The closure of manufacturing plants, restaurants, retail establishments and other places of business to limit the spread of COVID-19 has resulted in significant business interruption losses. The vast majority of these losses are likely to be absorbed by the affected businesses as: (i) many businesses have not acquired coverage for business interruption losses; and (ii) unless governments (or courts) intervene, few of the companies that have acquired business interruption coverage have coverage that is likely to respond to these types of losses (see the OECD’s Initial assessment of insurance coverage and gaps for tackling COVID-19 impacts 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 and a discussion of how business interruption insurance against pandemic risk could be provided with support from governments based on the experience of other catastrophe risk insurance programmes.

Businesses across many sectors of the economy have faced a significant decline in revenue as a result of government directives to close their businesses in order to slow the spread of the virus among employees and customers. Most governments have implemented programmes to support businesses that have faced significant disruption as a result of COVID-19, focused on ensuring the availability of financing for businesses or income for their employees. Some commercial property insurance policies also include coverage for business interruption losses which provides policyholders with protection against some of the losses that they incur when their business is forced to close, subject to the terms and conditions of the individual policy.

Insurers and their associations around the world have indicated that most policyholders have not acquired insurance coverage that will respond to the business interruption losses that result from COVID-19 business closures. In most countries, business interruption coverage is provided as an optional coverage attached to commercial property insurance that is often (but not always)1 triggered only as a result of damage to physical property. In addition, 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). Some explicit coverage for business interruption losses resulting from a pandemic has been made available as endorsements or specialty coverage although take-up of this explicit coverage has been limited (see Box 1).

A number of insurance supervisors are assessing the potential for business interruption coverage to respond to losses incurred as a result of COVID-19 related business closures. In the US state of Washington, for example, the Office of the Insurance Commissioner undertook a review of policy wordings offered by 84 insurance companies and found that only two insurance companies offered coverage for a pandemic in their base policies while 15 others offered limited coverage through endorsements to other policies (Washington state Office of the Insurance Commissioner, 2020[5]). In France, the Autorité de contrôle prudentiel et de résolution (ACPR) requested information from approximately 20 insurers (accounting for a significant portion of business interruption coverage in the French market) and found that only 2.6% of these companies’ policyholders had explicit business interruption for a COVID-19-type event while a further 4.1% had coverage that could potentially respond (i.e. their policy wordings did not provide certainty on coverage) (ACPR, 2020[6]).2

It appears that many policyholder claims for COVID-19-related business interruption losses are being rejected by insurance companies. For example, in the United Kingdom, a survey of hospitality-related businesses found that less than 1% of hospitality businesses, 3% of innkeepers and 4% of beer and pub businesses had received a positive response from their insurer regarding business interruption coverage for COVID-19 related closures (Gould, 2020[7]). Some insurance companies have responded by offering additional coverage or making voluntary payments to support businesses affected by disruptions as a result of COVID-19 (see Box 2).

The absence of (or uncertainty regarding) coverage has led (and will continue to lead) to a large number of disputes between insurers and their policyholders which is likely to take months (if not years) to resolve. For example, in the United States, over 1 000 COVID-19-related insurance coverage lawsuits have reportedly been filed (as of August 2020) with early outcomes suggesting different judicial interpretations of key issues and limited potential for any consolidation of proceedings (Covington, 2020[12]).

Some legislators, insurance regulators (particularly market conduct and consumer protection authorities) and insurance associations are taking steps to support a more efficient resolution of these disputes:

  • In the United Kingdom, the Financial Conduct Authority (FCA) has taken the unprecedented step of seeking clarity from the courts on some specific areas of potential coverage disputes3 in order to expedite a resolution and hopefully reduce the need for lengthy litigation between insurers and their policyholders (FCA, 2020[13]). A decision is expected in September. In August 2020, the FCA has set out expectations on how insurers should take into account government financial support to policyholders with valid business interruption claims (Anthony, Harunah and Somi, 2020[14]).

