America’s insurance capital to the (financial) rescue?

Over the past several weeks, among their other worries, organizations of all kinds across America have been reminded of an uncomfortable fact:  the “business interruption” provisions of their insurance policies may not respond to income lost due to COVID-19.

I hasten to add that there is a very good reason the property and casualty insurance industry has in many cases declined to cover business income losses due to contagious diseases:  the risk cannot be quantified and accordingly cannot be “underwritten” and assigned an appropriate premium.

It may seem paradoxical to many, but traditional insurance does not typically address truly unknown risks.  Instead, it bundles known and measurable perils, calculates the premiums necessary to defray a predictable range of impacts of such perils within a large group of at-risk people or organizations (using historical data), and thereby “spreads” the risk of that peril across the identified group, or “risk pool.”

Combine all those risks, all that data, and all those risk pools, and you have the insurance industry as we know it.

This is all by way of explaining, in the first instance, that the insurance industry does not currently maintain a deep pool of premiums collected over the years to address the risks of COVID-19 or other contagious diseases.  There is no “deep pocket” of funds set aside for such losses, so any government mandate that private insurers respond to COVID-19 claims for “business interruption” losses would necessarily involve the expropriation of premiums collected to protect insureds from other, covered perils.  This may not be a popular fact in our present circumstances, but it is a fact nonetheless.

There is, however, an opportunity in the current emergency to craft a public-private partnership that would have an enormously positive impact on our economy and the workers bearing the costs of “social distancing.”

If the federal government were to create a reinsurance fund to defray the costs of cornonavirus-related claims for lost business income and enlist the private insurance industry to adjust these claims for their existing insureds utilizing the infrastructure already in place for covered business interruption claims, we could effect a rapid infusion of liquidity into businesses and not-for-profit organizations across America, without any new government bureaucracy, and with the protections against fraudulent claims already employed by the insurance industry.

Some provision would need to be made for the additional expenses that would be incurred by private insurers to ramp up their business income claims facilities to this extent, but this could easily be done on an “at cost” basis without creating a windfall for the insurance industry.

To understand why this is the case, we must address another paradox of traditional property and casualty insurance.  As I’ve written elsewhere, insurance companies make very little profit on actual operations (collecting premiums and paying claims); instead, the bulk of their profits are derived from income on premiums that are invested in the capital markets as reserves against expected future claims.

No less a financial sage than Warren Buffett explains each year in his annual letter to shareholders of Berkshire Hathaway that the foundation of that company’s success is the successful investment of what he calls “float:”  collected insurance premiums held—sometimes over many years — until the claims on a particular risk pool must be paid.  In our present situation, this fact has an important corollary:  if an insurer has not collected premiums for a particular peril —say COVID-19— it has no kitty of money earning investment income and resulting profit– that is, no “float.”  In other words, no invested reserves, no profits for insurance companies.

Recognizing this, the federal government should design any COVID-19 reinsurance facility to reimburse payments on business income claims only as they are actually paid to insurance consumers by insurers.  This kind of “pass-through” approach would get money into the hands of affected organizations without enabling any windfall profit for the insurance industry.

Small businesses and other organizations that do not currently buy business interruption coverage could be given the chance to participate in an “assigned risk pool”—such as we already utilize in auto insurance—where they could purchase basic business income insurance (with retroactive coverage for COVID-19) that would be assigned to a participating insurer for servicing.

Would this approach be expensive?  Yes.  But at a time when leaders of all political persuasions agree that literally trillions of dollars of government stimulus will be needed to repair the effects of COVID-19 on our economy, the approach I’ve suggested would be an extremely efficient way for taxpayers to harness the talents and experience of a private insurance industry that is the envy of the world.

Sean M. Fitzpatrick teaches public policy at Trinity College in Hartford.  He previously led the Hartford Financial Group’s multi-billion dollar middle market property and casualty insurance business.