• Monday, May 27, 2024
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Designing insurance for the next pandemic


The grade II-listed Blackpool Grand Theatre has seen a lot in its 126 years, from the town’s rise as a booming seaside resort to its long decline into one of the most deprived parts of the UK. Now coronavirus might be about to deliver a fatal blow.

The Grand closed its doors on March 17, as the UK’s national lockdown began to bite and just one night into a run of the play Educating Rita. It has not opened them since.

Ruth Eastwood, the chief executive, made a £100,000 claim on the theatre’s insurance policy which, she says, would go about halfway to covering the costs of the closure. “We’re a tiny but important part of the country’s heritage . . . [An insurance payout] would allow us to probably survive this,” she says. “Our own reserves will run out in September.”

But Ms Eastwood has been told by Hiscox, the Grand’s insurer, that the policy does not cover the costs of the closure, because the government’s wide-ranging response to the pandemic falls outside the scope of the contract. Along with about 400 other companies the theatre is looking at whether to sue Hiscox over the claim.

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It is a story that is being repeated around the world. Insurers say the pandemic will be one of the most expensive events in the history of their industry, potentially costing them more than $200bn — with half of that in payouts. But there are thousands of businesses which have been unable to successfully claim and now, with lockdowns being lifted across the world, face ruin.

Although pandemic insurance has been available in the past, many companies thought the risk of an outbreak was remote and so few of them bought it. The industry is now under fire not just from unhappy customers, but also from politicians who argue that insurers should be doing more to help struggling businesses through the crisis.

Yet even before the postmortem is complete urgent attention is turning from this outbreak to how to deal with the next one, with some believing that could possibly be within the next six months if there is a second wave of Covid-19 infections that forces a return to national lockdowns.

With the industry under increasing scrutiny and company bosses worried about reputational damage, efforts are building on both sides of the Atlantic to work out how to handle a similar crisis better next time, and ensure that businesses like the Blackpool Grand can survive.

Mounting criticism

“We’ve got to get to a common solution,” says John Neal, Lloyd’s of London chief executive. “It has to be in place for a second wave. We’ve got weeks not months.”

Lloyd’s — which generated £36bn of insurance premiums last year and paid out more than £23bn in claims — has already held early-stage discussions with the UK Treasury about how to move forward. Separately, industry veteran Stephen Catlin has joined forces with Aviva chief executive Maurice Tulloch and RSA boss Stephen Hester to work on proposals.

The options: US Pandemic Risk Insurance Act

Introduced to the US Congress last week, the proposal mirrors the 2015 Terrorism Risk Insurance Act, with policyholders, insurers, and government sharing the risk of business interruptions. Policyholders would pay a deductible sum, after which the insurers would cover losses up to the equivalent of 5 percent of the insurers’ premiums in the previous year. After that, the government would pay 95 percent of all losses up to a cap of $750bn.

In France, where there has also been criticism of business interruption insurance, finance minister Bruno Le Maire has set up an industry group to look at how much cover can be provided in the future. It aims to produce proposals in June.

In the US, John Doyle, chief executive of the insurance broker Marsh, has written to the Trump administration’s economic team proposing a pandemic insurance scheme where risk is shared between the public and private sectors. He says such proposals are gaining traction in Washington.

“The industry does not want to face a reckoning like this ever again,” says one US insurance lobbyist.

The industry consensus is that only national solutions can work — anything else makes it too complicated to get government support. However, some insurers argue that any new system to cover pandemics has to be a cross-border effort to be effective.

“As long as people travel the solution has got to be global,” says Philippe Donnet, chief executive of Italy-based insurer Generali. “If countries don’t act together, we’ll get nowhere.”

Government backstops

Many countries already have insurance systems — with built-in government backstops — that cover terrorism and natural catastrophes such as flooding. Some observers have asked why such policies cannot simply be extended to pandemics.

“It is very important for people to understand what an industry like ours can do with its economics and what it cannot do,” says Oliver Bäte, chief executive of Allianz, one of the world’s biggest insurance companies.

Insurance, he says, works on the principle of diversification of risks. “If the government closes the economy because of a pandemic and it closes millions of businesses, there is no more diversification so we cannot cover that,” says Mr Bäte. “We need to model, risk by risk, what the industry can do itself, how useful that is for clients and beyond that limit what we as a society can or should do.”

The coronavirus crisis illustrates the problem. According to one senior executive, the US property and casualty insurance sector as a whole has $850bn of capital. But revenues for US small businesses alone, for example, add up to $400bn a month — and many of them have been closed for longer than a month. The industry does not have the capacity to pay out for long on that scale of losses without hugely increasing the size of its own balance sheet, which would mean big increases in premiums.

Insurers say government involvement is a critical first step. Under the Marsh proposal, policyholders would absorb the first layer of losses, followed by insurers, with the tail falling to the government.

“It’s not just about financial risk, it’s about managing risk, bending the risk curve . . . the goal is to have a faster [economic] recovery next time,” says Mr Doyle. If policyholders hold the first tier of loss that “gives them a stake in the outcome” — an incentive to adapt their businesses to minimize pandemic risks and costs.

In the US, the House financial services committee has called for “a reinsurance program similar to the Terrorism Risk Insurance Act to cover pandemics, by capping the total losses that insurance companies would face”. TRIA, which was created after the September 11, 2001, attacks, requires that insurers offer terrorism coverage, and in return, the government picks up losses above a threshold that varies with the insurers’ collected premiums in the previous year.

The options: The UK’s Pool Re

The UK’s terrorism insurer, Pool Re, was set up in 1993 and provides government backing to cover acts of terrorism. Businesses buy insurance from their usual insurer, which then passes the terrorism risk to Pool Re. Pool Re itself buys insurance from the government to cover the costs of very expensive attacks.

