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An Uninsurable Business Interruption

Amid possibly the biggest business interruption in history, millions of U.S. businesses (including mine) stand to collect nary a penny from their business interruption insurance policies.

Some politicians, including President Donald Trump, see this as a problem. But excluding losses caused by pandemics from such coverage is a feature, not a bug, of a well-designed system. It makes such insurance affordable in the first place. A political reflex to try to coerce insurers into covering losses they never agreed to cover could break that system outright.

The economic losses arising from the COVID-19 pandemic are staggering and universal, if unevenly distributed. A few industries have more work than they can handle, while many have been forced to shut down entirely. Many more must operate at greatly reduced volume to accommodate social distancing.

Business interruption insurance is more or less what the name implies. It provides money to let a business meet obligations such as rent and payroll, and sometimes to pay some measure of lost profits to the owners. But business interruption insurance does not provide insurance against all business interruptions. If the owner locks the doors for a two-week fishing trip, the insurance does not kick in. It may or may not cover strikes or other work stoppages; if it does, it is because the company decided to pay an extra premium for such protection.

This sort of insurance is mainly meant to cover losses from fires, floods, storms and similar disasters. These losses meet the classic definitions of an insurable risk: They rarely happen, they happen in statistically predictable intervals, they happen over relatively restricted areas, and the losses they produce are substantial. Insurers can spread the cost of those losses over a large population and over a period of years. Some of those years will produce greater losses, and some of them will be comparatively mild.

The SARS outbreak of 2003 was a wake-up call to insurers, who realized that a modern pandemic would meet none of those definitions. A pandemic would be, by definition, global rather than regional. It would thus produce claims from a huge share of policyholders all at once, at a random time, rather than from a small percentage of policyholders in any given year, with losses fairly predictably distributed from one year to the next. As David Sampson, the chief executive of the American Property Casualty Insurance Association, put it: “A pandemic by its very nature means that you can’t diversify risk, which is the fundamental basis of how insurance operates.”

Such losses are inherently uninsurable. If an insurer priced the product high enough to cover a claim by every policyholder at once, demand for the coverage would dry up. The result would be a price spiral, in which higher prices drove out more customers, which in turn would lead to even higher prices.

Assuming a company did collect premiums for such coverage, investing those premiums to generate an economic return would be nearly impossible. Insurance companies operate much like banks. They keep a comparatively small amount of cash on hand to meet customer demands and invest the rest in longer-term instruments. The yield on such investments pays interest to bank depositors and reduces premiums for insurance customers. But if a company has to keep enough cash on hand to meet demands from everyone at once, it can’t invest this way. And if the insurer has to liquidate investments during a catastrophic event, such panic selling can cause markets to crash and wipe out much of the invested capital.

SARS made insurers realize they had dodged a bullet. That outbreak proved not to be highly transmissible and was limited mainly to Asia. But it provided a taste of what a more serious pandemic might look like. As a result, insurers changed their policy language to specifically exclude coverage for pandemics. They implemented this change more than a decade ago, and nobody complained until now – when a pandemic came along. Until it did, everyone was happy to pocket the savings in reduced premium cost.

Everyone that buys business interruption insurance in the first place, that is. Industry studies show that as many as two-thirds of small businesses do not carry it. This leaves them vulnerable to routine, insurable disasters like structural fires that can put them out of business. Good public policy would encourage small businesses to buy such insurance; some landlords even require it. But if we push insurers to cover losses that they never meant to cover, we will produce the opposite result.

Trump indicated at a news conference last week that he thinks some policies are written broadly enough that pandemic-induced interruptions fall within their scope. Other policies may be ambiguous, so that an owner’s pandemic-induced illness might be excluded but a government shutdown order might not. The courts will ultimately sort this out. They generally observe a principle that, since the insurers write the policies, any ambiguity should be construed in favor of the customer. This is appropriate. But my guess (and that of most of the industry) is that the policies are correctly written to exclude losses from COVID-19.

Eighteen members of the House of Representatives, including a dozen Democrats and a half-dozen Republicans, wrote to four trade organizations urging that insurers “recognize financial loss due to COVID-19 as part of policyholders’ business interruption coverage.”

“We stand ready and willing to work with you on any future measures that might be necessary to see our country through this trying time,” they added. These comforting words, while noncommittal and nonbinding, point in the correct direction for how to handle a universal disaster. That direction is government.

Republicans and Democrats can agree – in fact, if you look at their actions, they already have broadly agreed – that only governments can marshal the resources and spread the costs of a society-wide disaster across that society. Rebuilding a destroyed community after a hurricane does not only benefit the people who lost property in that storm. It also benefits the people who will live, work and interact with that community for decades to come. Maintaining and restoring an economy in a once-in-a-century pandemic does not only benefit the people who lose money during the pandemic; it creates opportunities for those people, and the next generation, to make a living when the pandemic is over.

Private insurance can be a valuable lubricant and supplement to government action in mitigating disasters, but it cannot replace it. Making private insurance pay for losses for which it was neither contractually designed nor appropriately priced just serves to make such insurance less affordable and available for the losses it is actually well suited to cover.

The impulse to see private insurance companies as a deep pocket that we can tap at will to meet public needs is widespread but misguided. We should expect insurers to cover the losses they agreed in advance to cover – no less than that, but certainly no more.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s most recent book, The High Achiever’s Guide To Wealth. His contributions include Chapter 1, “Anyone Can Achieve Wealth,” and Chapter 19, “Assisting Aging Parents.” Larry was also among the authors of the firm’s previous book, Looking Ahead: Life, Family, Wealth and Business After 55.

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