COVID-19 and the draconian shutdown measures adopted by many governments to contain it have plunged the global economy into the deepest recession since the Second World War. For the global insurance industry, too, the pandemic is a severe loss event. Despite this massive strain, initially exacerbated by a steep decline in capital markets, insurers worldwide promptly paid legitimate claims in all areas where pandemic risk was intended to be covered; for example, under life, health and event cancellation policies. In addition, also during the lockdowns, insurers have continued to pay claims and benefits unrelated to the pandemic; for example, in motor, liability and annuities insurance.
The extent of correlation and aggregation of pandemic losses for businesses across the globe has put the insurability of pandemic risk in the spotlight. It touches upon the pivotal question of whether pandemics are a type of risk for which the insurance industry can play any kind of role or if this is the type of risk where traditional insurance products are not the solution. The first report in The Geneva Association’s research series on pandemics and insurance set out to explore – in objective terms – the capacities of insurers to absorb pandemic-related costs.
Severe mismatch between economic losses and premiums
The COVID-19 pandemic has exposed massive protection gaps in the area of business continuity risk. Less than 1% of the estimated global pandemic-induced GDP loss for 2020 (source: The World Bank) will be covered by business interruption (BI) insurance. The mismatch between economic losses and the risk-taking capacity of insurers who offer BI cover, as well as past demand for pandemic coverages, is staggering. With annual BI insurance premiums of about $30bn, insurers would have to collect premiums for 150 years in order to absorb the estimated $4.5tn global output loss inflicted by COVID-19 and its handling in 2020. Even the size of the entire global property & casualty (P&C) insurance industry (USD 1.6 trillion in premiums, according to McKinsey) is eclipsed by the economic damage from the pandemic.
In order to cover the total cost, all P&C insurers worldwide would have to collect premiums across all lines of business for almost three years, with no money left for covering private homes and vehicles, injured workers and numerous liability exposures. Therefore, P&C insurers have typically applied strict exclusions on pandemic business continuity risk and never intended to cover it.
Viability of life & health coverage
For life insurers, excess mortality (mortality above what would normally be expected over a specific span of time) associated with diseases is well-documented and researched. For P&C insurers, however, modelling pandemic risk is virtually impossible as it is driven as much by subjective decisions of countless government officials on national, regional or local levels as by epidemiology (Hartwig and Gordon 2020).
Average mortality rates among life policyholders are usually significantly lower than in the population as a whole, mainly on the back of medical underwriting in individual life insurance business. Also, due to higher than expected mortality rates, annuities may offer a natural hedge to the mortality shock caused by a pandemic (Cox and Lin 2007; GCAE 2006), especially as many life insurers focus on annuities rather than pure risk (term life) products and, as such, tend to be more concerned about life expectancy increases than sudden jumps in mortality. Against this backdrop, the underwriting losses of life insurers from COVID-19, while significant, are expected to remain manageable.
For health insurers, too, pandemic risk poses no fundamental insurability challenges and so far, the impact of the COVID-19 pandemic on private health insurance has been relatively modest. In many countries, for health insurance companies, the decline in medical care for non-COVID conditions and routine or elective procedures has more than offset the impact from COVID-19 claims.
Table 1 offers a comparative and illustrative summary assessment of barriers to the insurability of pandemic BI, mortality and health risks. Pandemic life and health risks are privately insurable in the context of COVID-19; however, for pandemic BI risks, six of the nine widely-applied insurability criteria (Berliner 1982) are deemed to present insurmountable barriers to insurability. A risk is uninsurable for professional risk carriers if at least one criterion is not satisfied.
BI coverage for pandemic not feasible
Pandemic-induced business continuity risk is obviously unique given its potential to impact virtually all policyholders simultaneously, over an extended period of time. Applying the two most relevant customary criteria of insurability to pandemic BI risk yields the following conclusions:
• Losses are neither random nor independent. Even though pandemics are naturally occurring phenomena, policy decisions to lock entire economies are deliberate and intentional. This means that expected loss amounts and risk loadings cannot be set. There are also no historical data for the policy responses witnessed during COVID-19. Furthermore, the strong correlation among individual risks renders efficient risk pooling and diversification impossible.
• The maximum possible loss is not manageable from the insurer’s solvency point of view. The uncontrollable aggregation of losses could be ruinous to the risk pool and, ultimately, to the insurance industry as a whole. This in turn could lead to significantly further financial stability risks across the wider economy.
It is important to understand the differences between pandemic and other catastrophic risks, first and foremost, in terms of the scope for global diversification (Figure 2). Pandemics are, by definition, not diversifiable as they occur on a very wide or even global scale (as opposed to epidemics which are more locally concentrated).
Some other risks such as terrorism or natural catastrophes are diversifiable on a global level and routinely transferred via re/insurance or Alternative Risk Transfer (ART) instruments. These disasters impact a limited number of policyholders for a limited period of time. As COVID-19 illustrates, economic losses caused by extreme pandemics and their handling by public authorities are neither locally nor globally independent. Therefore, pandemic business continuity risks are uninsurable for the private P&C industry.
Public- and private-sector decision-makers should resist the temptation to measure pandemic risk by a single yardstick. It rather requires a clear differentiation between uninsurable and insurable variations as well as a careful distinction from other catastrophic risks such as natural disasters, cyber and terrorism, with different local and global insurability and diversifiability characteristics. Government and society must accept this distinction when setting their expectations for the role of the insurance industry in addressing this issue in future.
The second report in the series on pandemics and insurance, to be published in 2021, will explore possible solutions: innovative, public-private efforts that recognise the enormous magnitude and unique nature of pandemic risks. A
Dr Kai-Uwe Schanz is deputy managing director and head of research & foresight at The Geneva Association.