Searching for True North

We may be social distancing, but clients and legislators are turning to brokers for a leg up in their COVID-19 response.

By Russ banham

Leader's Edge

As the world waits in isolation for the tragic human consequences of the novel coronavirus to lessen, the disaster’s economic toll continues to evolve.

The impact already is felt by a variety of companies of all sizes, with some industry sectors like airlines, cruise ships, hotels, and a multitude of smaller local businesses, reeling.

Expectations are that the property and casualty insurance industry will see exposures for workers compensation losses, cyber risks, directors and officers liability, employment practices liability, and unpaid accounts receivable losses.

The industry’s capital also will be affected by declines in investment income caused by sharply lower equity values and falling bond yields. Last but not least, the industry’s net premiums written may suffer, given the specter of widescale bankruptcies and approximately 16.8 million Americans out of work.

There is also a push in some sectors to require insurers to pay claims for losses their policies’ contract language excludes. Members of Congress, four states, and even President Trump has weighed in wanting insurers to assume business interruption losses of companies whose enterprises have closed down due to states’ shelter-in-place mandates, despite contract language that excludes coverage for losses caused by “communicable diseases” and stipulations that a property must incur physical damage for business interruption insurance to apply.

“It’s too early to tell how this will play out for insurers, but our general feeling is that the industry will be affected more by the erosion in capital caused by the freefall in the financial markets,” says Joseph Peiser, executive vice president and global head of broking at Willis Towers Watson. “Investment income will decline for a period of time.”

Nevertheless, if economic activity falls dramatically through the remainder of the year and beyond, Peiser says, it could reduce the ability of many companies “to buy as much insurance as they had previously, which could be more problematic than expected losses and investment income issues.”

Echoing some of these thoughts, Fitch Ratings revised its outlook for the underlying fundamentals of the P&C insurance sector from stable to negative on March 20. It cited COVID-19 related impacts on near-term performance and the credit quality of insurers. Of concern are longer-term underwriting losses in certain segments, legal challenges to contract terms, and the uncertain economy’s effect on premium growth.

As these varied challenges play out, insurance brokers are overwhelmed by client requests for prospective insurance coverage to transfer the risk of the next pandemic, with a few being asked to arrange insurance for the business impact of COVID-19, an impossibility akin to buying home insurance when the house is on fire.

One insurance policy created to specifically cover business losses caused by a pandemic, PathogenRX, is a parametric policy developed by Marsh, Munich Re and technology firm Metabiota and launched in April 2018. Not a single company purchased the innovative insurance, however, and it obviously is no longer an option for absorbing the current pandemic-caused risks.

But brokers are pressing on, even with shelter-in-place mandates.

“Our people are working remotely alongside their families, trying the best they can to assist our clients’ operational needs, with an eye toward getting them back up and running efficiently,” says Bumpy Triche, president of the Mid-South region at Arthur J. Gallagher. “They’re in the trenches doing coverage analyses, reviewing contracts, looking at renewals, and issuing policies at an unprecedented pace.

“In times of great uncertainty, our role as an advisor is to provide accurate, reliable information and be a calming influence” Triche adds. “Every broker is trying to be as supportive as possible, taking whatever reasonable measures are necessary to get our respective clients through this turbulent period.”

Taking Stock

At press time, the full impact of the coronavirus on the U.S. economy has yet to be realized, let alone tallied. The $2 trillion CARES federal stimulus bill and actions taken by the Federal Reserve to decrease short-term interest rates and buy bonds injected needed liquidity into the financial system. But will it be enough?

Economist Robert Hartwig, clinical associate professor of finance at the University of South Carolina’s Darla Moore School of Business, is optimistic the economy will rapidly rebound in late summer.

“The $2 trillion stimulus bill represents about 9% of GDP, which is enormous and should help many people and small businesses get through the months until the recovery,” he explains. “Once the stay-at-home mandates are pulled, all that pent-up consumer demand should explode.”

His upbeat projection is leavened by the possibility of a repeat visit by the virus in the fall, before a vaccine is developed and available. Were this to occur, Hartwig is confident that President Trump will unveil a second stimulus package to keep the economic engine humming. “I expect we’ll see positive economic growth by the third quarter of the year (2020), with the fourth quarter looking even better,” he says.

Many other economists, however, have a different opinion of when the economy will recover, with some not predicting a rebound until 2021 or later. For one thing, hunkering down at home may restrict spending, with consumers worried about the effects of another pandemic following on the heels of COVID-19, threatening all companies’ bottom lines and, in some cases, their survival.

