Some corners of the ILS market are more insulated than others against Covid-19 business interruption (BI) claims being forced through, but challenges are emerging as reinsurers try to close off their exposure to systemic pandemic risk.
BI – and potentially contingent business interruption (CBI) claims – have emerged as one of the greatest unknown factors in terms of how the pandemic will impact the (re)insurance market.
Most commercial property insurance contracts that include BI coverage may have a sub-limit on BI claims, and standard wordings require physical damage to a premises to trigger pay-outs – which should rule out widespread coverage.
But amid lawsuits against insurers that could be seen as test cases from a range of hospitality businesses, and pressure from some US states that have drafted proposals to enforce extensions of coverage, the industry is concerned that claims may yet flow through to the market – and from there, potentially impact reinsurers.
On the reinsurance side, property treaties may well be silent on pandemic coverage or be broad all-risk deals, and attempts by some carriers to firm up limitations on pandemic risks have been met with resistance.
ILS coverage: peril restrictions key
On the ILS front, there is still only minor involvement in direct commercial excess and surplus lines insurance – albeit much more than several years ago – and as these participants would have control over the wordings they offer, it is possible there would be more limitations on BI coverage.
On the reinsurance side, there will be a bigger potential gap between the cat bond world – where coverage is much more specifically tailored to natural catastrophe perils only – and the collateralised reinsurance segment, where some more general traditional market wordings could allow room for interpretation.
Regarding the cat bond segment, Aon Securities CEO Paul Schultz noted that as well as use of specific named peril definitions, most transactions also specifically exclude losses that are not part of the subject business or which do not result in property damage.
“We would expect that potential BI losses would be primarily attributable to transactions that have commercial exposures and have ‘other’ perils as a defined loss event,” he said, adding that less than 3 percent, or around $1bn, of all property cat bonds outstanding covered ‘other’ perils for commercial lines business.
On the traditional reinsurance side, it is possible there will be more room for pressure to “follow the fortunes” of insurers even if ILS managers have stipulated they are providing natural catastrophe peril coverage only.
In a sign of how this pressure can emerge, a number of reinsurers sought to introduce exclusions on communicable disease coverage in April renewals, but this attempt caused some friction.
Willis Re’s head of international business James Vickers said that in some cases, ILS firms had pulled back at renewals because there was no absolute Covid-19 exclusion in place on the covers when they had given undertakings to their investors not to accept any deals without exclusions.
Vickers argued that while it was reasonable for reinsurers to seek to put specific Covid-19 exclusions in place now that the risk was known, blanket exclusions of any pandemic or communicable disease were “not on” as reinsurers should be there to “follow the fortunes” of their insurance clients and trust their underwriting.
If insurers push back on these exclusions this could be problematic for ILS funds that have investor mandates to focus exclusively on natural catastrophe risks, he noted.
But equally, ILS managers could face criticism from investors if they fail to take steps in this direction.
One investor told Trading Risk that if BI claims were to wind up in the ILS market, this would be a final straw on top of issues with Florida loss creep and that the industry’s “credibility deficit” could push them out.
US the hotspot for BI disputes
The ILS market’s homeland in the US is expected to be the centre for a push for BI claims to be covered. Social inflation could see plaintiffs allocate “significant resources” to finding a weakness in the contract language of BI coverage to secure pay-outs for losses arising from the Covid-19 pandemic, AM Best senior managing director and chief rating officer Stefan Holzberger told Trading Risk.
However, Holzberger added that AM Best believed the contract language used by most insurers was quite clear on this issue. “[We expect] the courts to confirm the long-standing provisions of these insurance contracts.”
As for BI contracts which do not exclude losses originating from transferrable diseases, he said it “remains uncertain” whether they would have to pay out for claims stemming from the coronavirus.
However, while he stressed that such pay-outs ultimately hinge on physical damage arising from the coronavirus pandemic, he said it could be possible that some courts could interpret the existence of the coronavirus as constituting physical damage.
A lawyer echoed this point, stressing that all market participants will be keeping a close watch on the development of the lawsuits filed in the US, as they will set a precedent for other disputes.
Holzberger warned that defence and containment costs could spike as insurers are forced to defend their positions in lengthy legal battles.
On the reinsurance front, Holzberger and a Zurich-based source agreed that if policyholders have an all-risk policy and communicable disease is not a named exclusion, then coverage is likely to apply.
Continuing in this vein, Holzberger said the insurance industry learned “valuable lessons” from the 2003 outbreak of severe acute respiratory syndrome (SARS), with many expressly excluding communicable diseases from their post-2003 all-risk policies.
Holzberger noted that depending on the long-term relationship with the client, reinsurers could choose to honour claims even if the loss is trigged by an uncovered or excluded peril.
But he said the agency currently anticipated that reinsurers would incur a “manageable” level of losses including some BI, CBI, directors’ and officers’ and credit losses, and from other specialty classes tailored to pandemic events.
Further complexities and unanswered questions
Some property policies contain limited fungi, bacteria or virus coverage, though courts may still be required to step in and interpret the intricate details, but it is feasible that virus-related losses could be covered while bacteria-related losses are excluded, Holzberger said.
“What can further complicate claims assessments is that the recovery period for a BI claim may depend on a business’s decision to close in response to differing state and federal legislative rulings,” he added.
Insurers will likely continue to face potential BI and CBI claims until the Covid-19 situation abates, Holzberger said.
“For covered perils, BI or CBI would apply until any limits or sub-limits were reached and during the entire ‘period of restoration’. With the impact of Covid-19 likely to continue developing over the coming months, if not longer, it is impossible to be certain how long the ‘period of restoration’ will be for these businesses.”
With the validity of Covid-19 BI claims still very much up in the air and limited data available in company disclosures, it is impossible to know how much global at-risk limit there is, Holzberger said.
Protection gap needs plugging
In light of this “unprecedented issue”, it’s reasonable to assume cedants and ILS fund managers will want communicable diseases to explicitly be excluded from BI cover in future programmes, a source told Trading Risk.
The market participant said it is possible specific cover will be developed and sold for communicable disease in the future, as the ongoing pandemic has stressed the profound impact the peril can have on businesses and people tend to only realise lack of cover when a claim happens.
This may happen as a result of government intervention, or at least close regulation, as it is in everyone’s interest for this “protection gap to be plugged”.
“Creating specific cover for this would be the constructive approach,” the source said.
Given the systemic nature of the risk, there have been suggestions of government backstop schemes – similar to the terrorism pools set up in the US and UK – with Marsh CEO John Doyle throwing support behind such an idea in the US.
It is important to do everything possible to prevent bankruptcies, but pressuring insurers to pay out Covid-19 claims even where there are clear exclusions in place defeats their purpose and would come at too great a cost to the industry.
“The insurance industry simply does not have the financial resources to support the global economy in this way,” Holzberger concluded.