So, is a federal backstop program that is part of, or similar to, TRIA feasible or advisable? It’s too early to tell, but below are some initial “caveat emptor” thoughts I have.
FIRST of all, TRIA has not been tested, so we don’t know if this backstop program actually works, how well it might work, and how it might impact the insurance industry’s ability to assume risk in the future, much less be able to effectively respond to terrorist acts. In addition, for a claim to fall under TRIA, it must be caused by a traditional covered peril found in most property insurance policies. In the case of PRIA, the pandemic itself is the peril and it can impact the entire population.
SECOND, following that thought, the industry has significant financial assets but not manpower. We’ve already seen how difficult it is for government and all of its resources to respond to regionally localized claims involving hurricanes, tornados, flooding, and wildfires. The ability of the insurance industry to adjust claims on a nationwide basis would likely be extremely limited, begging the question of whether “insurance” is the proper mechanism for responding to truly catastrophic national or global exposures like pandemics.
THIRD, just as the manpower issue cannot be understated, neither can the required expertise of adjusters. PRIA would likely present a far greater indirect loss exposure than TRIA due to both the scope of losses and the impact of government-mandated business shutdowns, curtailments or operational modifications. The most significantly impacted traditional insurance coverage is business income. This insurance product is one of the more complex in the industry and, as a result, claims are FAR more difficult to adjust and require FAR greater expertise from adjusters than direct property claims.
And, specifically with regard to TRIA, so far, most terrorist attacks have been localized. While it’s possible that a terrorism attack could have a much more widespread impact, absent a war-like action of a nation, the risk is probably substantially smaller than the potential economic impact of a nationwide pandemic. As a result, the maximum possible (or perhaps probable) loss in a pandemic is likely to be measured in the trillions, not billions, of dollars.
FOURTH, TRIA is optional. Businesses do not have to buy TRIA coverage. Not long after TRIA was passed, a study conducted by the Council of Insurance Agents & Brokers (CIAB) found that fewer than 10% of small businesses and 20% of larger businesses purchased terrorism coverage where the cost was an additional 10-20% of their existing P&C premium. By 2013, the Congressional Research Bureau estimated that 60% of businesses had terrorism insurance, though that number was likely much smaller in higher risk areas where the coverage could cost thousands of dollars. According to a more recent report, this number has remained fairly constant, most likely due to the affordability of the coverage given the lack of terrorism incidents.
Can PRIA truly be an optional coverage or must it be mandatory? Because the risk of a pandemic, in both frequency and severity, is presumed to be far greater than anticipated terrorist attacks, insuring it will likely be far more expensive than TRIA coverage. If so, it’s quite likely that few businesses would purchase it if they want to remain competitive with those businesses that don’t buy in. Given that huge numbers of businesses can be impacted by a pandemic, what would become of the perhaps sizable majority of businesses that don’t purchase the coverage? Would the government simply allow them to go out of business? Highly unlikely. And, if interest-free loans or grants continued to be available, it’s even more likely that greater numbers of businesses would rely on that failsafe mechanism than paying large amounts for insurance coverage they may not need in the short term.
In addition, if the impact of a pandemic is likely to be far more significant in densely populated areas, much like flood insurance, adverse selection may play a role whereby even fewer businesses in sparsely populated areas will purchase the coverage even if priced lower than densely populated areas. And how might the uninsured otherwise affect the insured? Contingent business income coverage is critical to some businesses. For example, a business that has one or only a few suppliers or customers could be out of business if they suffered a loss. That likelihood is dramatically increased if they elect not to participate in a PRIA program such that the subject business would have an even greater need for contingent coverage.
Given these possibilities, would a mandated program be more feasible? For example, in response to civil unrest in the late 1960’s, the insurance industry implemented a system of civil disorder charges that applied to ALL commercial property rates. The charge varied geographically based on presumptive risks. In the case of a pandemic where the exposure is far more widespread, in order to generate the insurance proceeds needed, it’s quite possible that a mandatory funding mechanism could be indicated. Otherwise, an optional program is likely to fare far worse than the current federal flood insurance program which still does not use actuarially sound rates, suffers from adverse selection, and operates in the ‘red’ year after year.
FIFTH, is traditional business income insurance even a feasible risk management approach to a catastrophic pandemic? As mentioned earlier, business income coverage is a complex product that requires significant financial skill and analysis. Determining loss amounts is far from an exact science and, in fact, often involves a great deal of conjecture and supposition that usually leads to negotiated settlements. In the case of a pandemic that can impact hundreds of thousands (or more) businesses over a very short period of time, what private sector industry has the manpower and expertise to adjust claims rapidly to the satisfaction of business owners?
IF a PRIA program is remotely feasible, it would probably have to be based on a nontraditional and simplified insurance product. Perhaps, rather than base the amount of coverage on a complex “business income” calculation that requires speculation about all forms of revenue, expenses, and profit, the coverage should be limited to only “continuing expenses,” including payroll, to remain in operation for a specified period of time. The approach would be more analogous to the Maximum Period of Indemnity option currently available in ISO’s business income program.
A simplified product covering only continuing expenses for a limited period of time such as 4 months MIGHT be workable in a mandated basis, but great care must be exercised in constructing and administering such a program. And, keep in mind that, in risk management circles, primary coverage should be provided by the entity with the greatest control over the exposure. In the case of pandemics, that would be the government.
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