  • In Switzerland, the Ombudsman of Private Insurance commissioned published a mandated third party legal opinion seeking clarity on the applicability of various pandemic exclusions that are applied as part of the general conditions of some Swiss property and business property insurance policies (Dörig and Bösch, 2020[15]).

  • In South Africa, the Financial Sector Conduct Authority (FSCA) identified the types of business interruption policies that could potentially include coverage and the evidence required to demonstrate coverage which is meant to reduce variation in interpretation by insurance companies using similar wordings (FSCA, 2020[16]). Reportedly, the FSCA is also considering launching a test case in order to provide greater certainty on the applicability of coverage (Rumney, 2020[17]).

  • In Ireland, the Central Bank of Ireland has established a COVID-19 and Business Interruption Insurance Supervisory Framework that outlines its expectations of insurers in terms of responding to business interruptions claims, including guidance on the interpretation of some issues, the allocation of litigation costs, particularly for cases deemed to be possible “test cases” and a requirement for insurers to extend the benefits of dispute resolutions to other relevant policyholders (Carrigy and Grogan, 2020[18]), (Moore, 2020[19]).

  • In the United States, a legislative proposal has been introduced that would allow insurers to voluntarily make payments (reimbursed by government) for business interruption losses under policies that provide coverage for losses related to civil authority closures and apply a virus exclusion – as a means to address one specific area of potential coverage disputes (Office of Congressman Mike Thompson, 2020[20]).

  • In Australia, the Insurance Council of Australia (non-life insurance industry association) has launched a test case in the state of New South Wales based on two small business claims made to the Australian Financial Complaints Authority (AFCA). The aim of the case is to provide an interpretation on the application of infectious disease exclusions to business interruption policies that could potentially be used by AFCA in resolving similar disputes (Ladbury, 2020[21]).

Legislators in some jurisdictions have raised concerns about the lack of coverage for COVID-19-related business interruption losses. For example, 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[22]). 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[23]).

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) by businesses. 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[24])) 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. In the US state of California, a recent legislative proposal reportedly includes a rebuttable presumption that would, for the purposes of claims interpretation, require an assumption that during the state of emergency, COVID-19 was present, caused physical damage and was the direct cause of business interruption to businesses in the state (Insurance Journal, 2020[25]). At the time of writing, many of the state legislative proposals were at an early stage of development and some of the early proposals (including legislative proposals in the District of Columbia and Louisiana) have reportedly been abandoned (Foggan, Sabino and Sutta, 2020[26])).

Insurance regulators and supervisors (along with insurance companies) have raised concerns over the implications of retroactively expanding coverage obligations. 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[27]). In the United States, the NAIC 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[28]). The US Department of the Treasury has also noted concerns about potential interference with the contractual arrangements made between insurers and their policyholders and the possibility that such proposals could introduce stability risks (Vaughan, 2020[29]). In France, the ACPR 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[30]).

Proposals which may 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 and may far exceed the amount of surplus capital (see below). If surplus capital were exhausted as a result of mandated payouts for COVID-19 business interruption, the ability of insurers to respond to losses from future events would be uncertain. 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.

Policymakers and other stakeholders are beginning to examine longer-term solutions to the business interruption protection gap as many private insurance market participants have expressed concerns about offering comprehensive coverage without some form of loss-sharing programme. A number of insurance and risk management associations have publicly indicated their support for developing a programme to cover pandemic-related business interruption losses, including risk management, broker and insurance associations from across Europe and the United States (Ladbury, 2020[31]), (Collins and Norris, 2020[32]), (Ladbury, 2020[33]). In the United States, a legislative proposal to establish a federal pandemic risk reinsurance programme (“Pandemic Risk Insurance Act of 2020” has been introduced to Congress. Working groups, in some cases involving both the public and private sectors, have been established in France, Germany, Switzerland, the United Kingdom (amongst other jurisdictions), as well as by the European Insurance and Occupational Pensions Authority (EIOPA) to examine possible solutions for providing insurance for future pandemics (Direction générale du Trésor, 2020[34]), (Insurance Journal, 2020[35]), (EIOPA, 2020[36]).

