

BI cover typically comes with property insurance. It is meant to keep a business afloat while it’s temporarily closed as a consequence of physical damage, whether caused by fire, flood, theft, vandalism or something else.

Little wonder then that the first sticking point between insurers and authorities representing the insured – such as the FCA in the UK – has been the ability of the coronavirus to cause structural and tangible damage to equipment and properties. Legal cases in the US were built on the virus lingering on surfaces for 28 days, thus necessitating “remediation to clean surfaces.”

What has put defendants to a disadvantage has been the fact that, in the wake of the 2003 SARS epidemic, which in comparison was a minor and rather contained public health crisis, insurers went out of their way to add virus waivers to their BI policies.

About one-third of businesses take out BI covers, and only a fraction of them come with infectious and notifiable disease extensions. Although Covid had been added to the list of notifiable diseases at the beginning of the pandemic last March, unless the cover is for unspecified notifiable diseases, Covid will be an exclusion.

In the US there have been a slew of lawsuits in an attempt to force insurers to pay out for Covid losses, but about four times as many have ruled in favour of the insurers than against them. Currently, seven states also have pending legislation that could get insurers to retroactively pay for BI losses incurred by coronavirus lockdowns. If enacted, they will mandate the redefinition of property damage sustained by SMEs to include the presence of a person infected with Covid-19 in the policyholder’s premises, or in the same municipality or state.

The Supreme Court in the UK, meanwhile, has also widened the scope of BI policies that have to pay out. It ruled, among other things, that the pandemic, as well as the government and public response to it – that is, the lockdown, whether partial or complete, mandated or only instructed without the force of law – were all perils that will trigger compensation.

According to the FCA’s estimate this ruling will throw a lifeline to approximately 370,000 business, while critics argue that the judgement applies only to a particular wording in certain clauses of some contracts and will only be a drop in the ocean of six million British businesses.

Getting insurers to indemnify losses that they – in many cases – didn’t underwrite at all is a tricky sell. On the other hand, having spent hundreds of billions on protecting jobs and businesses, as well as fighting Covid, the UK government’s “nudge” to the insurance sector to pull its weight sounds like a legitimate endeavour.

But how can insurers – once bitten, twice shy – be incentivised to develop pandemic products in a post-Covid era, when these insurance events are almost impossible to predict and, for the scarcity of data, difficult to model? (The complexities of assessing this type of risk are well demonstrated by the fact that the Economic Forum’s Top 10 list for pandemic preparedness was led by the US and the UK in 2019.) A risk is deemed insurable only if it’s statistically assessable and independent from other risks in terms of time, geography and the type of risk – which a pandemic, by definition and experience, is not.

The new index-based insurance model

Pandemic insurance is not a new concept, though. San Francisco-based disease outbreak prediction start-up Metabiota, having teamed up with Munich Re and brokerage Marsh, put one on the table as early as 2018.

This offering wasn’t the kind of traditional insurance product that, for a set premium, gives the insured protection against losses they incur. Rather, it adopted an alternative, so-called parametric or index-based model which covers the probability of a predefined event occurring: if the water level reaches seven metres, for example, you’ll get paid.

The event triggering payout in a pandemic could include metrics such as mortality rates or border closures in an area. As cover is highly personalised and accommodates the risk appetite of the insured, cover events may vary from policy to policy. And as claim adjustment is eliminated from the process, payout is fast, which is great for the solvency of businesses caught up in a health or natural crisis.

Insurance experts with an orthodox approach argue that the parametric model should be regarded as a financial derivative rather than a type of insurance. Others, despite parametric pandemic insurance’s pre-Covid failure to sell, have high hopes of this new model filling in the grey area of BI insurance that the current pandemic so forcefully exposed.

Innovation network InsTech London’s Parametric Overview 2021 set the coverage that the insurance industry should be able to provide for a future pandemic at $200bn (£143bn), equivalent to the total of all losses insurers pay in a bad year of natural disasters.

But in order for BI insurance to turn the page after Covid and become revitalised, the state as the re-insurer of last resort will most probably have a role to play too. Not unlike after 9/11 – another historic loss event, when the US government passed the Terrorism Insurance Act (TRIA) to ensure the viability of the terrorism insurance market with a federal backstop – insurers will need some state guarantees as incentives to kickstart the pandemic insurance market.

TRIA originally was a three-year federal programme but has been extended several times – most recently in 2019 (until 2027). With a similar safety net provided by governments, insurers will be able to come up with new data analysis and modelling methods, as well as innovative BI and cancellation products that can help the global economy roar back to life. There needs to be a way forward. After all, the Great Fire of London, which devastated central London in 1666 with an estimated loss of £1.5bn in today’s money, resulted in, among other things, the world’s first property insurance policy.

Zita Goldman

Zita Goldman

Zita Goldman covers digital transformation with a focus on demystifying digital technologies and showing how they fit into a broader sectoral, macroeconomic, legislative and societal context. She has a passion for connecting the dots of current business and financial news and explaining inconsistencies, for giving hype a reality check and looking behind buzzwords for fresh meaning.

© Business Reporter 2021

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