COVID-19: The effects on the insurance industry and how to flatten the curve

The world is certainly going through turbulent times. This article is being penned whilst the author is under mandatory quarantine and self-imposed isolation, giving him the time and space to reflect on how our world is changing from one day to the next and trying to answer the perennial questions of how this situation came about, why we were not prepared for it and whether we should we have foreseen it. Naturally, these are accompanied by the issue of the solutions to be applied. We should also be asking ourselves what lessons should be learnt, how we can improve things and what the new world will be like. The same questions could, clearly, also be asked of the insurance industry, being that the latter is one of the best risk-sharing mechanisms out there. Finally, we should consider the manner in which this mechanism could help the world’s recovery.

The effects of this pandemic outbreak on the insurance industry are still to be quantified. There are far too many soldiers still lying on the ground at this stage, but a bit of guess work clearly indicates that there will be more than meets the eye. In this article we will try to foresee and analyse the effects on the insurance industry together as well as identify new opportunities. The latter is no mean feat as the industry approach towards epidemies and pandemics is very broad and varied, ranging from complete exclusion to full cover. The experience with past epidemics has resulted in many policy exclusions relating to disease. Therefore, any conclusions should always keep in mind the specifics of each individual insurance contract.

The claims hitting the insurance industry from the COVID-19 outbreak will be coming across a range of fronts, namely:

Health Insurance

Since epidemics primarily affect human health, health insurance is clearly in the front line of any assessment, albeit the fact that it was not the first one to be hit. If there is one sector of the industry which cannot say it could not be prepared for a pandemic it is, after all, the health one. Following the introduction of Solvency II, regulators have been insisting, rightly so I may add, that health insurers should include a pandemic scenario in their Own Risk & Solvency Assessment (ORSA). This exercise looks at the possible impact of different scenarios on the solvency of each company to ensure that insurers are prepared for that one-in-200-year catastrophic event. Therefore, whilst health insurance claims related to COVID-19 are clearly bound to surge, the industry here should have the required muscle to tackle the crisis. Furthermore, experience with pandemics and initial responses of healthcare providers normally indicates that the quantity of pandemic claims is mitigated by the postponement of other non-urgent treatments, hence diluting the effect over time. The intervention of public health systems in such a crisis in possibly covering the related treatment costs could also help mitigate the situation.

Travel Insurance

The travel sector was certainly the first to feel the pinch of the COVID-19 outbreak. Whether the cancellation & curtailment cover was in place or not, the stark reality on the ground is that travel insurers were faced with a tsunami of enquiries and claims which really stretched resources to the limit. Again, here, cover for such events varied tremendously, from full cover, cover in the event of travel advisories, cover only in the case of travel bans/cancellations to outright cover exclusion. Whilst the industry could argue whether it should pick up such covers or not till it is blue in the face, it is probable that the reputation of many insurers came out bruised from the whole situation. This may be an unfair conclusion particularly because several insurers did pick up cover in the normal manner and will be settling claims. Others were probably correct in their assertion that exclusions applied. There were also cases where the insurers waived the exclusion, understanding the particularities of these extraordinary circumstances. Where claims were paid, this was certainly no ordinary payment volume. Such covers are normally priced on the basis of a localised problem, such as the cancellation of one flight or a number of flights in one location (such as in the case of the volcano ash cloud). Here, however, we are talking about widespread cancellations on a global level.

Tour Operator Liability Insurance

The unprecedented wave of travel cancellations all over the globe coupled with the potential liability of European tour operators under the European Directive on package travel and linked travel arrangements is certain to test the insurers offering such liability covers in such times. Travel cancellations can only mean that many will be seeking to recoup their unrecoverable expenses and tour operators and agencies are likely to struggle if not covered.

Event Cancellation Insurance

This cover might not immediately come to the mind of the man on the street, but large event organisers are facing a dire situation. With all the bans and lockdowns directly hitting mass public events, many events had to be cancelled outright, from a simple conference to large-scale concerts and events. The organiser would have probably already invested huge sums of money in the organisation of such events, which, when coupled with lost income, results in bills running into millions upon millions. Just imagine that whilst authoring this article, football leagues have been suspended, UEFA has just decided to postpone EURO2020, major fairs are being cancelled and the Olympic Committee is still to decide whether to cancel or postpone the Olympic Games, some of the largest worldwide events which are most likely to be insured. The Olympics alone could see a cover requirement to the tune of 11.5 billion Euros.

Commercial Insurance

Certainly, the biggest wild card in this assessment lies in the insurances which businesses might already have in place. Whilst the businesses themselves do not contract the disease, the side-effects of the whole situation are certain to hit business owners very hard.

Business Interruption Insurance (BII)

Loss of business is certainly the prime cause of the hardships business owners are and will be facing. This could be the result of many factors, ranging from the closure of one’s own premises either because an infected person or employee was present on site to closure imposed by bans on the business (for example a restaurant) or via a lockdown, to remaining open for business but having potential customers staying away. Added to this, naturally, certain costs of keeping the entire business running and in particular the employee wage roll will keep being present, unless there is government intervention or the business itself folds.

