The COVID-19 pandemic and the measures taken to limit the spread of the disease have significantly disrupted economic activity in countries around the world, resulting in significant business interruption 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 – 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.

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Responses to the COVID-19 business interruption protection gap

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.

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Box 1. Insurer contributions to addressing policyholder losses

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.

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Longer-term policy responses to the pandemic business interruption protection gap

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.

Characteristics of pandemic risk

A pandemic presents different risks and challenges from many of the other types of perils that have been targeted by catastrophe risk insurance programmes.

Key uninsured (or underinsured) exposure is business interruption

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.

The cost of coverage may be substantial

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.

Challenges in ensuring broad coverage

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.

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Box 2. Private market coverage for pandemic risk

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.

Correlated exposures across countries and markets

Given the potential for a pandemic to affect all parts of the world (near) simultaneously, the financial benefits of diversifying exposure geographically will be limited (at least in the context of a global pandemic).5 Traditional (and potentially alternative6) reinsurance markets (i.e. reinsurance provided through capital markets) can provide coverage for risks at a lower cost than primary insurers operating in a single market through their ability to pool uncorrelated risks from around the world. In the case of alternative reinsurance markets, one of the attractive features for investors is a lack of correlation between the performance of these instruments and financial market performance. However, the current crisis has demonstrated that a large-scale pandemic has important (correlated) impacts on financial markets.

  • This characteristics of pandemic risk would likely lead to a higher cost for reinsurance or retrocession (including through alternative reinsurance markets) than in the case of other perils whose occurrence would not be correlated across countries or with financial markets.

Few risk reduction options

There would be challenges in terms of designing a programme that encourages risk reduction by policyholders.

  • There may be more limited actions that policyholders can take to reduce their risk than in the case of other types of perils.

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Potential design features of a pandemic risk insurance programme

Given the nature of pandemic risk, governments wishing to establish a pandemic risk insurance programme should consider how the following practices could support the design of a programme that achieves broad coverage, limits public sector exposure and encourages risk reduction.

Broad coverage through automatic extension

  • Governments may wish to consider approaches that involve an automatic extension of coverage for pandemic risk in order to ensure broad coverage. An automatic extension to include coverage for pandemic risk business interruption as part of commercial property insurance policies or an approach that involves the voiding of relevant exclusions under specific circumstances (e.g. a pandemic that has been formally declared as such by a government authority) would likely be more effective in ensuring broad coverage than simply making coverage available. As outlined in Annex A, programmes that make coverage available on an optional basis have generally had more limited success in reducing the protection gap for targeted perils. Voiding applicable exclusions might help address the challenges of integrating coverage for pandemic-related business interruption into the existing scope of commercial property policies.

Private market appetite should be assessed in order to leverage private sector capacity

  • The design of a pandemic risk business interruption insurance programme should involve a careful assessment of the appetite of private (re)insurance markets to provide coverage for different infectious disease outbreak scenarios. The limited ability to diversify risk in reinsurance and retrocession markets might suggest that government-backing should target the highest layer of losses, allowing private insurance (and reinsurance) markets to develop for losses below a threshold for government involvement. Catastrophe risk insurance programmes that provide coverage as direct insurance or for lower loss layers (usually) depend on private reinsurance, retrocession and capital markets for leveraging private market capacity although these markets may not have significant capacity for a peril that is difficult to diversify geographically, may be highly correlated with financial markets and could result in very large losses. However, the potential to imposition of broad-ranging restrictions as part of an effective response to an infectious disease outbreak may lead to many policyholders being affected simultaneously and may limit private sector appetite for first-loss coverage.

