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The vast majority of these losses are likely to be absorbed by policyholders as, unless governments (or courts) intervene, few companies have business interruption coverage that is likely to respond to these types of losses – exposing the existence of an important protection gap for some pandemic-related business interruption losses. This note provides an overview of how business interruption insurance against pandemic risk could be provided with support from governments, and some of the challenges and considerations necessary for establishing such a programme.
The closure of manufacturing plants, restaurants, retail establishments and other places of business to limit the spread of COVID-19 will result in significant business interruption (BI) losses. The vast majority of these losses are likely to be absorbed by policyholders as, unless governments (or courts) intervene, few companies have business interruption coverage that is likely to respond to these types of losses (see (OECD, 2020[2]) for a more detailed assessment of the insurance coverage available for COVID-19 related losses).
In response to the current crisis, policymakers in a number of jurisdictions are examining various ways to support commercial policyholders (particularly small and medium-sized enterprises (SMEs)) in the context of the uninsured business interruption losses that they are facing or are likely to face as a result of the current COVID-19 pandemic. Policymakers are also beginning to examine longer-term solutions to address the gap in financial protection for pandemic-related business interruption that has come to light as a result of the current crisis. This note provides an overview of the initial responses to the likely business interruption protection gap for COVID-19 as well as discussing how business interruption insurance against pandemic risk could be provided with support from governments based on the experience of other catastrophe risk insurance programmes.
Governments (executive and legislative branches) are considering (or have implemented) a number of programmes to support businesses that have faced significant disruption as a result of COVID-19. In many countries, this support include a variety of programmes aimed at ensuring the availability of financing for businesses or supporting their employees.
In a few jurisdictions, governments are also considering ways to ensure that insurance coverage responds to the business interruption losses that have been and are being incurred. Insurers and their associations around the world have indicated that most policyholders have not acquired insurance coverage that will respond to business interruption losses that result from COVID-19 business closures. The absence of (or uncertainty regarding) coverage is expected to lead to significant disputes between insurers and their policyholders over the coming months (if not years).1 In the United States, for example, legislation has been proposed in a number of jurisdictions (including District of Columbia, Louisiana, Massachusetts, New Jersey, New York, Pennsylvania, Ohio, Rhode Island and South Carolina (Turner, 2020[1])) that, if adopted, might require insurers to pay certain business interruption claims submitted by businesses that had business interruption insurance at the time COVID-19 measures were implemented – even where insurance policies have exclusions or other policy terms and conditions that ordinarily would preclude coverage for such losses. At the US federal level, legislation has been proposed that would require insurers to offer coverage for business interruption losses resulting from a viral pandemic or related business closure orders and voids any previous exclusion of that coverage (subject to the payment by the policyholder of any additional premium for the new coverage) (Heidtke, 2020[2]). Policymakers or legislators in other jurisdictions (including France and the United Kingdom) have also made inquiries (or statements of expectations) on how insurers will respond to business interruption claims related to COVID-19.2
Proposals to require insurers to pay claims for losses that they did not intend to cover and for which they have not collected premiums or set aside provisions/reserves could have serious implications. The scale of losses that policyholders are incurring as a result of business disruption are multiples of the amount that insurers will normally payout for business interruption claims. For example, in the United States, one estimate suggests that small businesses (businesses with fewer than 100 employees) may face monthly costs of USD 255 billion - USD 431 billion as a result of business closures, including incidental expenses, payroll obligations and lost profits (APCIA, 2020[3]). This would far exceed the premiums collected for these policies (approximately USD 4.5 billion) and would be multiples of what insurers normally payout for business interruption claims (insurers in the United States incurred, on average, USD18.4 billion annually in net claims between 2008 and 2016 on commercial multi-peril coverage, which would include physical damages, liability claims as well as business interruption (NAIC, 2018[4])). Insurers also have noted that estimated business interruption losses far exceed the amount of surplus capital available to pay such losses, which, if exhausted, would challenge the ability of insurers to respond to losses from future events. The certainty of contractually-agreed insurance coverage would also likely come into question if legislators could intervene to alter outcomes – and there could be cross-border implications if some of the losses covered retroactively in one jurisdiction are reinsured in another.