The applicable cover here in the event of an epidemic/pandemic prompts a minefield of interpretations. The norm for BII cover to apply is that it follows insured events under the other sections of cover, particularly the property damage. However stand-alone cover can also be purchased, and such covers are normally on the basis of ‘specified perils’. In such cases, the specified perils and, in particular the definitions used in the policy wordings are key, as they could refer to notifiable diseases, epidemics or pandemics. All these require an element of government or health authorities declaring such a status, making cover therefore not automatically triggered simply on the presence of the disease.

In the event of the closure of business premises due to the presence on site of an infected person either temporarily (until disinfestation) or for prolonged periods, an interpretation of disease contagion as a pollutant could trigger cover, although it is probably not the intention of insurers to pick up such situations. This matter is certainly debatable and subjective, and covers could include specific exclusions in this regard. It is certainly potential ground for a lot of litigation, therefore leading to added costs.

A loss for a business could also be an indirect one, particularly if the “damage” caused by the disease hit the insured’s customer or supplier. The norm here would be for such policies, also known as Contingent BII, to be more property damage-related, rather than for the outbreak of a disease or epidemic.

Supply Chain Risk Insurance

Aside from Contingent BII covers, Supply Chain Risk Insurance is now widely available, and could include pandemic as a specified insured peril. This kind of cover has been available for quite some time now following a string of natural catastrophes which exposed the risks associated with the supply chain failing to deliver on time. With many parts of China shutting down, the breakdown of the supply chain is, in the case of many factories in the Western world, to have to (or risk to) suspend production. The losses to manufacturers might be mitigated here by a reduction in demand, whereas the losses to the insurance industry emanating from such covers are probably limited by possible limitations in cover and the fact that the purchase of such cover is not as wide a practice in many industries as it should be. However, there could also be liability issues; for example, China is also one of the main suppliers of pharmaceuticals and medical supplies. A shortage of these could lead to liability exposures for health service providers.

Cyber Crime Insurance
Whilst the COVID-19 outbreak would not have a direct impact on Cyber Crime cover, the truth is that for many businesses, teleworking has become a reality, and a necessity, overnight. Therefore, with many employees working from home, this might mean that the potential cybersecurity measures within the usual ‘controlled’ office environment are not replicated, hence leading to higher risks of cyber criminals having easier access to unprotected networks/data. An increase in potential losses on this front is therefore not a far-fetched reality and the insurance industry might need to interact more proactively with its customers to ensure that proper cybersecurity arrangements are maintained. Aside from the commercial and reputational damage, European companies are now operating in a world dictated by GDPR, and any personal data breaches could result in hefty fines.

Third Party & Employer’s Liability Insurance

The measures taken to mitigate the spread of the COVID-19 virus have included the limitation of mass gatherings and in particular, have seen the closure of places like bars together with the prohibition of large-scale events such as concerts. This has, however, also highlighted the fact that owners of such places and /or organisers of such events have a risk exposure and could face potential legal liability if any third-party and/or employee contracts the virus whilst at the premises and suffers any expenses or permanent damage. Disease is normally one of the included ‘specified perils’, and any finger-pointing towards insured persons could open the flood gates to multiple claims unless specific exclusions apply.

Income Protection Insurance

Since insurers’ cover includes the inability of employees to work arising out of diseases, there is a likelihood that these insurers will also be affected by the Covid-19 outbreak, depending on the long-term effects which the disease might have. For example, a Covid-19 patient might suffer a % loss of function of the lungs. If such a patient happens to work in an industry where having a healthy use of the respiratory system is a necessity, cover under income protection policies might be triggered. At the moment it would seem that a number of insurers are suspending the sales of such cover until they can properly assess and quantify the potential losses and how best to move forward in offering these covers once more. However, this is more likely to be a precautionary measure, as the bulk of the acute cases relate to persons above the pensionable age.

Key Personnel Insurance

The outbreak of infectious disease has seen many cases where employees had to receive treatment or go on quarantine, either because of travel or possible contact with infected persons. Key employees are certainly not immune to the virus and this may be another source of potential headaches for insurers.

Aviation Insurance

Insurers on the aviation markets are most likely to be hit on different fronts. The most obvious ones could emanate from liability claims from passengers who might have contracted the virus either on the plane or whilst embarking/disembarking in case of any negligence from the airline. However, with so many aircrafts being grounded and airlines struggling even more than usual on the cash front, this might translate in reduced maintenance investments, which could place certain carriers on a higher risk curve across the various aviation insurance products. With aircraft grounded, the demand for insurance cover might also fall.

Indirect Losses

Investment Returns
Many insurance companies were already struggling with low interest rates keeping investment returns to a minimum but certainly now, with a recession looming and with markets tumbling, this source of income will be one which cannot be counted on in the immediate future.

Renewals
Aside from the effects on the claims front, the financial strain on many individuals and companies might lead to a reduction in the sales of those classes of insurance which are either not compulsory or which might not be considered an absolute necessity. Furthermore, some lines of business such as travel insurance might be impacted by the negative PR suffered during this outbreak as a result of declined claims.

