As businesses owners and management grapple with the immediate operational and financial implications of the COVID-19 pandemic, they also have an eye on the future. What lessons will be learned from current events and what plans need to be drawn up to ensure business continuity in the years to come?
The insurability or otherwise of losses attributable to the pandemic is not only of immediate concern as insureds seek to recover from their insurers but also something that will be a key consideration as strategic decisions are made. The possibilities for loss are innumerable. Most obvious perhaps is a loss of income caused by business interruption and one can also imagine claims being made by shareholders against directors and officers, by employees against employers and by patients and their families against healthcare providers. The list goes on.
Commercially bought first-party property insurance policies generally include coverage for loss of profits resulting from property damage, whether to the insured’s own property or to various other categories of property such as that of a customer or supplier. There are very few insurers who have specifically offered coverage for losses due to communicable disease. Where that is not included, property damage is the trigger for coverage under the policy. So, the question arises whether the presence of the virus at a property constitutes property damage and, if so, what is the quantum of loss caused by that damage. There have been past decisions by the courts, ruling that contamination of a building rendering it unsafe until decontaminated constitutes physical damage even without any structural alteration. It seems inevitable that insurers will be saying one thing and insureds another. The litigation has already begun.
In the captive world, members of group captives will most likely find that their coverage is restricted as it would be in the commercial market. For single-parent captive owners, however, the picture may be very different. Many captives specifically cover risks such as loss of key customer, loss of key supplier and loss of key employee and these policies are likely to provide broad coverage without the types of exclusions seen in commercial policies. Others may deliberately provide cover for the difference in conditions, plugging gaps in coverage arising from the exclusionary language in commercial policies. Many businesses may find their captive to be a real lifeline in times of peril.
Even if some of these risks are covered by insurance today, the insurance industry will most likely seek to exclude them in future. Why is this? Society Insurance Inc., which has denied coverage for business interruption claims and is being sued by several insured bars and restaurants, said: “Insurance has always identified and excluded coverage for loss events that are so large, or are so unpredictable that they outstrip the capacity of the industry to fund losses or even price the exposure accurately. Exclusions for acts of war, nuclear incidents and floods are part of insurance policies for these reasons.” This thinking is consistent with a basic principle of insurance that the premium of the many is pooled to pay the losses of the few. When the few become the many, the pool of premiums will be inadequate to meet the losses and so it is necessary to exclude from coverage those events that are foreseen to have that effect.
With that in mind, it is already clear that exclusionary language is being tightened up with specific communicable disease exclusions being imposed by reinsurers. Insurers are following suit. We are going to see greater restrictions on coverage at a time when the cost of insurance is increasing significantly. Businesses will need to pay very close attention at their next policy renewals and give deep consideration to how they intend to manage and finance risk in the future.
Could captive insurance be the answer? John Mina, CEO of Risk Strategies, a national speciality insurance brokerage said: “The devastating effects of COVID-19 and the future uncertainty around the financial impact to businesses are hard to fathom at this point. As a consequence, the traditional insurance market will not likely provide any meaningful pandemic insurance for quite some time. Captive insurance companies are well suited to support businesses with customised coverage for hard to insure exposures like pandemics.” Indeed, captive insurance companies are formed precisely to fund risks that are not transferred to the commercial insurance market, whether by choice or by necessity.
Captive insurance generally allows businesses to create a funding mechanism for their own retained risks. This is in contrast with the commercial world where risks and results are shared amongst many insureds. However, in the captive world, there can also be some sharing of risk through reinsurance pools and in group captive arrangements. Business owners and management considering the new or expanded use of a captive solution should think carefully about which risks can or should be shared and with whom they want to share them. It may, for example, be reasonable for a group captive to offer some strictly limited communicable disease coverage. After all, not every communicable disease loss event requires an epidemic and with a known and restricted pool of participants, the exposure may prove manageable. The prospective participant (and indeed the programme manager) should look carefully at comparing the likely loss of income impact of a pandemic on his own business and those of his fellow group members. A heterogeneous group captive with a significant number of hospitality business insureds could be an uncomfortable place for businesses that continue to operate while many other members file claims to be paid by the group as a whole. These challenges may be hard to overcome.
It seems more likely that pandemic insurance, and other risks uninsurable for the reasons discussed above, will be provided by single-parent captives with little pooling of these exposures and probably no reinsurance support unless at a very significant premium. While the captive, therefore, may not give access to third-party funding of these types of loss, what it can do is provide an excellent means to fund for the eventuality over multiple years.
By contrast, middle-market businesses choosing to insure some portion of their risk in a captive due to the steeply increasing cost of commercial coverage will more than likely seek to share part of that risk through a risk pooling mechanism or by joining a group captive. Doing so in a well-run programme helps to protect against spikes in claims activity and lowers volatility overall.
Before the outbreak of the COVID-19 pandemic, captive insurance practitioners were already seeing a heightened interest in captive solutions, which was driven by rate and deductible increases or in anticipation of those. Businesses with those challenges will now be faced with the added problem of being without cover for what has been proven to be a catastrophic exposure for many. It has never been right to approach risk management solely from the point of view of cost. Appropriate coverage has always been equally important. Current market conditions mean that both cost and coverage now share the spotlight.
As managements work to ensure business continuity, budgetary stability and control of their overall cost of risk, expect to see a marked uptick in the use of a captive as a key tool in addressing a company’s enterprise risk management.