Supply and Demand

This stark possibility stands in sharp contrast to initial economic concerns over the coronavirus, when it was thought to be confined to Wuhan, China. In January, the economic impact was viewed almost entirely through the lens of corporate supply chains. Foreign supplier-dependent industry sectors like manufacturing, telecom and technology were projected to experience great difficulties sourcing supplies in China to meet global demand for their products.

It turned out that many large companies had little to no trouble sourcing supply, having learned from the supply chain havoc wreaked by the 2011 floods in Thailand and the earthquake and tsunami that devastated Japan the same year. Their supply chains had become more resilient in intervening years, with beefed-up inventories and contracts with backup suppliers in place. Smaller companies are a different story. Lacking risk management departments and capital resources to create multi-tiered supply chains, they continue to confront sourcing challenges.

All companies, however, have a bigger problem—low demand. “Permanent changes in demand across the value chain are under way from the massive global disruption we’re experiencing,” says Iain Donald, partner and head of North American markets at security consulting firm Control Risks. “Companies need to figure out what demand will look like in the future and then do something about it operationally. … It takes enormous agility to shift fixed costs to meet expected changes in demand.”

Main Street businesses have a bigger problem than just expected demand, of course. Despite the availability of federally provided emergency advance loans and employee payroll protections, not many small local enterprises have the capital needed to survive an abrupt and lengthy halt in commerce. The Brookings Institution estimated in April that one quarter of small businesses (those with fewer than 100 employees) are at an “immediate risk” of closure. Another 28% fell into the research organization’s “near-term risk” category.

And that has manifold implications for insurers, including reduced net premiums, a decline in the trade credit and cargo insurance market, and a leap in claims for unpaid accounts receivable.

Plaintiff Possibilities

Many companies are hoping their businessowners insurance policies will absorb the lengthy disruption in business income caused by the shelter-in-place mandates. These hopes are likely to be dashed by the policies’ contract language. This hasn’t stopped a growing number of companies from filing claims, which are subsequently denied by the insurer.

In response, more than a dozen businesses have filed litigation against their insurers. The first lawsuit was filed by the Oceana Grill restaurant in New Orleans, which maintains the wording of its all-risks insurance policy provides coverage for business income losses caused by a pandemic. According to the court record, the policy (purchased from a Lloyd’s of London syndicate) does not contain an exclusion for business income losses caused by a viral pandemic, and it provides insurance for business losses attributed to a shutdown of the business by a civil authority.

Several other lawsuits interpret the “physical damage” coverage requirement in property insurance policies to mean something other than a building damaged by fire or a windstorm. In Proper Ventures LLC v. Seneca Insurance Co., the policyholder, a Washington D.C.-based sports bar, argues that the pandemic made its premises unusable, constituting a direct physical loss. According to reports, the policy does contain the traditional communicable disease exclusion. The industry inserted the exclusion into policies following prior epidemics and pandemics like SARS and swine flu.

Whether or not these lawsuits will prevail is an open question. “It comes down to the specific policy wording,” says Peiser. “Generally speaking, these would not be covered events, but it is highly dependent on the insured’s contract language.”

Larger businesses also are expected to claim business interruption losses. In some such cases, the policies were customized to waive the physical damage requirement and communicable disease exclusion, Peiser says. “We’re in the process of going through claims right now to determine how many companies fall into this category, but I don’t believe it will be a significant number,” he adds.

Workers Compensation Claims

Aside from business interruption coverage, different lines of insurance are expected to produce claims related to the coronavirus. Workers compensation is a case in point. Employees who prove they contracted the virus during the natural course of their work would be able to receive benefits.

“The industry will see an increase in severe claims in the healthcare sector from the first responders who became infected through contact with individuals having the virus,” says Hartwig. “Their lost wages would be covered, including the length of time they spend in quarantine.”

Theoretically, employees compelled to work at home who become infected also could be covered.

“If you become ill or injured at home during the scope of employment, you would be covered for workers compensation,” says Tom Fitzgerald, president of QBE North America’s specialty and commercial insurance business. He is referring to the fact that workers compensation laws say that, if you contract an illness during the course of employment, you are covered for workers compensation. Companies are requiring people to work at home, where they can contract the coronavirus from others working at home. If the infected employee cannot work, will the employer continue to provide compensation, according to state statutes? Nobody really knows.

Whether or not the industry will pay such claims is open to interpretation. “The coronavirus would have to be deemed an occupational disease,” Peiser explains. “It will play out on a state-by-state basis.”

Sharing this perspective is Mike Chapman, president of Hub International’s South region. “It’s a gray area how the industry will respond to workers who say they contracted the virus at their homes during work hours,” he says.

Another industry concern is that some employees, fearful of job termination during the crisis, may be tempted to file fraudulent workers compensation claims, asserting they contracted COVID-19 at work or during at-home work hours. “A spike in fraudulent claims is possible, with some people claiming they contracted the virus during the course of employment,” Hartwig says. “They may argue that no test was available at the time to prove this was the case.”