Insurance supervisors have also raised concerns about the implications of retroactively expanding coverage obligations for the solvency of insurance companies. In the United States, the National Association of Insurance Commissioners issued a statement raising concerns with proposals to require retroactive coverage of business interruption claims and highlighted the significant solvency risks to the sector as well as the macroprudential risks associated with such proposals (NAIC, 2020[5]). In France, the insurance supervisor (Autorité de contrôle prudentiel et de resolution) has reminded insurers that they should not make payments for losses that are not included within the scope of coverage that they provided (ACPR, 2020[6]). The International Association of Insurance Supervisors issued a statement in May that cautioned against “initiatives seeking to require insurers to retroactively cover Covid-19 related losses, such as business interruption, that are specifically excluded in existing insurance contracts”. The IAIS also noted that these “initiatives could ultimately threaten policyholder protection and financial stability, further aggravating the financial and economic impacts of Covid-19” (IAIS, 2020[7])
While there are few good options for addressing the current protection gap for business interruption losses resulting from COVID-19, some insurance companies are examining other options for providing support to policyholders on a voluntary basis (see Box 1). These types of initiatives might help address some of the reputational impacts that insurers will certainly face as a result of claims denials.
There may be other ways for insurance companies to contribute to supporting businesses disrupted as a result of COVID-19 without taking on responsibility for the entire scope of business interruption losses and there are some examples of where (re)insurance companies have agreed to compensate policyholders for losses that they have not contractually agreed to cover.1 The spread of COVID-19 and related business closures have had a number of implications for the value of insurance companies’ liabilities due to changes in individual and corporate behaviours. A number of insurance companies across the world (including in Canada, France, Germany2, the United Kingdom and the United States) are partially refunding policyholders for premiums paid for personal motor vehicle insurance based on the expectation that claims experience will improve significantly as a result of reductions in traffic and distance travelled. The California Insurance Commissioner has ordered insurers to provide refunds to policyholders across at least six lines of business where claims experience is expected to improve (personal motor vehicle, commercial motor vehicle, workers compensation, commercial multi-peril, commercial liability, medical malpractice, and “any other insurance line where the risk of loss has fallen substantially as a result of the Covid-19 pandemic”) (Ladbury, 2020[8]).
The insurance sector has an opportunity to consider ways in which improvements in performance across some lines of business would allow for a voluntary contribution to supporting policyholders facing significant uninsured losses. Insurance companies in France, for example, have announced their intention to contribute EUR 400 million to a solidarity fund established by the French government to support businesses affected by COVID-19 (FFA, 2020[9]). In Germany, the state of Bavaria brokered an agreement between a number of insurers and representatives of trade associations for insurers to offer a voluntary payment (i.e. without an acknowledgement of any legal obligation) to policyholders in the hospitality sector for 10% to 15% of the normal daily cost of business disruption (Bayerisches Staatsministerium für Wirtschaft, 2020[10]) (it will be up to individual policyholders to decide whether to accept this payment).
1 For example, in Switzerland, many of the cantonal (public) insurance companies that provide property coverage for fire and natural catastrophe perils have committed to offer compensation to policyholders on a voluntary basis (and up to an aggregate limit) for earthquake damage as earthquake has historically been excluded from property insurance coverage.
2 German insurers will provide refunds to policyholders subject to developments in claims experience in other business lines.
Policymakers are beginning to examine longer-term solutions to the BI protection gaps.3 In the United States, for example, members of the House Financial Services Committee are beginning to explore to the possibility of establishing a Federal Pandemic Risk Reinsurance Program that would operate in a similar way as the Terrorism Risk Insurance Program by providing a federal backstop for insured business interruption losses above a certain threshold due to public health emergencies (pandemics and infectious disease outbreaks) (Best, Dawson and McCarty, 2020[11]). In France and the United Kingdom, working groups have been established to examine possible solutions to providing insurance for future pandemics (Direction générale du Trésor, 2020[12]), (Insurance Journal, 2020[13]).