Require greater business continuity planning relevant to a pandemic

  • One of the challenges that has exacerbated business interruption losses (in some sectors) has been difficulties in transitioning to a work from home approach. Insurers could be required to ensure that policyholders have business continuity plans or other risk mitigation measures in place (or could offer premium discounts) that support the continuity of operations (where possible) and reduce the amount of business interruption losses incurred in the event of widespread business closures. The insurance sector could also become an advocate for strengthening government preparedness through a pandemic risk insurance programme. For example, the insurance sector might only making coverage available if government invests sufficiently in health care capacity.7

The recent experience with COVID-19 may limit the appetite of private insurance markets to insure pandemic risk for some time. While catastrophe models for pandemic risk have existed for a number years, these models are focused on morbidity and mortality, not the business interruption losses that would be addressed by a pandemic risk business interruption insurance programme. As a result, it may take some time before private (re)insurance markets will be willing to make available significant capacity for pandemic risk and therefore thresholds for government involvement may need to be set at fairly low levels initially.

copy the linklink copied!Annex 1.A. Catastrophe risk insurance programmes

In a number of countries, insurance programmes or pools have been established, usually with the support of the public sector, to provide insurance coverage for certain risks and/or for certain segments of the population.8 In many cases, these programmes have been established to provide affordable insurance coverage for risks that have been deemed uninsurable through private insurance markets – although in others, the programmes have been established in order to promote solidarity in terms of loss-sharing across regions. Since 2000, approximately 40% of all economic losses due to flood, storms and earthquakes in OECD countries have been incurred in countries (or regions) covered by catastrophe risk insurance programmes.9

Overview of catastrophe risk insurance programmes

Perils covered

Some of these programmes have a broad scope, covering multiple perils and lines of insurance. For example, the Consorcio de Compensación de Seguros (CCS) in Spain provides insurance coverage for residential and commercial property, motor vehicles as well accident and sickness against a broad range of both natural and man-made perils. Others are focused on specific (high-risk) perils (e.g. earthquake in Japan or wind in the US state of Florida), specific lines of business (e.g. residential property for natural hazards or commercial property in the case of terrorism) or even a particular exposed segment (e.g. residential property at high-risk of flooding in the United Kingdom).

Type of coverage provided

There is a broad range of approaches to providing programme coverage. Some programmes offer direct (primary) insurance while others provide a reinsurance coverage. Many of the terrorism insurance programmes (and some natural catastrophe insurance programmes) are organised as co-insurance pools that collectively access reinsurance and (in some cases) a government backstop. The US Terrorism Risk Insurance Program is administered as a co-insurance arrangement that shares losses between the government and insurance companies at a defined ratio once losses exceed a specific threshold. Table A.1 provides an overview of the types of insurance programmes for catastrophe risk that have been established in OECD and a few non-OECD countries and territories.

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TableA.1. Catastrophe risk insurance programmes

Programme

Risks covered

Type of insurance

Public sector involvement

Australia

Australian Reinsurance Pool Corporation (ARPC)

Terrorism

Reinsurance

ARPC is a government enterprise

Backstop for losses above ARPC capacity and up to AUD 10 billion

Austria

Österreichischer Versicherungspool zur Deckung von Terrorrisiken (OVDT)

Terrorism

Co-insurance/ Reinsurance

None

Belgium

Government backstop for losses above a specific threshold resulting from

an extreme event

Terrorism Reinsurance and Insurance Pool

Terrorism

Co-insurance/ Reinsurance

Backstop for losses above TRIP capacity and up to EUR 300 million

Denmark

Danish Storm Council

Storm surge and inland flood

Direct insurance

The Storm Council is a public entity that provides compensation for damages funded by a tax on fire insurance policies.

Danish Terrorism Insurance Pool for Non-Life Insurance (TIPNLI)

Terrorism (NBCR)

Reinsurance

Reinsurance coverage provided for up to DKK 15 billion for losses exceeding industry retention

France

Caisse centrale de réassurance (CCR)

Flood, earthquake, tsunami, landslide, mudslide, avalanche, subsidence and cyclonic winds

Reinsurance

CCR is a government entity backed by an unlimited government guarantee

Gestion de l'Assurance et de la Réassurance des risques Attentats et actes de Terrorisme (GAREAT)

Terrorism

Co-insurance/ Reinsurance

GAREAT’s reinsurance coverage is provided by private reinsurers and CCR (government entity)

Germany

Extremus

Terrorism

Direct insurance

Backstop for losses above Extremus capacity and up to EUR 6.48 billion

Iceland

Natural Catastrophe Insurance of Iceland (NTI)