Fitzgerald echoed this possibility. “Workers compensation may be perceived as a better financial prospect than unemployment benefits,” he says.

In the meantime, brokers are tracking furloughed workers and those working from home to extract premium reductions from carriers. “As payrolls drop and job risk categories change, we want to be sure the premiums clients paid up front for workers compensation are adjusted to reflect the reduced exposures,” says Peiser.

Other Lines Affected

Insurers of employment practices liability also are expected to incur an increase in claims. Employees laid off may file a wrongful job termination lawsuit against the employer, asserting they were fired because of their age, race, gender, sexual orientation, or other protected class under Title VI legislation. “We’ve seen an uptick in employment practices litigation following other economic downturns in the past and are likely to see it again,” says Hartwig. “It’s almost unavoidable.”

Chances this litigation will prevail are small, says attorney Dan Rabinowitz, partner and chair of the insurance group at law firm Kramer Levin Naftalis & Frankel. “Courts will be leery of claims in an environment where unemployment is in the double digits,” he explains. “People looking for remedies involving discrimination theories will be disfavored.” What’s likely to be more problematic for EPL insurers is the financial cost of having to defend the lawsuits, he adds.

D&O liability insurance is certain to take a hit. “Whenever the stock market drops precipitously, we get a flood of D&O claims,” says Peiser. “All sorts of allegations will be made about lack of management preparedness and disclosure.”

Rabinowitz agrees. “D&O is a target-rich environment because the plaintiff’s bar is so prolific at going after the Ds and the Os,” he says. “They’ll come armed with complaints that the coronavirus was a ‘foreseeable event’ and the company should have done these 17 things to prepare for it but didn’t even bother to disclose the risk.”

Cyber risk insurers also can expect an increase in claims, now that the “secure environment” has migrated from corporate offices to people’s homes. “The threat landscape has gone up exponentially,” says Fitzgerald. “We’re particularly concerned about the explosion in phishing attacks.”

In March, hackers launched more than 500,000 phishing attacks, up an astonishing 667% from the prior month’s statistics, according to Barracuda Research. Approximately 9,000 of these phishing attacks were related to COVID-19. Hackers are preying upon people’s emotions, sending emails with malware-infected attachments offering needed supplies and home-based exercise tips.

“People are frightened, making them more susceptible to phishing,” says Peiser. “Once inside the home network, the risk for employers is the ‘bad actors’ will create a pathway into the corporate network and IT systems and shut them down until a ransom is paid.”

Hartwig cites a different cyber threat facing small businesses. “A growing number of restaurants and dry cleaners that have shut down are suddenly offering delivery services, collecting credit card information on their websites for the first time,” he says. “How secure are these websites against the possibility of a data breach?”

Peiser notes that part of brokers’ critical work right now is helping clients assess the extent of loss from the complicated exposures presented by the coronavirus. “We’re helping clients evaluate where coverage exists and doesn’t at the same time we’re advising them on policy renewals,” says Peiser. “When disaster strikes, you need an expert to help get you through it. This is our wheelhouse; this is what we do best.”

Insuring the Next Pandemic

These varied and complicated claims scenarios are occurring simultaneously with requests for the industry to insure the next pandemic. Since comprehensive data on the extent of economic disruption caused by COVID-19 is not available, it is too soon to discern if a pandemic insurance policy can be underwritten, much less priced at an amount companies can afford.

As insurers contemplate a solution, they may want to consider a parametric insurance product. “We designed PathogenRX with an economic loss trigger and a mortality trigger similar to ones used in the life reinsurance market,” says Martin South, president of Marsh’s U.S. and Canada operations. “Our goal was to provide financial protection to businesses with U.S. and Asian pandemic risks.”

Though no organization purchased PathogenRX before the COVID-19 outbreak and buyer interest and exploration were only “modest,” South says. “it’s tremendous right now. Together with Munich Re, we are actively seeking additional capacity to keep up with demand and protect our clients.”

Other brokerages that have put together parametric insurance products absorbing different types of risks in the past are mulling the development of a similar product covering the next pandemic.

“We’re largely in a ‘wait and see’ mode as everyone—underwriters, brokers and governments—figure out the ultimate losses caused by the coronavirus,” says Matthew Dyk, U.S. leader of Gallagher’s parametric and weather risk solutions. “I’m not sure there’s enough capacity to cover it all, but I see parametric products playing a role in future epidemic and pandemic risk transfer. We’re actively collaborating with markets to figure out how to create such products and evaluate appropriate structures.”

