Business interruption: Keeping calm and carrying on
The challenges of 2020 placed an intolerable burden on both buyers and carriers of business interruption coverage, but what have insurers learnt about underwriting the risk and how to structure a sustainable product going forward?
The word ‘unprecedented’ became a cliché in 2020 for good reason, especially from an economic perspective. Except for times of war, the Covid-19 pandemic is the only time that entire business sectors have been brought to a halt, with thousands of business owners forced to shut shop and rely on their business interruption cover.
This brought small business insurance sector to the forefront of many entrepreneurs’ minds and conflict soon arose around how this coverage was being provided. In 2020, the Financial Conduct Authority (FCA) and eight insurers went to court to seek clarification over disputed words in various business interruption insurance policies.
Insurers had reviewed and updated the wording of the policies following the 2002 SARS outbreak, but many policyholders questioned whether wording did, in fact, exclude them.
The High Court generally found in favour of the FCA and businesses, and a ruling from the Supreme Court widened the types of policies that should pay out. The regulator noted that the case would affect 370,000 businesses that held one of the 700 different policies issued by 60 insurers.
With billions of potential payouts still to be made questions remain for insurers despite the outcome of the judgement, says Clive O’Connell, partner and head of (re)insurance at City law firm McCarthy Denning.
“Although the Supreme Court case gives a good degree of certainty as to what business interruption wordings mean, which should allow for better pricing of cover in the future, there is a big question as to whether the industry has the capacity to offer cover for future pandemics or whether potential policyholders could afford the premiums that the industry would be required to charge,” says O’Connell. “Most insurers are likely, where possible, to exclude cover.”
The publicity from the court case, and the obvious financial burden of covering businesses faced with the uncertainty of Covid-19, has spread reluctance throughout the insurance industry. Gordon Vater, business development director at Gallagher Bassett, has already seen policies become more restrictive in a reactive move from insurers.
“We have already seen rates harden – premiums have moved up and policies are more restrictive. I think mainstream carriers will be very careful about the risks they write, but I also think they have an opportunity to really engage with customers and pass on greater knowledge around products,” he says.
“Fundamentally, the [business interruption] sector is resilient and always finds a way to move through to the other side, like the 2008 crisis,” says Vater. “The difference this time around is not only do we have a crisis, but we have real change in customer behaviour.”
According to the ABI, insurers are expected to pay out up to £2.5bn in business interruption cover due to the pandemic. Huw Evans, director general of the trade body, praised the efforts of the industry but admitted “uncomfortable gaps” had been exposed between what insureds expected and what insurers paid out.
As a result, wordings are being revisited in light of the pandemic and ensuing court case. These policies – when accessed – are becoming clearer and there remains an opportunity for insurers to provide cover to businesses that need this protection.
Covid-19 has made an entire generation of business owners consider the worst-case scenarios they face and realise how vulnerable they are. As such, this could lead to a new relationship risk (from both insureds and insurers).
“The industry, as well as business and governments, need to confront why risk-takers thought tail-risk insurance (in the form of an insurance contract or redundant cash on balance sheets) was optional for their businesses, when they’d never dream of buying a home, car or health without comprehensive insurance coverage,” says James Berkeley, managing director of Ellice Consulting.
“We don’t operate in an environment for which most conventional risk management literature prepares us. Executives and their advisors do not fully grasp the ‘model error’ in forecasting models. The irony is the insurance underwriting industry understands that and structures their own organisations appropriately.”
Insuring businesses in an uncertain world
Nonetheless, change is occurring among insurers to cater to this greater demand for resilient (and more clearly worded) business interruption cover. In the UK, the government has paid heavily to support the private sector (issuing £74bn in business loans as of March 2021), which highlighted the lack of insurance cover among businesses.
As such, more is needed on this front, as O’Connell explains: “Business interruption can be a considerable macroeconomic risk. If all who needed it had bought it, there wouldn’t have been sufficient capacity. Another solution is necessary as, while Covid-19 may be on the wane, other pandemics are likely to follow.”
To strengthen the design and issuance of this coverage, better access to insureds’ data could be a possible route for insurers. Vater expects larger carriers to still play a role, but that they will embrace insurtech in new ways and to avoid the mistakes of 2020.
“I am sure we will see MGAs and insurtechs having a look and introducing new ideas – parametrics, for example – but I think these types of policies will be driven by the larger players,” he says.
“We may see businesses thinking about self-insurance in some of these areas and that may extend to the SME’s who may adopt relationships with other SMEs to have a fund for this coverage. It is still early days.”
Berkeley agrees that technology could play a better role in supporting business interruption policies that work, but stresses solutions will need to go further. In 2020, business owners were forced to confront their worst (and unexpected fears) in the form of a true black swan and this new attitude towards risk needs to be considered.
“Technology can be helpful where it can better align capital with the actual risk,” says Berkeley. “[But] tech cannot replace the human mind in the risk-taking decision for these classes of extreme events.”
Essentially, there are far too many socio-economic variables and too much complexity to be reasonably assessed.
“Under extreme value theory, a precautionary position [for insurers] is the only sensible stance,” says Berkeley.
“If you cannot get comfortable, do not write it. The insurance industry unlike finance, has learned there are risks that must be hedged, and those that are uninsurable must be cut off.”