Volcanic eruptions, earthquakes, landslides, avalanches, flood

Direct insurance

NTI is a government entity backed by an unlimited government guarantee

Japan

Japan Earthquake Reinsurance (JER)

Earthquake, volcanic eruptions, tsunami

Reinsurance

Losses above certain thresholds are shared by the government and industry

Netherlands

Nederlandse Herverzekeringsmaatschappij voor Terrorismeschaden (NHT)

Terrorism

Reinsurance

Backstop for losses above NHT capacity and up to EUR 50 million

New Zealand

Earthquake Commission (EQC)

Earthquake, volcanic eruptions, tsunami, landslides, storm/flood (for land only)

Direct insurance

EQC is a government entity backed by an unlimited government guarantee

Norway

Norsk Naturskadepool

Flood, storm, landslide, avalanche, volcanic eruption, earthquake

Direct insurance

Established by legislation

Spain

Consorcio de Compensación de Seguros

Flood, earthquake, tsunami, volcanic eruption, windstorm, terrorism

Direct insurance

CCS is a government entity backed by an unlimited government guarantee

Switzerland

Kantonalen Gebäudeversicherungen (19 cantons) (e.g. Neuchâtel)1

Flood, cyclone, hail, avalanche, landslide (as well as fire)

Direct insurance

Established by legislation

Interkantonale Rückversicherungsverband (IRV)

Flood, cyclone, hail, avalanche, landslide (as well as fire)

Reinsurance for cantonal insurers

Established by legislation

Schweizerische Pool für Erdbebendeckung

Earthquake

Direct insurance (compensation)

None

Turkey

Turkish Catastrophe Insurance Pool (TCIP)

Earthquake, tsunami, landslide (and other perils triggered by earthquake)

Direct insurance

TCIP has access to EUR 250 million in reinsurance provided by the government.

United Kingdom

Flood Re

Flood

Reinsurance

Established by legislation

Pool Re

Terrorism

Reinsurance

Backstop for losses above Pool Re capacity (not sure if maximum)

United States

National Flood Insurance Program (NFIP)

Flood

Direct insurance

NFIP is administered by the Federal Emergency Management Agency (a government agency)

The NFIP collects premiums and has the authority to borrow from the US Treasury.

Terrorism Risk Insurance Program

Terrorism

Co-insurance

Federal government backstop through co-insurance for losses above industry loss of USD 200 million with cap on overall losses of USD 100 billion

California Earthquake Authority

Earthquake

Direct insurance

Established by legislation

Citizens Property Insurance Corporation2

Storm (wind)

Direct insurance

Citizens is a government entity

Florida Hurricane Catastrophe Fund (FHCF)

Storm (wind)

Reinsurance (reimbursement)

Established by legislation and administered by a government agency

China

China Residential Earthquake Insurance Pool (CREIP)

Earthquake

Direct insurance (co-insurance pool)

The co-insurance pool is reinsured by a state-owned reinsurer

India

Indian Market Terrorism Risk Insurance Pool

Terrorism

Co-insurance/ Reinsurance

The co-insurance pool is reinsured by a state-owned reinsurer

Romania

Pool-ul de Asigurare împotriva Dezastrelor Naturale (PAID)

Earthquake, flood, landslide

Direct insurance

Government is lender of last resort for losses beyond PAID’s financial capacity

Russian Federation

Russian Anti-Terrorism Insurance Pool

Terrorism (and SRCC)

Co-insurance/ Reinsurance

None

Chinese Taipei

Taiwan Residential Earthquake Insurance Fund (TREIF)

Earthquake, tsunami, landslide (and other perils triggered by earthquake)

Reinsurance

TREIF may seek access to government collateral to support funding for losses beyond TREIF’s financial capacity

South Africa

Sasria

Terrorism (and SRCC)

Direct insurance

SASRIA is a government entity although is not backstopped by an explicit guarantee

Note: 1 As noted, there are public cantonal insurers in 19 Swiss cantons. The information provided in the table is for the Établissement cantonal d'assurance et de prevention in the canton of Neuchâtel (as an illustrative example). 2There are a number of other pooled and/or residual insurance arrangements for wind risk in other states, including Alabama, Georgia, Louisiana, Mississippi, North Carolina (the North Carolina Coastal Property Insurance Pool, formerly known as the Beach Plan), South Carolina and Texas (the Texas Windstorm Insurance Association).. Similar to Citizens in Florida, these programmes are aimed at making insurance coverage available to households that are unable to secure coverage in the private market.

