Insurance is a financial product that is based on social need. It doesn’t serve just the interests of one, but of many. From regulation through academic theory, it is widely accepted and required that “the business of insurance is to serve the public trust.”
I have been thinking a lot about that concept, now that the world is faced with an economic shutdown caused by a pandemic. Individual property insurers have traditionally been reluctant to take on widespread and mass disasters because, from an actuarial standpoint, the risk of ruin is greatest with these calamities. Many insurance companies use bad-faith tactics to avoid their responsibility to policyholders. This unfortunate trend is highlighted when insurers balk at the challenges that come with widespread disasters.
Historically, fire insurers were concerned about having too high a concentration of risk located in one city, where one major fire could financially bankrupt an insurer’s surplus. Unfortunately, this happened far too often in the U.S., and resulted in states establishing departments of insurance with audited solvency requirements for each insurer to meet before the state would issue a license to sell policies.
As policies changed in the middle of the 20th century to cover multiple risks of loss, “all-risk” insurance became the predominant form of coverage for commercial insurance. The general rule is that any “risk” is covered unless specifically excluded. The days of insurers having to worry about one large-scale urban fire were replaced with concerns of widespread floods and earthquakes, which were often excluded risks of loss. Separate insurance could be bought for those perils for an additional premium.
With commercial interests becoming interdependent on a global economy, actuaries and underwriters also had to be concerned with global loss of income from acts of terrorism, which had much larger implications than the specific target of the acts themselves. For example, the September 11th attacks shut down an economy, despite the occurrence of only a few actual physical acts of damage.
The federal government, recognizing that private insurers often refused to provide insurance coverage because of large-scale risks, has established various programs in partnership with private insurers for risks of loss such as flood, crop and terrorism.
With the COVID-19 crisis, the federal government is once again being called upon to provide support as a backstop with an insurance program and as a partner to private insurance. Time will tell how this will work, but my prediction is that a Pandemic Risk Insurance Act (PRIA) will be established for future such events. However, I can almost promise that it will either have significant limitations or will not be cheap.
The problem is that businesses vary in the amount of lost income and type of pandemic. While maybe a once-in-a-hundred-year event, losses can vary greatly for the time a business is closed due to civil orders in response to the pandemic. Pandemics also affect an entire country’s economy, as opposed to the regional impact of a flood or earthquake. The current COVID-19 pandemic impacted all businesses to some degree.
Pricing coverage for loss of income from a pandemic is a statistical process. Will this risk of a pandemic be a once-in-a-hundred-year event? Or is it something that’s more common — say, once in a generation? The frequency of something happening times the severity of the loss is a basic formula for determining price of insurance. Pandemics can be off the charts in terms of the amount of loss if they’re worldwide. And their frequency seems to be increasingly difficult to determine.
The point it is that we want to prepare for and hedge against these losses, and that’s the role of insurance. Given the huge financial stake, I can also predict that the insurance industry will be a major risk-management participant, urging government and business leaders to prevent and plan for mitigation of these terrible events. The insurance product is much more affordable when we can better control risks of loss.
Going back to urban fires as the catastrophic event which most concerned commercial and residential insurers 150 years ago, the fire insurance industry was a leader in preventing and mitigating against such loss. While widespread wildfires are now a larger risk of loss because of population growth into rural areas, the urban version is a remote event because of fire safety engineering supported in part by the insurance industry.
My prediction is that we’ll see greater leadership and concern for the control of future pandemics as we embrace loss mitigation and prevent strategies which those in the insurance industry will be encouraging if PRIA is passed. Insurance is a social product, and society wants first to prevent the onset of these terrible events, which cost human life and economic hardship.
Crises like COVID-19 put relationships between insurance companies, regulators, and politicians under a magnifying lens, as we make our way through unchartered waters in formulating insurance practices. For now, we’ll wait to see what comes of this pandemic, and how insurance companies react in shaping future policy.
Chip Merlin is founder and president of Merlin Law Group, which represents insurance policyholders in disputes with insurance companies. He is the author of Pay Up! Preventing A Disaster With Your Own Insurance Company.