Why forcing insurers to cover pandemic is a bad idea

Insurance companies put in a position to cover business interruption losses regardless of how their commercial contracts were originally constructed could threaten their solvency on a global scale, warns a new report.

In addition to negatively affecting the carriers’ liquidity profile, “this would generate downward pressure on the financial strength ratings of P&C insurance companies,” DBRS Morningstar said in its commentary, P&C Insurance: The Conundrum of Business Interruption Coverage during the Coronavirus Pandemic.

In the United States in particular, but also in some Canadian legal circles, there is talk about just how bulletproof pandemic exclusions are under BI policies. Both U.S. and Canadian insurance professionals are confident that pandemic exclusions apply to most standard commercial policies offering BI coverage.

“Business interruption was never designed to respond to pandemics,” as Colin Simpson, president and CEO of the Insurance Brokers Association of Ontario (IBAO), told Canadian Underwriter in March. “It’s generally linked to named perils within a policy, like floods and fires, for example. There’s a business interruption element to that, but a pandemic is something totally different.”

But a broader conversation about the topic is beginning to emerge because three U.S. states — New Jersey, Massachusetts and Ohio — are looking to force retroactive policy changes to include pandemic coverage. DBRS also noted that public officials in the U.K. are calling for the same.

The American Property Casualty Insurance Association (APCIA) estimated such a move could cost American P&C insurers between $220 billion and $383 billion per month. To put this into context, the “total surplus for all of the U.S. home, auto, and business insurers combined to pay all future losses is roughly only $800 billion,” APCIA noted in a lengthy media statement.

To look at it in another way, American P&C insurers handled three million claims during the 2005 hurricane season (Katrina, Wilma, Rita and more). COVID-19 pandemic-related claims could see 30 million claims from small businesses operating in the United States, APCIA noted.

A high number of claims from retroactive changes “would have a material adverse impact on the capitalization of the industry globally, and it could cause a liquidity crunch for some companies facing an unexpected surge in BI losses,” DBRS Morningstar’s report said.  “This would generate downward pressure on the financial strength ratings of P&C insurance companies, particularly those that focus on commercial lines, where BI coverage limits tend to be materially higher.”

And what about reinsurance companies? What would happen if they had to cover pandemic-related BI losses for which they never originally priced? “This would leave direct insurance companies in a very precarious situation that could make them not viable within a very short time, unless there were to be a government backstop similar to that provided by the Terrorism Risk Insurance Act in the United States,” the DBRS Morningstar said.

Related: How Canada’s P&C industry will weather the economic storm from COVID-19

Another unintended consequence of such a move is that any future attempts to offer such a product in the future would be too expensive for clients, “because insurance companies will have to price in the potential risk of being forced to cover BI losses outside the language of their policies,” according to the report.

That reinforces what Simpson earlier told Canadian Underwriter. “If you were to look at it through a different lens, in the future, could the insurance industry respond to it [pandemic risk]? The answer would be no, unless there are sufficient funds on the balance sheet to pay out claims of this magnitude. And we can see from the press that there are a number of businesses that are being interrupted.”

Let’s say insurance companies were forced to cover losses outside of original contracts. DBRS Morningstar predicted that companies will face more litigation around coverage.

“This is compounded by the fact that BI policies tend to be tailored to the specific needs and the nature of the commercial activity of the insured clients, which leaves interpretation of these contracts up to the courts of law in many cases,” its report stated. “Although we expect that existing BI contracts will be ultimately upheld, and that the overall claims and loss ratios for most business lines will be manageable for the P&C insurance industry following the coronavirus, increased litigation costs will adversely affect insurance companies’ profitability in 2020 and 2021.”