Source: (OECD, 2020[17]), (OECD, 2018[18]), (OECD, 2016[19]), (IFTRIP, 2017[20]), (World Forum of Catastrophe Programmes, n.d.[21])

The different approaches lead to different outcomes in terms of: (i) achieving a broad level of coverage for catastrophe perils (or the specific peril targeted); (ii) improving the affordability of coverage for targeted perils; (iii) maximising the role of private markets; and (iv) providing incentives for risk reduction. The following section provides a brief discussion of good practices for achieving these outcomes.

Achieving broad coverage for targeted peril(s)

An obvious indicator of a catastrophe risk insurance programme’s success is the extent to which the intervention achieves broad coverage for the targeted peril(s), whether through the programme directly or in combination with coverage provided by the private insurance market.

To achieve this, a number of countries impose requirements such as:

  • Policyholders are required to purchase coverage for the targeted perils (e.g. Iceland, some Swiss cantons, Belgium for terrorism in some lines of business);

  • Insurance companies are required to include coverage automatically (e.g. France, Spain, Australia for terrorism10) or make coverage available (e.g. Japan and California for earthquake, United States for terrorism); or

  • Lenders are required to ensure that their borrowers are properly insured (e.g. United States for flood in designated high-risk flood zones).

In general, the share of losses insured tends to be higher where the purchase of insurance is mandatory or where standard property policies are automatically extended to include coverage for the targeted peril(s) (New Zealand and Chinese Taipei in the case of earthquakes, France, Norway, Spain and Switzerland for the broader set of perils)11 (see Figure A.1).

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Figure A.1. Insured share of losses for perils covered by catastrophe risk insurance programmes
Figure A.1. Insured share of losses for perils covered by catastrophe risk insurance programmes

Note: For the purposes of this calculation, catastrophe risk insurance programmes include Denmark (storm), France (storm, flood, earthquake), Iceland (storm, flood, earthquake), Japan (earthquake), New Zealand (earthquake), Norway (storm, flood, earthquake), Romania (storm, flood, earthquake), Spain (storm, flood, earthquake), Chinese Taipei (earthquake) and Turkey (earthquake) as well as Switzerland (flood and storm, depending on the canton that was mainly impacted) and the United States (flood, earthquake (California), and storm (if the main impacts occurred in Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina or Texas)). It should be noted that in France and Spain, only some storm events are covered by the catastrophe risk insurance programme as these programmes include a wind speed threshold.

Source: OECD calculations based on (Swiss Re sigma, 2019[22]).

Improving the affordability of coverage

By pooling a large share of a country’s exposure to a given peril (or set of perils), a catastrophe risk insurance programme might be able to achieve a lower aggregate cost of coverage than individual insurers could achieve on their own.

Risk diversification

A single pool providing coverage for all of a country’s building stock, for example, would create a more diversified portfolio of risks than any insurance company could achieve on its own (without a 100% market share).12 An insurance company (or pool) with a higher level of risk diversification will have lower economic and (often regulatory) capital needs (other things equal) and can therefore offer lower pricing.

Reduced cost of reinsurance

Also, the cost of reinsurance tends to decline as the level of diversification increases so the cost to reinsure a single (diversified) pool of risks should be lower than the aggregate cost of reinsuring multiple (less diversified) pools of risks – which also should contribute to lower pricing for the policyholder.

Lower capital required

An assessment of the amount of capital required to protect against a 1-in-100 hurricane affecting eight US states was found to be 45% less (USD 71 billion instead of USD 130 billion) if the states pooled their risks rather than covering the risk independently (Dumm, Johnson and Watson, 2015[23]).

The impact of a catastrophe risk insurance programme on improving affordability will be greatest where the programme is able to establish a highly diversified pool of risks.