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 future pandemics (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.

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

Gaps in coverage may exist (or may emerge as a result of COVID-19) across other lines of business (e.g. event cancellation, health or various liability coverages) which may also need to be addressed through through some form of catastrophe risk insurance programme.

Catastrophe risk insurance programmes are often targeted at property damage, whether to residential or commercial buildings. In mature insurance markets, coverage for property damage is acquired by almost all commercial entities. As a result, coverage for property damage of the peril targeted by the catastrophe risk insurance programme can be attached to the coverage that already exists in the market and achieve broad penetration (although some programmes have established their own coverage terms and conditions).

However, the share of businesses that have acquired business interruption coverage is much lower. In the United States, for example, approximately 30% of businesses have acquired coverage for business interruption. In France, the Fédération française de l’assurance estimates that approximately 50% of SMEs have business interruption coverage (relative to 100% that have coverage for property damage) (FFA, 2020[37]). As a result, it would likely be more difficult to achieve broad penetration by attaching pandemic coverage to business interruption policies.

In addition, 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. 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.

While it is difficult to assess the frequency of pandemics, the potential severity of losses is immense. The magnitude of business interruption losses that are likely to be incurred as a result of COVID-19 (whether by policyholders or their insurers) is much higher than the losses incurred as a result of any recent single catastrophe event. For example, in the United States, one estimate suggests that small businesses (businesses with fewer than 100 employees) alone 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[38]). 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).

Potential losses of this magnitude would far exceed the amount of premiums collected for business interruption coverage. For example, the approximately 20 French insurers surveyed by ACPR reportedly collected a total of EUR 354 million in premiums for business interruption coverage in 2019 (ACPR, 2020[6]).

Figure 1 provides broad estimates of the potential magnitude of pandemic-related business interruption losses (as a multiple of past catastrophe losses from a single event) and the potential premium requirements (as a share of gross direct property insurance premium) – based on an assumed return period of 1-in-100 years (which may underestimate the actual frequency of pandemics). As an example, for the United Kingdom, estimated pandemic-related business interruption losses of USD 85-147 billion for a two-month period of confinement are estimated to be 18 to 32 times larger than the estimated economic losses from the Yorkshire floods in 2007 (USD 4.5 billion) and, based on a 100-year return period, would require (at a minimum – and without considering capital requirements) annual premiums of USD 848 million to USD 1 474 million, equivalent to approximately 2.9%-5.0% of all gross direct premiums written for property damage and business interruption (residential and commercial) in 2018 by British insurers.

The cost of capital requirements – which are usually higher for low frequency events, would not benefit from any significant deductions as a result of diversification4 and would need to account for the high-level of uncertainty regarding frequency and severity – would add a substantial amount to the premium requirement.

These estimates suggest that providing comprehensive coverage for all business interruption losses for a pandemic of similar magnitude as COVID-19 would entail absorbing losses at much greater levels than any catastrophe event in the past and would require a significant increase in the amount of premiums collected to fund those losses.

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.

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.

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 The ability of reinsurance markets (including alternative risk transfer through capital markets) to provide coverage for risks at a lower cost than primary insurers operating in a single market depends on their ability to pool uncorrelated risks from around the world.

The nature of pandemic risk challenges the ability of the private market to diversify the risk and would likely lead to a higher cost for reinsurance or retrocession (including through alternative risk transfer markets) than in the case of other perils whose occurrence would not be correlated across countries or with financial markets. In the case of alternative risk transfer markets, one of the attractive features for investors has been a lack of correlation between the performance of these instruments and financial market performance.6 However, the current crisis has demonstrated that a large-scale pandemic is also likely to have a negative impact on financial markets.