Assuming this to be the case, businesses with the capital to pay the premium would be able to ride out the next pandemic’s business income losses. There’s also the possibility that traditional insurance policies may be rewritten to provide a modicum of protection. In either case, Fitzgerald is optimistic the industry will find a solution.

“I led the U.S. organization at Aon through both Superstorm Sandy and the financial crisis of 2008 and know how this industry always comes through in times of crisis and fear,” he says. “As we’ve done for hundreds of years, bring us an exposure, and to the extent that we can underwrite and price the risk, we will figure out how.”

Russ Banham is a Pulitzer-nominated financial journalist and best-selling author

Sidebar: Breaking the Rules

COVID-19 puts Business Interruption coverage front and center.

Despite requirements in business interruption policies that physical damage occur and exclusions for communicable diseases, legislators in four states are demanding that insurers pay business interruption claims.

Bills in the legislatures of New York, Massachusetts, Ohio, New Jersey and three other states and the District of Columbia, if passed, would require insurers to cover claims for companies with between 100 and 150 employees, depending on the state.

“Consumer advocates and political activists are saying the insurance industry must step up and absorb business income losses, maintaining that this is what business interruption insurance is for, whereas the industry is responding that it never underwrote or reserved capital for pandemic-induced business interruption losses,” says attorney Dan Rabinowitz, partner and chair of the insurance group at law firm Kramer Levin Naftalis & Frankel. “For the time being, both sides are at an impasse.”

An Unfair Burden

The insurance industry is not completely off the hook for substantial virus-linked losses in several lines of business. If insurance carriers in the four states were compelled to absorb business income losses that their contractual obligations do not require, the American Property Casualty Insurance Association estimates, the expense could reach an alarming $383 billion per month. For the most part, industry participants are sanguine that state legislators will not achieve their aims.

“Legislative efforts to retroactively change contracts are ill-advised and have been struck down by the courts in the past,” says Joseph Peiser, executive vice president and global head of broking at Willis Towers Watson. “While we recognize that these are unprecedented conditions, our general expectation is that clients should not rely on this happening.”

Agreeing with this position is Robert Hartwig, associate clinical professor of finance at the University of South Carolina’s Darla Moore School of Business. “The contractual language is crystal clear,” says Hartwig, former chief economist at the Insurance Information Institute. “There will be no coverage forthcoming for companies with business interruption coverages that exclude losses due to viral and bacterial contagion.”

Nevertheless, the U.S. Congress on March 18 reached out to The Council and three other major insurance trade groups to request that the industry recognize financial loss due to COVID-19 as part of policyholders’ business interruption coverage.

The leaders of the four trade associations, while sharing the government’s commitment to finding solutions to the ongoing economic debacle, responded that business interruption policies “do not, and were not, designed to provide coverage against communicable diseases such as COVID-19.” They further pointed out that the insurance industry’s policies are “vetted and approved by state regulators.”

The National Association of Insurance Commissioners, an organization composed of state insurance regulators, affirmed this role, commenting that business interruption policies were neither designed nor priced (in most cases) to provide coverage for a coronavirus and, in fact, exclude this risk.

“If insurance companies are required to cover such claims, such an action would create substantial solvency risks for the sector, significantly undermine the ability of insurers to pay other types of claims, and potentially exacerbate the negative financial and economic impacts the country is currently experiencing,” the NAIC stated. 

Hartwig concurs. “Putting insurers on the hook for claims they never collected a single penny for will create chaos, to the point that the business interruption insurance market will disappear overnight,” he says.

Bridging the Divide

Many insurance brokers feel stuck in the middle between clients hurting from the business impact of COVID-19 and insurance policies that do not provide these businesses with a financial recourse.

“We understand the fear and uncertainty our policyholders feel,” says Bumpy Triche, president of the Mid-South region at Arthur J. Gallagher. “The number of companies impacted is astounding. We also understand why some legislators are in a rush to find a vehicle to provide relief and recognize why they look to insurance to be that vehicle. Historically, the industry has been the front line in a catastrophe, providing capital to help businesses reopen and communities rebuild. But retroactively redrafting contracts is a frightening and dangerous precedent.”

There’s still an important role the industry can play, by participating in an insurance solution with government and industry to ensure the next pandemic doesn’t take the wind out of the sails of so many businesses, Rabinowitz says.

“We need a thoughtful and nuanced approach, whereby the industry’s unique architecture to assess business risks, measure exposure frequency and severity, collect premiums, and pay claims is brought to bear, with the federal government absorbing the bulk of catastrophic losses by spreading these costs across society,” he explains. “If a viable private-public solution gets traction, there will be less pressure on legislators in the four states to continue with their demands.”

He adds, “You can’t rewrite insurance policies to cover something they don’t.”

R.B.