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.

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2 Comments

  1. Thank you for explaining this in such a clear and concise manner, it should be required reading for all elected officials so they can better understand the reality the private sector faces. No businesses will successfully file a LOB claim because of Covid-19.

    After the federal government stabilizes the economy, we need an extended period (10 years minimum) of pro-growth economic policy in Connecticut. This means reducing taxes, mandates and regulations, especially on small and medium sized businesses and on our middle class. State government also needs to drastically REDUCE their budget (30-40%) over the next 5 years until hopefully the private sector recovers from this event.

    Before this crisis, Connecticut was considered an uncompetitive state for business, due to our high TOTAL tax burden and expensive TOTAL cost of living. Maybe this event is the wake up call the Democrat Party needs to admit their economic policy for the past 30 years was wrong and finally change direction.

  2. My initial thought was that instead of the insurance industry being involved, it would be the banking and loan industry.

    Much like Sallie Mae, a public private relationship could be designed (quickly) whereby micro loans could awarded monthly to both private people and private companies with a variable intrest rate equal to the prime rate, with a set payoff of 10 years. The total amounts would be awarded based on 2019, 2018 or even 2017 tax records. With limited withdrawal equal to total reported income.

    The loans could be fast tracked through a loan manager, like an FDIC lender, at .25%. and guaranteed by the feds.

    Loan payouts would be through the FDIC banks, on a bimonthly basis. Not to exceed 12 months.

    This way people and small businesses can in affect insure themselves by spreading the impact of this over a 10year period.

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