Overheads
At least in the short run, the insurance market might see an increase in its overheads, particularly through the higher number of claims and enquiries received. Furthermore, many companies have had to invest in new modus operandi particularly in operational systems associated with tele/remote working. Having said this, this situation has forced many companies to review the way things are done and practices such as the abovementioned tele/remote working for employees could lead to savings in the long run too.

The Way Forward

The insurance industry must not only think in terms of flattening the curve, but rather of staying ahead of it. It must look ahead and see how insurance will be and be perceived to be in a modified insurance appetite environment. Similar past problems have led to a lot of product innovation, particularly on specific covers for infectious diseases and supply chain risks, although the uptake of these covers was very slow. Possibly, however, the perception in the developed world might still have been that such problems are not that frequent, or that it is only a problem in the poorer countries. This COVID-19 outbreak and, in particular, the extreme social distancing measures taken by many governments will certainly be a wake-up call for many. What was previously considered as a possible 1-in-200-year event might in fact be more frequent than anticipated. The insurance industry, therefore, has to act and fast. Being one of the best risk-sharing mechanisms, the insurance industry has to be ready with new solutions and also ensure that it remains strong.

The social role of the industry is also now further enshrined under the Demand & Needs requirements within the Insurance Distribution Directive. Therefore, simply excluding infectious diseases is not a possible answer. The need for cover is urgent and insurers have to find the best way to make the cover available in a way which keeps costs reasonable and at the same time does not constitute a threat to their solvency.

In this regard, investing in a new insurance undertaking (which therefore has no claims legacy) becomes very appetising once the crisis is over. We are likely to see start-ups mushrooming in many jurisdictions such as Malta, which is ideal for such operations. Furthermore, with the demand for specific covers for infectious diseases on the rise, these in themselves could present business opportunities.

Needless to point out, any offers for such cover have to be properly managed particularly because of the potentially large losses. This is where reinsurance and potentially Insurance-Linked Securities might come into play. New covers for infectious diseases would require some form of Stop Loss or catastrophe cover. Reinsurance and CAT Bonds would be part of the solutions.

Traditional CAT Bonds, however, follow the insurance loss in the first instance and are therefore indemnity triggered. During epidemic outbreaks, though, certain operations such as healthcare service providers, hospitals, the logistics industry, the hospitality / travel industry and other similar industries might require an immediate cash injection based on a parametric trigger (such as the number of infected persons within a timeframe or number of countries shutting down their borders). The quick settlement would support these industries in dealing with the immediate issues, such as potential cash flow issues related to employee salaries whilst on lockdown, re-routing of passenger repatriations, hosting of non-paying customers at hotels whilst these are blocked in the country, additional re-routing expenses for logistics operators and the potential need for additional resources in certain industries. The fact that there might be demand for all these new forms of exposures, and that the response might be through parametric triggers, could also give a new sense of being to FinTech and in particular Blockchain solutions. Smart contracts are certainly already geared toward such potentially catastrophic situations.

Such parametric CAT Bonds and covers are not new. Following the outbreak of the Ebola virus in Africa, in 2016 the World Bank created the Pandemic Emergency Financing Facility (PEF) which was also backed by reinsurers such as Munich Re and Swiss Re. This Pandemic Bond is aimed at acting as a fast capital injection to tackle emergency responses and assist medical efforts for the spread of certain diseases in West Africa. In such cases, and, as we are learning through this Covid-19 outbreak, time is of the essence. Such products can also be used in combination with more generic fund capitalisation. The diagram below explains how the PEF works in this regard:

Source: www.worldbank.org

Other opportunities might come in the form of offering customers certain cover in relation to outbreak situations. For example, the DBS Bank in Singapore, as part of its contribution to society, is offering its customers a free 30-day COVID-19 Hospital Cash policy which gives daily cash benefits (circa Eur 60/day) in the case of hospital confinement, together with a lump sum (circa Eur 600) in the case of ICU confinement. In this case, Chubb is the insurer acting as security on this policy.

Travel policies might start offering cover for expenses incurred as a result of being quarantined whilst abroad, or due to the impossibility of returning to one’s own country. For example, it is estimated that between 400,000 to a million Britons might currently be trapped outside the UK without being able to return home. The expenses such persons may incur might become considerable not only for potential repatriation but even simply to survive until the possibility of leaving the destination travelled to arises.

Event cancellation covers will, likewise, certainly be under pressure to include infectious diseases and Business Interruption covers. The latter will need to respond to possible prolonged periods of closure not only to cover profits, but also work-from-home expenditure and the salaries of idle employees. Demand for cover for loss of key personnel and the inability to work of other employees is certain to be on the increase.

The opportunities that such scenarios as the above present are likely to be numerous. Innovative covers, coupled with some out-of-the-box thinking, could be the response to trigger the much-needed recovery of the insurance industry once this crisis is over.

Mr Julian Boffa is an Insurance Regulatory Advisor within the Insurance and Pensions team of GANADO Advocates, focusing mainly on re/insurance, corporate governance, compliance and regulatory matters. He regularly advises and assists insurance and reinsurance operations with their licence applications and other ongoing requirements.