April 19, 2020
3 Challenges for Pandemic Coverage
by Jason Schupp
While many see a useful model in the Terrorism Risk Insurance Act, it is not an off-the-shelf solution for pandemic risks.
The nation’s immediate strategy to support businesses affected by the COVID-19 pandemic has now formed around a portfolio of emergency federal loan and grant programs authorized by the Coronavirus Aid, Relief, and Economic Security (CARES) Act. As these programs become operational, policymakers are turning their attention to the risk of future pandemics.
When confronting the “new” risk of terrorism nearly two decades ago, policymakers forged the Terrorism Risk Insurance Act (TRIA) as a public-private partnership with shared financial responsibility for terrorism losses but heavily relying on the commercial property and casualty insurance industry’s product design, operational and claims administration capabilities.
Naturally, TRIA has emerged as a leading model for a future pandemic program – generally referred to as the Pandemic Risk Insurance Act (PRIA). While a reasonable starting point, TRIA is far from an off-the-shelf catastrophe risk program.
Congress designed TRIA to progressively recede from the terrorism insurance marketplace until expiring three years later. This temporary program is now in its fourth extension, guaranteeing a total program life of at least 25 years. Not a single dollar has been paid out from the federal backstop — owing more to the success of the U.S. law enforcement, defense and intelligence communities than to any beneficial feature of the program itself. While TRIA may offer the reassurance of longevity, this model remains (thankfully) wholly untested, such that any underlying design flaws only become visible on careful inspection.
We can test the efficacy of PRIA by answering three questions related to our current experience with the loan and grant programs authorized by the CARES Act:
- Which businesses should be entitled to claim benefits under the program?
- What benefits should be available?
- Who has the infrastructural capabilities to deliver the necessary benefits?
CARES Act loan or grant programs are available to nearly all businesses that meet the size requirements. An otherwise eligible business must certify merely a general need for financial relief as a result of the pandemic such as that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the applicant.”
PRIA would reach far fewer businesses. Under that program, insurers must first offer a policy of commercial property insurance without a virus or pandemic exclusion. No business is required by law to purchase it. In fact, under TRIA, only half of all businesses pay a premium for the removal of the terrorism exclusion. According to data released by the U.S. Treasury, 29% are informed that there is no additional charge for removal of the terrorism exclusion and the rest simply opt not to pay the average 2.5% additional premium.
We do not know how much insurers would charge to remove a virus or pandemic exclusion as required by PRIA. However, it is likely to be much more than the current charge to remove terrorism exclusions. As a rough benchmark, it takes the insurance industry about 10 years to charge enough terrorism premium to equal the amount of commercial property insurance losses from Sept. 11. It would take 125 years to collect enough premium just to equal the initial round of funding for the CARES Act’s Paycheck Protection Program.
Take-up rates for policies without virus or pandemic exclusions under PRIA will certainly be somewhere far less than 100%. Even if three-quarters of policyholders pay for the removal of the exclusion, many U.S. businesses would be left with no economic support in the event of another pandemic. If the cost of coverage is more than a couple of percent of total policy premium, take-up rates would be even lower, leaving vast amounts of the U.S. economy “willingly” exposed.
CARES Act programs are largely aimed at encouraging businesses to keep employees on the payroll. For example, Payroll Protection Program loans can only be used to cover expenses for payroll, rent, mortgage interest and utilities. If at least 75% of the loan proceeds are spent on payroll (subject to caps on high earners) during the first eight weeks, the entire loan is forgiven.
Business income coverage under a standard commercial property insurance policy also covers the expense of continued payroll, rent and utilities. However, insurance also covers the profits a business would have made and the full amount of salaries, including those paid to high-earning executives. While those benefits are more generous while they last, Civil Authority Coverage typically only extends to the first four weeks of a government-ordered shutdown (half the time period of the Paycheck Protection Program).
Of course, not every policyholder purchases a typical policy. Under TRIA (and therefore our hypothetical PRIA), captive insurance companies are full-fledged participants in the program. A captive is an insurance company set up and owned by its policyholder, typically a large corporation. Hundreds of large corporations (including the New York Times, Credit Suisse and the New York Stock Exchange) have established captives, allowing access to TRIA on far more favorable terms than those available via the traditional insurance market. For example, while small businesses are effectively shut out of property insurance coverage for terrorist attacks using nuclear or radiological weapons, a large corporation can negotiate with its insurance subsidiary for hundreds of millions or even billions of dollars of such protection, with 80% of the losses picked up by the federal backstop.
Large corporations would surely deploy these same strategies to maximize the value of PRIA. While a small business may be lucky to afford the standard four weeks of Civil Authority Coverage, a big business could ask its captive to provide coverage for 40 weeks or even 400. Certainly, the captive would not impose on its corporate parent restrictions on share buybacks, dividends or executive bonuses such as those demanded by the CARES Act’s Main Street Lending Program.
Claims Administration Capacity
TRIA contemplates that insurance companies possess the claims administration capacity to manage up to $100 billion of shared industry and federal losses. Hurricane Katrina was the largest property insurance event in U.S. industry’s history, resulting in about half that amount in paid claims.
Under the CARES Act, U.S. lenders have been called on to administer $349 billion in loans through the Paycheck Protection Program and a further $600 billion through the Main Street Loan Facilities. Just the initial funding of the Paycheck Protection Program is the equivalent of insurance companies facing down claims from Hurricanes Katrina, Maria, Irma, Andrew, Harvey, Ike and Wilma, Sept. 11 and the Northridge earthquake all at the same time, together with 10 years of National Flood Insurance Program and National Crop Insurance Program claims. The insurance industry is simply not designed to operate at that scale.
See also: 10 Moments of Truth From COVID-19
A Path Forward
While there are other “glitches” in the Terrorism Risk Insurance Act that should give us pause before expanding the model to include pandemics, the three points explored here should be enough to warrant a thoughtful debate about the objectives of any proposed pandemic risk management program and how best to implement it.
For example, we may find insurance companies can make available policies without virus or pandemic exclusions, but small businesses are unwilling to bear the consequent cost. A program with low take-up rates is worse than no program at all. Today, we can extend loans and grants to businesses that did not have the choice whether to buy insurance coverage. Once we have PRIA, we cannot.
Similarly, we may find the business income loss benefits made available to small businesses are modest and difficult to trigger compared with loan forgiveness under the Paycheck Protection Program. Meanwhile, large corporations can use their captive insurance companies to engineer bailouts that make the terms of the airlines’ $25 billion Payroll Support Program look stingy.
Finally, we may conclude business income coverages in standard commercial property insurance policies are too complex to quickly administer during a pandemic. We may also come to believe insurance companies should invest more heavily into maintaining robust catastrophe claims management capabilities.
If we do not get to the bottom of these challenges before committing to a new pandemic program, we will surely struggle with them when we most desperately need the program to work.