Given the recent experience with COVID-19, it is likely that insurers will be reluctant to provide broad coverage for business interruption in the near future (or at least not at a cost broadly accessible to commercial policyholders). Some reports suggest that insurers are reducing or eliminating any potential coverage for pandemic risk in property damage and business interruption policies (Marsh, 2020[1]) and are considering applying various exclusions in other lines of business where some exposure is likely (e.g. directors and officers liability insurance (Collins, 2020[44])).

The potential that confinement measures would be imposed broadly as part of any effective response to an infectious disease outbreak is likely to limit the appetite of private insurance markets to offer significant capacity even in terms of first-loss coverage as such measures would lead to many policyholders being affected simultaneously. In the United States, for example, the insurance associations that have put forward the Business Continuity Protection Program proposal (see below) do not include a risk-taking role for insurers (although (re)insurers in France have indicated that they would be willing to provide EUR 2 billion in (first-loss) coverage capacity with access to reinsurance through CCR (public reinsurer) (FFA, 2020[37])).

There is also a high-level of uncertainty related to the frequency and severity of infectious disease outbreaks. 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.

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.

In many jurisdictions, policymakers, legislators and insurance organisations have established working groups, developed legislation and made various proposals on the establishment of pandemic risk insurance programmes. In some cases, these proposals have been published or reported in the media.

EIOPA has developed an issues paper setting out some of the issues and options for establishing an insurance solution for addressing pandemic-related business interruption losses (“shared resilience solution”), based on discussions with representatives from the insurance industry and commercial insurance buyers. The issues paper outlines potential options for addressing risk assessment challenges (such as the modelling of non-damage business interruption (NDBI) risk) and incentivising risk prevention measures (through pricing and contractual terms) as well as some potential product design features to provide NDBI cover in the short or medium term (such as the choice of payment trigger, the scope or mandatory nature of the cover). The paper also sets out risk transfer approaches based on different mechanisms for risk sharing between insurers, reinsurers and governments at national or European level (EIOPA, 2020[47]).

As noted above, the French Minister of Economy and Finances established a working group in April comprised of representatives from business and insurance associations, CCR and members of Parliament mandated to develop a framework for providing insurance for exceptional events, such as a global pandemic.

The Fédération française de l’assurance, a member of the working group, has published its proposal for a CATEX (catastrophes exceptionnelles) programme to provide coverage for business interruption losses that result from a reduction in economic activity following an extraordinary event (pandemics, terrorist attack, natural catastrophe, etc.). Under the proposal, the coverage could be triggered by a state administrative action that resulted in the closure of businesses in a given geographic region for a specified amount of time and would apply to businesses directly affected by the administrative order as well as those indirectly affected as a result of reduced economic activity outside the specified region. The coverage would be attached to either commercial property or business interruption coverage and would be available to SMEs (TPE and PME in French). The coverage would provide lump-sum payments (i.e. without loss adjustment) and would be calibrated to replace gross business disruption costs net of salaries and profits. The coverage would be funded by a premium paid by SMEs and backed by the government based on the existing regimes for natural catastrophes and terrorism risk. As noted above, French insurers and reinsurers have indicated that they would provide EUR 2 billion in capacity based on an expectation that CCR would provide reinsurance for additional amounts (FFA, 2020[37]).

It should be noted that, at the time of writing, the formal proposal of the working group has not been published and that other members of the group are reportedly developing alternative proposals (Ladbury, 2020[48]).

The German Insurance Association (GDV) established an expert group from the insurance industry to develop potential models to address the economic impacts of pandemics. The GDV published a Green Paper in June 2020 proposing the establishment of a legal entity that would collect funds from policyholders (either directly as risk-based premiums or through a compulsory flat-rate levies attached to certain policies) and would make payments to policyholders in the event of a WHO-declared pandemic and/or the declaration of regional epidemic by the relevant German public authorities. Payments would be made to all businesses (flat-rate levy model) or those that paid premiums for coverage based on the amount of capital accumulated by the legal entity (including as a result of any reinsurance coverage acquired by the entity) – with the government providing a backstop for losses above the capacity of the legal entity (GDV, 2020[49]). According to the GDV, representatives of the business community have initially indicated that they would prefer a voluntary solution.

