Last 27th July 2020 EIOPA published a paper stressing the need of shared public and private insurance coverages to protect individuals and businesses from the financial consequences come from the business interruption caused by potential future pandemics.
COVID-19 has provoked the most serious global economic downturn since the Great Recession of the 1930’s, affecting an enormous part of the society, worldwide, at the same time. Insurance companies by themselves would not be able to offer coverages against the losses policyholders may incur because of a pandemic: the insurance business rely on risk pooling and geographic diversification, while a pandemic hits everybody, everywhere. The premiums needed to cover the claims originated by a business interruption would be just too high: it has been estimated that, given the current tariffs applied to these policies, an amount of premiums collected for a hundred years would have been enough to cover the claims occurred in just two months of pandemic. This ignores that COVID-19 has also affected other lines of business (such as life, health and travel) and, furthermore, that it has indirectly damaged the Asset side of insurers’ Balance Sheets as well, because of the economic downturn.
On one hand these facts seem to discourage insurance companies from covering pandemic risks, but, on the other, people need these type of coverages and, as reported by MARSH in their June 2020 Insight (“Pandemic Risk Protection”), the business community has already expressed a strong will to buy. A solution may be for the insurance companies not to “play alone”.
EIOPA has identified four principles to guide a “shared resilience solution” scheme to cover pandemic risks:
- shared costs and responsibilities between private and public sector
- coordination across public and private entities
- coverage conditional upon implementation of efficient prevention and adaptation measures
- insurance provided against a portion of the economic costs only.
The key elements to manage the significant protection gap are:
- Risk assessment
Insurance companies can perform a suitable risk assessment by having access to all relevant data. Some of them (like type of virus, contagion development, lock-down figures) can be found from public sources, while others (like granular data of losses per company) cannot: a collective effort to make this type of data available would be crucial.
Another key element is to improve the pricing model: the usage of current catastrophe models appears to be insufficient when the effects of the application of a lock-down drive a relevant portion of the risk.
- Product design
A simple and transparent wording is essential, as business interruption policies are not common in European markets. The coverage should target small and medium enterprises, being them those mostly affected by the downturn, without the financial capabilities to withstand any sustained shut down of their activity. The coverage should be parametric, defined over an objective insurance “trigger”, such as an earthquake magnitude. In the case of a pandemic, the trigger may be the contagion growth in the area where the business operates, or a measure of the reduction in the economic activity. A parametric coverage would offer the clients the advantage of a prompt settlement (as the amount would be quickly determined), but would expose them to the risk that the payment is not a good proxy of the losses they have actually incurred.
- Risk transfer
An insurance cover for business interruption caused by a pandemic needs a shared solution comprising public and private sector participation, to enable a risk transfer among different actors: private companies, insurance undertakings, reinsurance industry, national governments and, finally, the European Union. The risk transfer from one level to the next needs to follow a clear mechanism, not necessarily static over time: private insurance companies may start with a limited risk appetite (and a relevant public support) and may increase it over time, while their risk assessment improves and the public intervention can decrease. A co-insurance agreement can be set between private and public to share the losses at a given percentage.
Having acknowledged that a public intervention is needed, it is important to avoid public subsidy to pose a risk of moral hazard by reducing incentives for the clients to invest in risk prevention. This can be avoided by defining premiums that reflect the preventive measure put in place by the clients (e.g. lower premiums for those who have settled better measures) and by leaving them with some risk, for instance by capping the benefits to a given amount.