Opinion: Here’s how to set up future BI pandemic coverage

If the property and casualty insurance industry wants to avoid future entanglements around business interruption insurance, as seen during the coronavirus pandemic, then a robust public-private partnership (P3) might provide a solution.

COVID-19 has highlighted the issue of how to finance catastrophic losses. The pandemic will generate insured losses of US$107 billion for the global P&C industry, according to recent estimates by Lloyd’s. This amount is based on contract language in which business interruption (BI) policies, with few exceptions, exclude losses arising from epidemics and pandemics.

However, even though most BI policies do not provide coverage for losses arising from COVID-19 closures, groups of business owners and lawyers worldwide are calling upon insurers to make good on a promise they never made.

The impact of COVID-19 on Canadian businesses is staggering. In April 2020, the parliamentary budgetary officer (PBO) listed 18 federal programs affected by COVID-19 (both new initiatives launched to help Canadians and impacts on existing programs). Of the programs supporting businesses, the PBO has estimated costs of $123 million to the air transportation sector, about $5.7 billion to the GST credit special payment, and more than $76.8 billion (across two initiatives) in temporary wage subsidies.

The Canadian insurance industry could not cover this expense without devastating and potentially fatal impacts on solvency. To put this amount into perspective, a 2016 report by the Property and Casualty Insurance Compensation Corporation (PACICC) concluded that if a B.C. earthquake generated more than $35 billion in insured losses, the industry would collapse.

The price tag for temporary wage subsidies alone is double this amount.

iStock.com/Warchi

This raises the question: Should, or could, BI insurance cover pandemic risk? The status quo, which involves specialized coverage for pandemics that few businesses purchase, will likely be untenable in the future given the increasing losses from COVID-19. This may result in either the future exclusion of all coronaviruses, or, if they are covered, the cost of BI coverage will not be affordable for most organizations.

A solution for future pandemic losses is needed. To date, Canada’s experience with insurable catastrophic losses has been comfortably within the industry’s capacity and government support has not been necessary. Despite sustained efforts from PACICC and Insurance Bureau of Canada, Canada is the only G7 nation without a P3 between insurers and the federal government to finance catastrophic losses.

We need a robust and sustainable P3 to respond to catastrophic losses, whether they result from pandemics or natural catastrophes, to mitigate the inevitable negative consequences that will follow a significant disruption to the insurance industry.

There are several potential models. For pandemics specifically, the high degree of correlation suggests that a strictly private market solution (insurance, reinsurance, and insurance linked securities), which is available for natural catastrophes, is not realistic.

The first option is that the government be the primary insurer. Similar to employment insurance (EI) or workers’ compensation coverage, if coverage is compulsory, having the government as the primary insurer is a reasonable option. Since both EI and workers’ compensation are tied to employment, they provide an example of how BI coverage for epidemics could be structured to achieve broad-based coverage with a mechanism for risk-based financing.

Another model draws on the expertise of primary insurers. This option entails a time deductible, like standard BI policies (e.g., 5 days), a small layer (e.g., 80% coverage of revenue for 2 weeks) written by primary insurers, and the government playing the role of reinsurer for any losses beyond this timeframe. An important requirement is that businesses are only eligible for ex post government relief if they purchase this coverage. This model leverages the primary insurer’s expertise in underwriting, pricing, and claims management. It also allows for differential responses across the country so that the level of financing could match the severity of the outbreak.

A final option has the private insurers writing the coverage, but the government is the sole insurer. This is similar to TRIA (Terrorism Risk Insurance Act) in the United States. Private insurers would offer BI policies, including specialized coverage for epidemics. The government, through ERIC (epidemic risk insurance coverage), would reimburse private insurers for a portion of their losses arising from the epidemic. Under TRIA, “the government recoups some or all federal payments under the act from insurers in the years following government coverage of insurer losses.” Whether this should be part of ERIC is an issue for consideration depending on the severity of the outbreak. A primary objective of ERIC is to ensure affordability for businesses.

Improving the resiliency of the Canadian P&C insurance industry in the face of future catastrophic losses is critical. As such, now is the time for the federal government to enter into discussions on designing a robust P3 to protect the interest of all Canadians.

Mary Kelly is a professor of finance and chair in insurance at the Lazaridis School of Business and Economics at Wilfrid Laurier University. Anne Kleffner is a professor and chair in insurance and risk management at the Haskayne School of Business, University of Calgary.

Feature image by iStock.com/z_wei