In the United Kingdom, industry representatives have formed working groups to develop solutions to the business interruption protection gap for pandemic risk.

A set of working groups have been established to develop a proposal to establish Pandemic Re which would create a government-backed reinsurance pool. The initiative includes broad participation from across the UK insurance sector and intends to submit a proposal to the UK government later this year.

In addition, the Lloyd’s market has developed and published details on three proposed solutions to address various elements of the pandemic-related business interruption protection gap (Lloyd’s, 2020[50]). The proposals have been published as open-source frameworks for the design of programmes to deal with non-damage business interruption (including pandemics) in the short and longer-term:

  • For the short-term, Lloyd’s has proposed the establishment of a ReStart programme that would pool capacity within the Lloyd’s market to provide business interruption coverage for small companies for future potential waves of COVID-19 (with the possibility to extend the scope of the programme to include SMEs more generally).

  • For the medium and longer-term, Lloyd’s has proposed the establishment of Recover Re which would collect premiums (under a policy that lasts multiple years) to be used to make payments to policyholders for non-damage business interruption after an event, including the current COVID-19 pandemic as well future pandemics or other perils that lead to business interruption (without the physical damage that triggers such coverage in many commercial property policies). Policyholders would make continuous premium payments over many years to fund a pool that would provide this coverage. The role of government would be to provide a guarantee against policyholder premium payment defaults and, potentially, to fund payouts in the initial years before Recover Re accumulates sufficient capital.

  • For the longer-term, Lloyd’s has proposed the establishment of Black Swan Re, a reinsurance pool backstopped by a government guarantee that would provide coverage for systemic non-damage business interruption losses. Under this proposal, the insurance industry layer would be relatively small at first but would increase over time (subject to loss experience).

In the United States, a legislative proposal to establish a federal pandemic risk reinsurance programme – the “Pandemic Risk Insurance Act of 2020” (PRIA) – has been introduced in Congress. The programme would operate in a similar way as the Terrorism Risk Insurance Program by providing a federal backstop for business interruption and event cancellation losses incurred by participating insurers as a result of a “covered public health emergency” (i.e. an event certified as such by the Secretary of Health and Human Services, such as a pandemic or infectious disease outbreak). Under the draft PRIA legislation, the private sector would take on some portion of the future pandemic risk. The federal reinsurance would cover 95% of losses above an individual participating insurers’ deductible once an industry loss threshold of USD 250 million was achieved – with an overall annual limit of USD 750 billion in annual payouts. The purchase and offering of the federally-reinsured coverage would be voluntary (Dawson and McCarty, 2020[51]), (Sclafane, 2020[52]). The legislation has been endorsed by a number of business and insurance associations, including Non-profit New York, the U.S. Travel Association, The National Retail Federation, the American Society of Association Executives, and the Council of Insurance Agents and Brokers (amongst others) (Office of Congresswoman Carolyn Maloney, 2020[53]).

A group of US insurance associations (American Property Casualty Insurance Association (APCIA), the National Association of Mutual Insurance Companies (NAMIC) and the Independent Insurance Agents and Brokers of America (Big I)) have proposed the establishment of a Business Continuity Protection Program that would provide federal compensation for up to 80% of specific types of operating expenses (including payroll, employee benefits and other operating expenses) for up to three months following the declaration of an emergency. Businesses would need to purchase this protection in advance and would need to certify that: (a) the proceeds of the compensation will be used to retain employees and pay necessary operating expenses; and (b) that the business will implement all applicable federal guidance on health and safety measures during the health emergency. The protection could be acquired by any business incorporated in the United States on a voluntary basis. The private sector would not take on any of the future pandemic risk, and it would be completely backstopped by the U.S. federal government (NAMIC, APCIA and Big I, 2020[46]), (Hatler, Mihocik and Roman, 2020[54]).