Maximising the role of private markets

An important objective of catastrophe risk insurance programmes should be to maximise the contribution of private markets to providing coverage - and therefore minimise the exposure of the public sector to losses from the targeted peril. The catastrophe risk insurance programmes that have been established for various perils aim to achieve this objective through a variety of approaches.

Coverage limits

Some programmes that provide government-backed direct insurance limit public sector exposure by placing ceilings on the amount of coverage available (New Zealand, Romania, Chinese Taipei, Turkey, United States (flood) – Japan’s Basic Earthquake Insurance policy is also limited although the government-backed coverage is provided through reinsurance). In some of these cases, coverage is limited to an amount that is significantly below the sum insured under the standard property insurance policy which limits the government’s potential exposure. In a few countries (e.g. New Zealand), the private market has developed coverage for amounts above the limits imposed by the catastrophe risk insurance programme although in most countries, losses above the basic coverage are often uninsured (see Figure A A.1).

Risk selection

Programmes can also be made available only to policyholders who are not adequately served by the private market. The insurance coverage for terrorism provided by Extremus in Germany (which benefits from a government backstop) is only available as an endorsement for policies with sums insured above EUR 25 million as the market is able to provide coverage against terrorism for smaller coverage levels. Some US states have residual market mechanisms that act as insurers of last resort and will only accept policyholders that can demonstrate that they could not access coverage in the private market.

Flexibility to leverage market capacity

Many programmes provide government-backed coverage as reinsurance (or as a backstop through co-insurance in the United States for terrorism) which usually means that, through the use of retention requirements, direct insurers will absorb most or all losses for smaller-scale events and only high loss events above the threshold would be covered by the programme. Some countries adjust the level of direct insurer retention over time, either based on specific measures of the capacity of the private market (e.g. Japan for earthquake) or with the aim of increasing the private market’s share of risk over time (Australia, United Kingdom, United States for terrorism, see Box A.1). In the United States, the trigger for Terrorism Risk Insurance Act backstop is set at a level where direct insurers will often seek private reinsurance to cover losses below the programme trigger.

Many of the catastrophe risk reinsurance programmes make reinsurance available but do not require direct insurers to make use of that reinsurance capacity (Australia, United States for terrorism, United Kingdom for terrorism and flood, France for natural catastrophe risk and for terrorism risk coverage for smaller companies) which allows direct insurers to retain the risk if they have sufficient capacity or transfer the risk to private market reinsurers.

Returning risk to the market

Most catastrophe risk insurance programmes make use of private market reinsurance (for programmes that provide direct insurance coverage) or retrocession (for programmes that provide reinsurance coverage). Many of the terrorism (re)insurance programmes operate as co-insurance pools that jointly access reinsurance coverage from private reinsurance markets (Austria, Belgium, France, Netherlands, India, Russian Federation) while programmes providing reinsurance tend to access private retrocession markets to increase their claims-paying capacity for large (infrequent) events (Australia and United Kingdom for terrorism, Turkey for earthquake). Japan Earthquake Reinsurance retrocedes a part of its exposure back to direct insurers. As noted above, the pooling of risk prior to transferring that risk to the market can have cost-saving benefits.

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Box A.1. Increasing the sharing of terrorism risk with private markets: Australia, United Kingdom and United States

In Australia, the United Kingdom and the United States, a number of changes have been made to terrorism (re)insurance programmes in order to increase the share of risk retained by (or transferred to) private (re)insurance markets:

  • In Australia, deductibles (retentions) are established (per event) as a share of fire insurance premiums and subject to both a company minimum and maximum deductible and an industry-wide maximum deductible. Since 2007, the company-specific deductible has been increased to 5% of the company’s fire insurance premium (from 4%) and a minimum deductible of AUD 100 000 has been implemented. Maximum company and industry-wide deductibles have been increased from AUD 10 million to AUD 12.5 million and from AUD 100 million to AUD 200 million, respectively. ARPC has also developed a retrocession programme to increase its capacity to absorb losses before calling on the government guarantee.

  • In the United Kingdom, a per event industry deductible is applied and has been increased from GBP 100 million to GBP 150 million. Pool Re has also transferred a significant amount of risk to retrocession markets in recent years.