A draft bill based on the TRIA model proposing a pandemic reinsurance scheme was introduced to the US Congress last week. If signed into law, the Pandemic Risk Insurance Act would force businesses and insurers to take some of the risk. After that, the government would pay 95 per cent of all losses up to a threshold of $750bn.

Evan Greenberg, chief executive of insurer Chubb, believes that insurers could take on more of the risk than is suggested in some of the proposals in circulation. “If the bills are intended to stimulate a private market to take on more business interruption risk that has [previously] been uninsurable, I’m in favour — again, if properly structured with the right risk-reward terms.
“[But] the vast majority of the US insurance industry at the moment appears to be against taking more pandemic risk. I am in the minority. Look at most of the industry proposals: they have the industry administering claims only — I think that belittles our industry and makes us less relevant.”

Pricing the biggest risks

Threshold up to which the US government would pay 95% of losses under the proposed Pandemic Risk Insurance Act

In claims that the insurance industry expects to pay out due to the pandemic

Losses absorbed by France’s natural catastrophe insurance scheme before the state intervenes
Axa chief executive Thomas Buberl sees the French natural catastrophe insurance scheme, which was set up in 1982, as a potential blueprint. Every insurance contract includes a small premium for the scheme, which is split evenly between the government and private companies. When disaster hits, the private sector pays out first and the state kicks in afterward. The scheme can absorb about €4.5bn in losses before the state intervenes.

“What is important is that you have . . . private companies having skin in the game from the very first euro and you have state backing for the rest,” says Mr. Buberl.

Paula Jarzabkowski, professor of strategic management at Cass Business School, says that even though the government would potentially be shouldering much of the risk — especially in a repeat of this year’s events — it is still worth setting the scheme up as an insurance vehicle.

“The first thing an insurance mechanism does,” she argues, “is that it makes you plan . . . you would have thought about who needs what money, and how you get it there.”

Flawed pandemic bonds

This is where the World Bank’s $320m pandemic bond scheme — an insurance-like instrument set up in 2017 to pay out to poor countries in the early stages of a coronavirus-like crisis — appears to have fallen short. Despite having the objective of providing “surge funding” during the outbreak, it has been heavily criticized for paying out late and in small sums.

When the Pandemic Emergency Financing Facility (PEF) was launched in July 2017, then World Bank president Jim Yong Kim described it as “a momentous step that has the potential to save millions of lives and entire economies from one of the greatest systemic threats we face”. But the bonds were only triggered a month ago and will pay out $196m to be divided up between 64 countries — an average of $3m each.

Critics argue that the World Bank’s experiment was doomed to failure, noting that the triggers to release the funds were so complex that it was impossible for them to pay out early when the funds were most urgently required. The criteria meant there needed to be: 250 deaths, split between at least two countries — one of which needed to be eligible for World Bank funding; for 12 weeks to have passed from the start of the outbreak; and for the virus to be spreading exponentially in some of the poorest countries in the world.

The World Bank has so far pledged up to $160bn to help countries respond to coronavirus, dwarfing the $196m bond payout.
“The truth is if we hadn’t done the PEF, and spent the money on preparedness instead, we would have saved more lives, because some countries would be in a lot better shape now,” says Peter Sands, executive director of The Global Fund to fight Aids, TB and Malaria. “We have insurance that works perfectly well in some scenarios, but we’re trying to use it for something where it doesn’t work instead of creating proper incentives for people to prepare properly.”

The World Bank says it is not planning to renew its pandemic insurance programme. But some believe that such instruments are a valuable tool in spreading and quantifying risk. The triggers for payouts, they argue, just need to be finessed. Indeed, losses this time around have not damped interest from some investors in the bonds, who believe the risk-reward balance could still look appealing in the future.’

The options: The French Caisse Centrale de Réassuranc

In operation since 1982, it is seen by some advocates as a model for pandemic insurance. Property insurance policies have a surcharge to cover natural catastrophe risks, which is split evenly between the government and private insurers. When disaster hits, the insurers pay out a fixed amount first, then the government steps in.

Leading figures in global health argue that insurers need to work with international agencies and be more creative in constructing the next insurance mechanism to cover the pandemic risk.

“If capital market actors have to accept instruments they’ve never seen before, so be it. It’s an exceptional event that requires an exceptional instrument,” says Prashant Yadav, a senior fellow at the Centre for Global Development in Washington. “The real opportunity here is to bring together insurers and reinsurers and ask them if there is a second wave, how much risk are you exposed to, and how much are you going to invest to mitigate that?”

Designing something for a repeat of the current crisis, says one industry adviser, is like “shutting the stable door after the horse has bolted”. Some in the industry believe that any new scheme needs to think beyond pandemics.

“The issue is more about the . . . impact on the economy, not the trigger,” says Julian Enoizi, chief executive of Pool Re, the UK’s terrorism insurer. He adds that the next crisis could be completely different — a systemic cyber attack or a climate event. “When a black swan event happens we should be thinking about covering businesses for their business interruption losses and not be focused on the triggering event.”

But casting the net so widely adds other dilemmas. The insurance industry, and the investors that back it, are used to looking at potential problems and calculating how much they would cost. Holding money back for an unknown problem would create questions about exactly what sort of event would trigger payouts from the scheme, and who would make the decision about when to pay claims.
“I don’t think you can have an all risks cover for all society . . . but we already have a lot of solutions for key risks including natural catastrophes,” says Mr Bäte. “We don’t know what the next problem is, but I’m loath to try to solve all problems at the same time.”