10 March 2020IT & claims management analysis

Coronavirus exposes gaps in commercial coverage; captives could offer solution

The spread of the coronavirus, first through Asia and now into Europe, the US and the rest of the world, has exposed gaps in many companies’ insurance coverage. With large Chinese cities and ports in lockdown and employees not reporting to work, supply chains have already been severely disrupted.

There is still some confusion around whether or not existing policies will cover claims related to the coronavirus. Aidan Kelly, director in Aon’s risk finance and captive consulting team, believes the coverage gaps are relatively limited.

“From the conversations we have had with clients around the wording of their GL policies, it looks like they will be covered,” Kelly told Captive International. “There are generally no specific exclusions for coronavirus or pandemics, for GL. For business interruption losses, it will depend on the policy form and whether non-property damage BI is excluded or has been specifically written back using a captive, as an example.”

Lorraine Stack, managing director in Marsh's captive solutions practice, sees a bigger problem. “Traditional property and casualty policies are likely to provide only limited coverage for public health emergencies and pandemics,” she said.

Businesses face a particular problem where governments issue force majeure certificates to shield domestic firms from liabilities arising from their inability to fully perform contractual obligations in relation to COVID-19, she added. As Marsh noted in a note on the implications of the coronavirus: “As of February 14, 2020, the China Council for the Promotion of International Trade had issued 1,615 force majeure certificates to Chinese firms, covering 30 sectors and a total contract value of $15.7 billion.”

The extent to which captives can play a role in plugging these gaps is open to debate.

Kelly pointed out that high severity/ low frequency risks, such as the coronavirus, tend to be poorly suited to captive purposes generally. “With only one client and revenue source, captives do not want to be in a position where they have one single large claim that will erode their capital base. They want predictable, frequent and low severity losses that they can model easily,” he said.

Kelly therefore does not see captives as the optimal vehicle for managing this risk.“Given the uncertainty of the effects, timing and dispersion surrounding this event, it may be challenging to use a captive to assist with any risk financing needs,” he said.

However, Kelly added: "It may be an opportunity for captive owners to review their current programs and sub-limits and plan for captive involvement for the next pandemic/disease outbreak rather than react to this event."

Stack agreed  it may be too late for some companies to respond to the current crisis through their captive, although she did not rule it out completely. “It may be possible to write insurance to protect against the longer term unknown impacts of the coronavirus in some cases, but this will require creativity and there are likely to be better ways to use captives to mitigate the fall out,” she said.

Stack added: “The full impact of this crisis in an insurance context is still evolving but likely to have long term effects.”

The impact on surety and trade credit, in particular, will be felt long after the coronavirus itself has subsided, she added. “Captives can play a key role here in mitigating long term impacts by providing a flexible mechanism to deliver essential tools of commerce where commercial insurance market options are either diminishing, or providing an insufficient response to rapidly changing global environments,” Stack said.

However, she stressed the biggest beneficiaries are those that conducted such reviews of their programmes in the past. “Some companies were assessing the gaps in their commercial coverage five years ago and have been writing business interruption, surety and trade finance coverage through their captives for some time,” said Stack. While this trend was not caused by the outbreak of the coronavirus, the crisis has illustrated the prudence of taking such steps, with these far-sighted companies now reaping the benefits, she added.

Marsh manages around 1400 captives and produces regular benchmarking reports to track how the captives market is evolving over time. There has been a general increase in interest in captives over the past six to eight months, much of which can be attributed to the hardening market. This interest is seen across geographies and coverage lines, and certainly has not been driven by companies worrying about whether their commercial policies will pay out if there is a global pandemic.

However, Marsh’s latest findings do indicate that captives are significantly increasing their activities in exactly the lines of business that are most likely to be affected by events like the coronavirus, such as business interruption, surety, supply chains and trade credit.