  • In the United States, the co-insurance provided under the Terrorism Risk Insurance Act is only available for events that lead to industry losses above USD 200 million (an increase from USD 100 million in 2015). Individual company deductibles have increased from 15% of TRIA-eligible premiums to 20% (i.e. premiums written in lines of business that are eligible for coverage under the Act) while the industry share of losses once the programme is triggered has increased from 15% to 20%.

These changes have led to a significant increase in the share of losses that would be covered by private insurance companies and a corresponding reduction in government exposure. For example, based on an estimate of the losses incurred after the September 11th terrorist attacks and a simplified application of the programme triggers and thresholds in place in 2017, the amount of losses that would not be covered by the programmes (and left to be absorbed by policyholders or the state) would decline by approximately USD 4 billion in Australia, USD 2.7 billion in the United Kingdom and USD 800 million in the United States (see Figure A A.2).

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Figure A.1. Estimated impact of terrorism (re)insurance programme changes on loss distribution
Figure A.1. Estimated impact of terrorism (re)insurance programme changes on loss distribution

Note: The distribution of losses was estimated based on insured loss estimates provided in (Swiss Re sigma, 2019[22]) and the terms of coverage of each terrorism insurance programme in 2017 and 2007 (or 2014 in the case of the United Kingdom). A number of simplifying assumptions were made, including: (i) that all reported losses fell within the scope of coverage of the programmes; and (ii) related to the market share of different primary insurers (required for the calculation of applicable deductibles in Australia, United Kingdom and United States – simplified with the assumption that only the 6 largest providers of commercial insurance faced losses).

Source: OECD calculations

Ceiling on government exposure

Another way to limit government exposure to losses for perils targeted by catastrophe risk insurance programmes is to establish a ceiling on the amount of losses that the government will absorb. Most programmes that apply a ceiling will force losses above the ceiling to be absorbed by policyholders on a pro rata basis (Australia, Netherlands and United States for terrorism). Some programmes also reduce the ultimate public exposure by allowing or requiring insurance companies to repay the government for any amounts paid.

Providing incentives for risk reduction (directly or indirectly)

Insurance will make a greater contribution to managing catastrophe risks if the process of transferring these risks supports risk management. Insurance can play an important role in improving risk management by supporting risk assessment/understanding and encouraging risk reduction:

Use of modelling for risk management

The (re)insurance sector has developed a strong capacity for modelling the financial consequences of catastrophe risks, whether natural or man-made. This modelling capacity has broader (if underutilised) applications to other aspects of risk management, including for informing land-use planning and building code development as well as in decisions on investing in structural mitigation infrastructure.

The need for private sector (re)insurers to accurately price and provision for the occurrence of catastrophe events has driven the development of the modelling industry which means that model availability and sophistication is generally highest where private (re)insurers play a large role in providing coverage for catastrophe perils. Programmes that maximise the role of private insurance markets are therefore more likely to support the development of a modelling industry and its derivative benefits.13

Pricing that reflects risk reduction

Pricing for insurance (or reinsurance) coverage that varies by level of risk should provide an incentive for policyholders (or insurers) to invest in risk reduction (or ensure underwriting discipline) in order to lower the cost of that coverage.

While a number of catastrophe risk insurance programmes have implemented pricing that varies by risk zone or building type – none have implemented an approach to pricing their insurance, reinsurance or co-insurance coverage that provide significant incentives for reducing risk. Implementing variable pricing (and particularly, premium reductions for risk mitigation measures) is a challenge for many types of perils (and potentially impossible for some) although advances in modelling will continue to support the ability of these programmes to price their coverage based on more granular assessments of risk.

Risk reduction pre-requisites

Some programmes include specific risk reduction requirements as part of programme design – which is particularly relevant in countries where important risk management decisions are made at different levels of government. For example, the US National Flood Insurance Programme is only made available in communities that have agreed to implement certain floodplain management techniques. In France, deductibles are increased for properties that face repetitive losses if the municipality has not implemented a risk reduction plan. In the United Kingdom, the reinsurance coverage made available through Flood Re is only available for properties constructed after 2009 which is meant to ensure that new developments only occur in areas where insurers are willing to provide coverage without Flood Re backing.