There is significant international experience in establishing catastrophe risk insurance programmes to respond to other catastrophe perils which may provide some lessons for responding to pandemic risk (although pandemics may present different risks and challenges, as outlined in the section below). Annex A provides an overview of catastrophe risk programmes and good practices for supporting broad coverage, lowering the aggregate cost of coverage, minimising public financial exposure and encouraging risk reduction through programme design.
A pandemic presents different risks and challenges from many of the other types of perils that have been targeted by catastrophe risk insurance programmes.
Catastrophe risk insurance programmes are often targeted at property damage, whether to residential or commercial buildings – and therefore can generally follow the coverage that already exists in the market (although some programmes have established their own coverage terms and conditions).
One of the main (disputed) limitations to coverage of business interruption losses resulting from COVID-19 (or other infectious diseases) in many jurisdictions is that coverage may only be triggered as a result of physical damage and contamination may not be considered property damage.4 The challenge will be to add coverage through a pandemic risk insurance programme without altering existing commercial practices related to the coverage of non-damage business interruption.
While it is difficult to assess the frequency of pandemics, the potential severity of losses (as illustrated by COVID-19) is immense.
The magnitude of business interruption losses that are likely to be incurred (whether by policyholders or their insurers) is much higher than the losses incurred as a result of any recent single catastrophe event. As noted above, a one-month business closure would cost an estimated USD 255 billion to USD 431 billion for US SMEs alone. By comparison, the Great East Japan Earthquake in 2011 (the largest economic loss from a single event since at least 1970) resulted in USD 234 billion in losses (in 2018 USD). As a result, a pandemic risk insurance programme may not be to provide coverage at an affordable cost for all business interruption losses.
The design of a catastrophe risk insurance programme would need to consider the best way to achieve broad coverage. Where optional coverage for pandemic risk has been available, it has not been frequently acquired (see Box 2).
The experience of COVID-19 will certainly lead to an increase in interest for such coverage although it’s not assured that this will lead to a long-term change in voluntary take-up particularly if the cost of coverage is substantial. Experience from other catastrophe risk insurance programmes suggests that merely making coverage available may not be sufficient for achieving broad coverage.
The capacity of private insurance markets to provide coverage for pandemic-related business interruption losses has been mostly untested:
In most countries, business interruption coverage is provided as an optional additional coverage attached to commercial property insurance that is often (but not always) triggered only as a result of damage to physical property. Many insurance companies and their associations have indicated that business interruption losses as a result of a pandemic were not specifically contemplated as a potential exposure under policies where business interruption coverage is triggered by physical damage.
In a few countries and policies (notably, in the United States), an exclusion was developed (more than 15 years ago) and has been applied with the aim of specifically excluding coverage for losses due to virus (or bacteria).
There is at least one specific coverage available for business interruption losses due to infectious diseases, developed in 2018, although there has reportedly been almost no take-up (Collins, 2020[14]). The Insurance Services Office in the United States developed two optional endorsements for commercial property policies applicable to business interruption losses as a result of business closures related to COVID-19 in February 2020 although it is too early to determine whether insurers will seek to offer that coverage (Barlow, 2020[15]).
Business interruption as a result of a viral, bacterial or other biological contamination may be covered under specific coverages developed for non-damage business interruption which is available although not generally acquired. This type of coverage has been developed to respond to any interruption to business that does not involve physical damage to the insured premises or a building in proximity to the insured premises. The extent to which non-damage business interruption due to pandemic-related closures has been considered in these policies is unclear.
Given the current crisis, it is likely that insurers will be reluctant to provide broad coverage for pandemic risk in the near future (or at least not at a cost broadly accessible to commercial policyholders). Some reports suggest that insurers are considering applying various exclusions in lines of business where some exposure is likely (e.g. directors and officers liability insurance (Collins, 2020[16])) – although not necessarily in commercial property insurance policies as most insurers already believe these losses are not covered.