24 March 2020Actuarial & underwriting

Pandemic insurance? I’d have been laughed out of the conference room! Yet captives could be part of the solution

While the science community has long warned that a global pandemic was inevitable, corporate risk managers have been woefully unprepared for the carnage that COVID-19 has wreaked on their businesses. Risk managers that Captive International spoke to admitted that when they were having discussions about the big risks facing their businesses before the outbreak started, the risk of a pandemic did not register in their conversations.

Risk managers were not alone in being unprepared for COVID-19. In January the World Economic Forum named the top five risks facing the world: it cited extreme weather events, failure to adapt to and mitigate climate change, human environmental damage as greater threats to the global economy, along with threats to biodiversity and ecosystems and major natural disasters. No mention was made of pandemics.

One risk manager said: “If I had presented a proposal to the board six months ago for pandemic insurance, at the price that would have cost, I would have been laughed out of the conference room. That coverage would have been seen as way too expensive. Now I can certainly have that conversation.”

The onset of COVID-19 has therefore caught most companies off guard. Risk managers doubt they have any meaningful coverage for the losses they have coming in their insurance policies. The situation is still developing fast. Many do not yet have a clear picture of the full extent of the losses they will see from COVID-19, either in terms of exactly where those losses are occuring, or their magnitude. But it is already clear that access to materials and transport links have been severely disrupted.

One risk manager summed it up: “Our business interruption policies require evidence of physical damage to property. But in this instance there is no fire, no earthquake. COVID-19 infects people, not property.”

Another said the role of the captive will be critical in helping its parent through this crisis, even if it is not by providing insurance coverage for COVID-19 itself. Rather, captives can help their parent companies by paying other claims that come in promptly, to ensure companies have the cash flows they need.

“In a crisis, cash is king,” the risk manager said. “Cash is the lifeblood of all companies, whether they are big or small. And many captives are sitting on piles of cash.”

Where they are able, captives can also help their parent companies by making intercompany loans, he added. This will get cash into the hands of corporate managers who can use it to keep their businesses operating while its usual sources of income have dried up.

It is unlikely that many captives currently provide pandemic coverage. But some believe they will play an important part in their future pandemic insurance strategies, that will be developed when attention turns from business continuity, which is risk managers’ current top priority, to thinking about the future.

A number of risk managers thought captives could write pandemic coverage, although they agreed only a small portion of the risk could be retained: most of the risk would have to be taken out in the reinsurance market. Few captives would have the capital required to pay out on any comprehensive coverage, given the extent of the losses companies appear to face at this early stage in the crisis.

One risk manager said: “We will have to look at what the captive can do. When this is finished appetite for pandemic coverage among insurers will be even lower than it already was, so there won’t be much choice.”

But this would probably only be feasible for the biggest captives. Another risk manager said: “The insurance industry will come up with new forms of coverage for pandemics and we will certainly investigate that. But I don’t see how we could accept this kind of risk in our captive, this is too much risk. If we did it would only be a very small slice of the risk.”

Another risk manager argued that captives are poorly suited to this kind of low frequency, high severity risk, due to the lack of historical claims data on which to base their underwriting decisions.

However it is secured, risk managers will certainly be looking for pandemic coverage: nobody believes COVID-19 will be the last pandemic to ravage business activity. Indeed, many acknowledge this could be a mere dress rehearsal for a far more devastating pandemic, with a higher mortality rate. Most estimates for COVID-19 put the mortality rate at between 1 percent and 4 percent. Avian flu, by contrast, has a mortality rate between 30 percent and 60 percent.

The availability of pandemic coverage going forward is a significant concern. Even large commercial carriers could be reluctant to get involved: rates are already increasing and re/insurers are focused on maximising their profitability. If they do write this kind of coverage, it will not come cheap. Many insurers may prefer to stay out of it altogether.

One person said: “Managing this risk will be expensive. Premiums have already been rising and my fear is that insurers will see this as an opportunity to raise them even further, across all coverages. We have seen them do that in the past when there have been big risk events like this.”

One possible solution that has been suggested would be to use the model the US adopted to provide terrorism coverage, through the Terrorism Risk Insurance Program. In this instance, governments work in partnership with insurance companies to make up for the lack of capacity in the commercial market. This solution is understood to be under consideration by senior lawmakers in the US.

One risk manager said: “Risk managers need to have a very frank and honest conversation with their insurance partners, to gauge their appetite for this kind of risk. We need to ask them whether they are prepared to offer this kind of coverage in the future, because right now that appetite is not there.”

For now, however, risk managers remain focused on more immediate problems, such as business continuity and the safety of their employees. The issue of whether they will be  covered for the losses they are currently incurring looms large, but is a problem for another day, while the question of how they will insure their businesses against future pandemics will have to wait even longer. But they know they have some difficult decisions to make in coming months.

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More on this story

Actuarial & underwriting
19 March 2020   AM Best is developing a stress test to apply to its rated insurance companies' balance sheets to gauge the impact of the COVID-19 virus fallout on their businesses.