Implement pandemic perils into TRIA? No! A free market solution is needed


Implement pandemic perils into TRIA? No! A free market solution is needed

Marcus Schmalbach, RYSKEX

Should pandemic be included in TRIA? What is needed is innovation, not state aid, says Marcus Schmalbach of Ryskex, who takes a look at the current market situation and invokes the spirit of Adam Smith.

Spring is the time for conferences: presentations from well-equipped panels, combined with convivial rounds at the bar, where industry representatives join together for a drink and contracts are extended with a handshake.

Not so this year. You sit in your home office in casual clothes and discuss internet-based service providers with each other. The different approaches can be seen as exciting. If captive insurance managers are currently looking for clauses to cover the predominant damage caused by a pandemic, the risk-takers hope to have as little toxic paper on their books as possible.

Newspapers and television stations speak of an unprecedented situation and an immense impact on the economy. Such a pandemic is really something new—and very unpleasant—but the effects are well known and were predicted by various experts last year. 

The state to the rescue?

Meanwhile, the voices of the parent companies and various captives managers can be heard, calling for state aid. Especially in the US, there have been loud calls for the incorporation of pandemic risk into the Terrorism Risk Insurance Act (TRIA) 2002.

TRIA created a federal “backstop” for insurance claims related to acts of terrorism. It was ratified in the wake of the 9/11 2001 attacks and has been consistent ever since. It was a very sensible approach at the time, as it was classified as a 1 in 100, or maybe even 1 in 500 years risk, which was not included in classic insurance models.

“I have discussed a VUCA World Policy with various actuaries and experts: a parametric solution which covers the 10 largest prevailing risks.”

It took eight years before another event—this time the subprime mortgage crisis—led to new calls for state aid.

Now it is the coronavirus outbreak that is to be the special case, requiring the cushion of state subsidies.

The pattern that emerges is that with the increasing economic crises—which are due to globalisation—the state and thus the taxpayer should always step in. What an irony that the tax-paying American indirectly ensures that my blue-chip shares can ultimately pay my dividend—as a German.

This article is by no means intended to be socially critical. The aim is to be a reminder that such mechanisms are not provided for in a free market economy.

What has changed in the last two decades? Pretty much everything. In 2002 nobody had heard the term VUCA—volatility, uncertainty, complexity and ambiguity. Today it has become a household word, present on every pitch deck from the startup to the presentation at the shareholders’ meeting to the slides of the major consulting firms. 

Expect the unexpected

Can the unexpected be insured? Many experts will now say ‘no’. I think this is the wrong approach. Now that we are all sitting in our home offices and have plenty of time, being able to work efficiently, and not rushing to the airport and being trapped in endless meetings, we have time to rethink the concept of insurance from scratch.

Questions to be considered include:

  • Why can’t many of the top entrepreneurial risks be insured?
  • Why are many contracts so complicated that claims are not clearly defined?
  • Are the coverage concepts really designed to cover existing risks?
  • Why is the combined ratio of many market participants continuously negative?
  • Why is the ecosystem of captive insurance so complicated in the age of digitisation?
  • Why do I have to go from box to box to get risk protection and I cannot trade risks like stocks?
  • Are the coverage concepts really designed to cover existing risks? 

I am happy to give you the answers right now: because it has always gone well so far. At decisive moments the state cushioned the balance sheet and defaults with taxpayers’ money, and then everything went its usual course.

The impact of these crises, and the government intervention that follows, is increasing. Pure statistics say that in 10 years—after a post COVID-19 bull market—a bear market will begin. Next time it probably won’t be triggered by terrorism, pandemics or banks, but by cyber attacks or climate change. Then the calls will come again for government aid: TRIA will have to be expanded to accommodate yet another component. 

Time to think differently

I do not yet have a solution for these impacts, but I am happy to provide food for thought. I have discussed a VUCA World Policy with various actuaries and experts: a parametric solution which covers the 10 largest prevailing risks and a second compensation trigger linked to the impact on the parent companies of captives.

Since it is known that an impact will occur, it deviates from the classic insurance model, true to the law of large numbers, and looks rather like a fund. The risk management of the parent company and the captive managers set it up, define the triggers and sell it to the capital market bit by bit. The more attractively designed it is, the higher the demand on the part of the capital investors will be.  

An alternative would be for a US onshore domicile to set up a rescue fund for VUCA World risks and sell it as a bond and the domicile-based captives to buy these bonds.

It is frightening how often the state has intervened/has had to intervene in the market economy in recent years. If you can always rely on your big brother, and don’t really need solutions in case of emergency, and this slows down innovation.

The weak are kept alive and the Darwinian idea of survival of the fittest is denied. If there is one good thing about the crisis, and the resulting isolation, it is the opportunity to question the market and your own systemic relevance, and to reinvent yourself. 

Accordingly, I would like to thank those who have read so far. You have now earned a recommendation or food for thought. From The ability to provide cover when the traditional insurance market can't or isn't willing to offer is a key differentiator of a captive. Further the traditional insurance market isn't equipped for actual tail risks as cover is usually based on historical events.

Being able to support the parent is of direct added value, which each captive manager needs to prove to some extent. It is crucial to deal with new models (data driven parametric solutions), technologies (the internet of things, blockchain and artificial intelligence) and strategic solutions (capital markets, captive-as-a-profit center, how to cover the next crisis triggering event and its consequences).

The risk landscape is changing, but so are the opportunities. The industry must reinvent itself.   

Marcus Schmalbach is chief executive officer of Ryskex. He can be contacted at:  

RYSKEX, Marcus Schmalbach, Terrorism Risk Insurance Act, TRIA

Captive International