What AM Best Says
An ‘Existential Threat’
AM Best: Forcing insurers to cover business interruption claims retroactively would have grave implications for the industry.
- John Weber
- June 2020
Insurers could see widespread insolvencies if forced to cover COVID-19 business interruption claims, according to a Best's Commentary, Legislation to Nullify BI Exclusions Poses Existential Threat to P/C Insurers. Stefan Holzberger, chief rating officer, AM Best, discussed the report with AMBestTV.
Following is an edited transcript of the interview.
What's the central issue regarding BI coverage and COVID-19?
The economic reality is that the COVID-19 pandemic has had disastrous effects for U.S. businesses. We read about it in the news every day. Small, medium-size, Main Street businesses are forced to close their doors, lay off employees, and, in many cases, are struggling to avoid bankruptcy.
These events have created a huge amount of political pressure to figure out a relief valve to support these businesses, even beyond the loan programs already sponsored by the federal government. It's these political pressures that have brought business interruption coverage to the forefront.
Business interruption coverage is typically triggered by events that cause direct physical loss to a covered property. Those events could be, for example, a fire, vandalism, burst pipes, or natural catastrophe events such as tornados or windstorms.
The bills currently under consideration at the state and the federal level attempt to retroactively put business interruption coverage in place for loss of use and occupancy to premises resulting from COVID-19. For the vast majority of insurance policies in the United States, this legislation would sanction an interpretation contrary to the insurance policy's original intent.
The reason for this is clear, because most business interruption policies specifically exclude losses caused by a virus, a bacterium, or other microorganism.
At AM Best our role is to evaluate the financial strength of insurance companies. Business insurance is a central aspect of our analysis. In the event that policy exclusions relating to COVID-19 are nullified, we would expect to see a large number of insurer insolvencies.
If retroactive coverage came into effect, what could this mean for commercial lines insurers?
AM Best estimates the loss of revenue to businesses with fewer than 100 employees to be roughly $294 billion per month. The potential impact on insurers of forcing them to apply business interruption coverage to this lost revenue would be between $150 billion and $200 billion per month.
We estimate the capital and surplus of the commercial lines industry in the U.S. to be roughly $633 billion. That's a broad estimate encompassing the capital and surplus of dedicated commercial insurers in the U.S. We've also included the capital of predominantly personal lines insurance companies, insurance groups that also underwrite some commercial business.
We wanted to arrive at the greatest figure we could in terms of what's backing commercial insurance business in the United States.
If you take that $633 billion and you add two months of losses, or look at that $633 billion in relation to two months of losses, even at the low end of $150 billion per month, you can see that half, roughly, of the capital and surplus of commercial lines insurers in the United States would be eroded in merely two months.
Based on what we're seeing in the market today, we know that it will take much more than two months for businesses to restore to that pre-COVID-19 level of business volume.
Would any particular group of insurers be more at risk here?
At AM Best our role is to evaluate the financial strength of insurance companies. Business insurance is a central aspect of our analysis.
In the event that policy exclusions relating to COVID-19 are nullified, we would expect to see a large number of insurer insolvencies. To your question, the companies that would be most at risk would be the small- to medium-size insurers who specialize in business insurance.
The national and international commercial insurers would certainly experience a material reduction to their capital, but most would survive. In contrast, the hundreds of regional commercial insurers who are writing insurance business for Main Street commercial businesses, those are the companies that would be most at risk of an insolvency.
The companies simply do not have the capital resources to cover a loss of this magnitude. It's for this specific reason that these small- to medium-size insurers, and really, for that matter, practically all insurers in the United States have used the ISO exclusion and excluded pandemic risk from their insurance policies.
Beyond the initial financial implications for insurers, what would the long-term implications be of this action?
For one, we would see a shortfall in the availability of insurance in the United States. You'd have companies that would be financially impaired and unable to continue to write commercial insurance business.
You'd have, probably, quite a few other insurance companies who, based on current market conditions and the uncertainties around the insurance contract, would choose to cease writing commercial insurance for the time being.
What that means is that individuals, businesses, state and local governments could find a capacity shortfall, could find it very difficult to obtain the insurance that they needed. For those businesses or individuals that did obtain the insurance, they would certainly be purchasing that insurance at higher rates.
Another important aspect is the financial markets. The financial markets that are already on unstable ground would be further in disarray because if you envision the commercial insurance market having to liquidate hundreds of billions of dollars of assets in order to pay claims, which would mean a huge influx of sell orders into the investment markets, which would further erode investor confidence, as well as asset valuations.
Also, the sanctity of the insurance contract would be put into question. How could an underwriter underwrite and price an insurance policy if the coverage terms could be changed after the fact?
One last point, getting back to the whole premise of introducing business interruption coverage and factoring in business interruption coverage as a relief valve for the difficulties experienced by U.S. businesses, the whole premise is the idea of, how best do we restore the economy under these unprecedented times?
How do we get confidence in the economy and businesses back up and running? It would seem to me that would be very difficult to reach a stable economic position with consumer confidence and growth without a healthy insurance market there to protect the assets of individuals and businesses.