References

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[14] Collins, S. (2020), “Insurers wary of meeting growing demand for specialist pandemic cover”, Commercial Risk, https://www.commercialriskonline.com/insurers-wary-meeting-growing-demand-specialist-pandemic-cover/ (accessed on 21 April 2020).

[33] Collins, S. and B. Norris (2020), “Rims supports moves to create pandemic insurance pools”, Commercial Risk, https://www.commercialriskonline.com/rims-supports-moves-create-pandemic-insurance-pools/.

[12] Direction générale du Trésor (2020), Installation d’un groupe de travail sur le développement d’une couverture assurantielle des événements exceptionnels, Ministère de l’Économie et des Finances, https://www.tresor.economie.gouv.fr/Articles/2020/04/22/covid-19-installation-d-un-groupe-de-travail-sur-le-developpement-d-une-couverture-assurantielle-des-evenements-exceptionnels.

[23] Dumm, R., M. Johnson and C. Watson (2015), “An examination of the geographic aggregation of catastrophic risk”, Geneva Papers on Risk and Insurance: Issues and Practice, Vol. 40/1, pp. 159-177, http://dx.doi.org/10.1057/gpp.2014.20.

[29] FCA (2020), FCA seeks legal clarity on business interruption insurance alongside package of measures to help consumers and small businesses, Financial Conduct Authority, https://www.fca.org.uk/news/press-releases/fca-seeks-legal-clarity-business-interruption-insurance (accessed on 4 May 2020).

[9] FFA (2020), 3,2 milliards d’euros de mesures exceptionnelles pour faire face à la crise du COVID-19, | Fédération Française de l’Assurance, https://www.ffa-assurance.fr/actualites/32-milliards-euros-de-mesures-exceptionnelles-pour-faire-face-la-crise-du-covid-19 (accessed on 21 April 2020).

[2] Heidtke, D. (2020), Congress Proposes Bill for Coronavirus Business Interruption Insurance Coverage, Duane Morris Insurance Law, https://blogs.duanemorris.com/insurancelaw/2020/04/16/congress-proposes-bill-for-coronavirus-business-interruption-insurance-coverage/#page=1.

[7] IAIS (2020), IAIS facilitates global coordination on financial stability and policyholder protection during Covid-19 crisis, International Association of Insurance Supervisors, https://www.iaisweb.org/page/news/press-releases/file/89860/iais-media-release-financial-stability-and-policyholder-protection.

[20] IFTRIP (2017), World Terrorism Insurance Pools and Schemes, International Forum for Terrorism Risk (Re)Insurance Pools, http://iftrip.org/wp-content/uploads/2017/02/IFTRIP-brochure-final.pdf.

[13] Insurance Journal (2020), “UK Insurance Industry Leaders Form Steering Group to Propose Pandemic Response, Chaired by Catlin”, Insurance Journal, https://www.insurancejournal.com/news/international/2020/04/21/565589.htm.

[8] Ladbury, A. (2020), “APCIA says ’let the market work’ as California commissioner demands premium refunds”, Commercial Risk, https://www.commercialriskonline.com/apcia-says-let-the-market-work-as-california-commissioner-demands-premium-refunds/?inf_contact_key=232841a04543af588dea20c51a459aa0d18a532c4142cb79caf2b269de1401fa (accessed on 21 April 2020).

[32] Ladbury, A. (2020), “Risk managers will support creation of state-backed pandemic pools to plug coverage gap”, Commercial Risk, https://www.commercialriskonline.com/risk-managers-will-support-creation-of-state-backed-pandemic-pools-to-plug-coverage-gap/ (accessed on 21 April 2020).

[5] NAIC (2020), NAIC Statement on Congressional Action Relating to COVID-19, National Association of Insurance Commissioners, https://content.naic.org/article/statement_naic_statement_congressional_action_relating_covid_19.htm.

[4] NAIC (2018), Statistical Compilation of Annual Statement Information for Property/Casualty Insurance Companies in 2017, National Association of Insurance Commissioners, https://www.naic.org/prod_serv/STA-PS-18.pdf.