A “Pandemic Reinsurance Corporation” proposal has also been reported in the media although it does not appear to have been formally proposed as legislation. Under this proposal, reinsurance coverage would be made available for both small and large businesses although with small businesses receiving payouts based on a standard formula and large businesses receiving payouts calculated on an indemnity basis. The coverage would automatically be included in small business insurance policies (business owner policies or workers compensation policies) although large businesses would need to specifically acquire the coverage. The insurance industry would be responsible for approximately USD 15 billion of losses faced by small businesses and a similar amount for large businesses after a few years (Sclafane, 2020[55]).

In early July, a large US property and casualty insurer (Chubb) released a proposal for establishing a Pandemic Business Interruption Program involving facilities for small companies and for medium and large companies. For small businesses, the programme would provide a fixed payment based on a multiple of payroll costs in the event of a government-declared pandemic and lockdown with a first layer of losses (beyond a deductible and up to USD 250 billion) co-insured by insurance companies and government (with the industry share increasing over time) and an excess layer of USD 500 billion funded by government. Policyholders would only be required to pay premium to cover the industry share of losses which would reduce the cost of this insurance. Companies would be required to opt-out of purchasing this coverage and, in doing so, would confirm that they will not have access to business interruption coverage or federal assistance programmes in the event of a pandemic. For medium and large companies, business interruption coverage could be acquired on a voluntary basis from private insurers who would cede a proportion of the risk (and premium) to a government reinsurer (Pandemic Re). Coverage would be limited to USD 50 million per policy and the industry retention would be limited to USD 15 billion initially and increasing over time (Chubb, 2020[56]).

Table 1 provides a comparison of some of the common design features across the various proposals.

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.7 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.8

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).

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 a federal backstop 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.

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.

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 terrorism9) 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)10 (see Figure A.1).

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.

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).11 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.

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.

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[64]).

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.

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

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).

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.

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.

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.

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.

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.

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.12

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.

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.

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Contact

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

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

Notes

← 1. In some countries (e.g. Germany), business interruption coverage may not require physical damage although pandemic-related exclusions may apply.

← 2. The ACPR found that, in the case of the 93% of policyholders whose coverage would not respond to COVID-19-related business interruption losses, the vast majority had business interruption coverage that would only be triggered by physical damage to the insured’s property while only a few had policy wordings that excluded pandemic as a peril for the purposes of administrative business closures (ACPR, 2020[6]).

← 3. The FCA is seeking an urgent declaratory judgement from the courts on the applicability of non-damage business interruption coverage (including coverage for pandemics, denial of access and civil authority closures that do not require physical damage to be triggered) provided in a set of 17 commercial property policies to COVID-19-related losses. The test case will not address the uncertainty related to whether virus contamination could be considered physical damage, which is another significant area of potential disputes (FCA, 2020[75]) (Jones and Cohn, 2020[76]), (Le Marquer, 2020[77]).

← 4. In many solvency requirement frameworks, insurers can reduce the amount of capital that they hold for a given level of liabilities to account for the level of diversification in their portfolio (as, for most perils, not all policyholders will be affected simultaneously). It would be difficult to demonstrate that liabilities for business interruption losses from an infectious disease outbreak with potentially global implications are diversified and should benefit from a capital requirement deduction. This lack of diversification applies especially for monoline insurers. For insurers with multiple lines of business, there is risk diversification between pandemic losses and losses from other lines such as earthquake, fire or motor.

← 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 risk transfer 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. That said, Lloyd’s has recently indicated an interest in examining the potential for capital markets to provide capacity for pandemic-related business interruption coverage (Lloyd’s, 2020[50]).

← 7. 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).

← 8. OECD calculations based on (Swiss Re sigma, 2019[63]). 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.

← 9. In Australia, this is achieved by the voiding of terrorism exclusions in the event that a terrorist incident is declared.

← 10. 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.

← 11. 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.

← 12. 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).

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