[28] OECD (2020), Initial assessment of insurance coverage and gaps for tackling COVID-19 impacts, OECD, Paris, https://www.oecd.org/daf/fin/insurance/Initial-assessment-of-insurance-coverage-and-gaps-for-tackling-COVID-19-impacts.pdf (accessed on 20 April 2020).

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[1] Turner, H. (2020), “These states introduced COVID-19 business interruption coverage bills”, PropertyCasualty360, https://www.propertycasualty360.com/2020/04/09/these-states-introduced-covid-19-business-interruption-coverage-bills/ (accessed on 21 April 2020).

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Contact

Mamiko YOKOI-ARAI (✉ Mamiko.Yokoi-Arai@oecd.org)

Leigh WOLFROM (✉ Leigh.Wolfrom@oecd.org)

Notes

← 1. In the United Kingdom, the Financial Conduct Authority has taken the unprecedented step of seeking clarity from the courts on some specific areas of potential coverage disputes in order to expedite a resolution and hopefully reduce the need for lengthy litigation between insurers and their policyholders (FCA, 2020[29]).

← 2. On 25 March, the Chair of the UK House of Commons Treasury Select Committee wrote to the Association of British Insurers requesting information on the approach that insurers will take to business interruption claims and the amount of losses that insurers expect to pay (Stride, 2020[34]). In France, a senator representing the district of Ille-et-Vilaine submitted a written question to the Minister of Economy and Finance on 9 April regarding the need to extend retroactive coverage for business interruption losses through the French natural catastrophe insurance programme (Robert, 2020[35]).

← 3. Including Insurance Europe, Federation française d’assurance, Association of British Insurers, Federation of European Risk Management Associations, Airmic (United Kingdom) and Rims (United States) (Ladbury, 2020[32]), (Collins and Norris, 2020[33]).

← 4. In many jurisdictions, business interruption coverage is normally only triggered as a result of covered physical damage to the insured premises (or a premises in proximity in the case of civil authority or a denial of access extensions). In some countries (e.g. Germany), business interruption coverage may not require physical damage although pandemic-related exclusions may apply.

← 5. Not all infectious disease outbreaks will necessarily result in a global pandemic and therefore some diversification benefits may be possible to achieve.

← 6. There has been very limited use of alternative reinsurance markets for the coverage of pandemic risks (and no experience focused on business interruption) which would likely lead to a higher cost for such coverage in the short-term.

← 7. In the United Kingdom, for example, insurance companies have historically agreed to provide broad coverage for flood damage based on a commitment by government to make sufficient investment in flood risk mitigation.

← 8. There are also a number of catastrophe risk insurance programmes that provide governments with a source of funding for emergency response and recovery, usually established on a regional basis in order to benefit from geographic diversification (e.g. CCRIF in the Caribbean and Central America, PCRIC in the Pacific Islands and SEADRIF in South East Asia).

← 9. OECD calculations based on (Swiss Re sigma, 2019[22]). For the purposes of this calculation, catastrophe risk insurance programmes include Denmark (storm), France (storm, flood, earthquake), Iceland (storm, flood, earthquake), Japan (earthquake), New Zealand (earthquake), Norway ((storm, flood, earthquake), Spain (storm, flood, earthquake) and Turkey (earthquake) as well as Switzerland (flood and storm, depending on the canton that was mainly impacted) and the United States (flood, earthquake (California), and storm (if the main impacts occurred in Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina or Texas)). It should be noted that in France and Spain, only some storm events are covered by the catastrophe risk insurance programme as these programmes include a wind speed threshold.

← 10. In Australia, this is achieved by the voiding of terrorism exclusions in the event that a terrorist incident is declared.

← 11. In Romania and Turkey, there are requirements to purchase insurance coverage for earthquakes (as well as floods and landslides in Romania) although there are challenges in both countries in enforcing these requirements.

← 12. However, it should be noted that the establishment of a single pool for all risk also creates an accumulated exposure which would likely increase the need for public-sector backing.

← 13. Catastrophe risk insurance programmes in some countries have also played a large role in supporting the development of catastrophe models for the perils that they cover, particularly where the peril is not widely covered by private insurance markets (e.g. terrorism).

Disclaimer

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