Jay Kesan | Publications

Jay Kesan .P and Linfeng Zhang

In response to the COVID-19 outbreak, many states have issued stay-at-home orders to limit the activities of businesses, especially the ones defined as non-essential.  On top of that, many residents have voluntarily reduced their outdoor activities to avoid the risk of getting infected.  Because of those measures, many business owners are seeing a sharp decrease in the number of customers, and the continuity of their operations is at risk.

In these circumstances, many businesses will turn to their commercial insurance providers and seek compensation based on their business interruption (BI) policy coverage for their loss of income.  Disappointingly, many commercial policies contain provisions similar to the following statement — “We will not pay for loss or damage caused by or resulting from any virus, bacterium or other microorganism that induces or is capable of inducing physical distress, illness or disease.”

This virus exclusion was developed by the Insurance Services Office (ISO) in 2006 after the outbreak of SARS, and it grants insurers the ability to deny claims related to pandemics like COVID-19.

Nevertheless, many policymakers believe that insurers should play a more significant role in helping the economy as this shutdown continues.  Thus far, states including Ohio, Massachusetts, New Jersey and New York have introduced bills to require insurers to cover BI claims due to COVID-19.  Such an intervention is unprecedented and remains debatable.  For example, the New York State bill states:

“Notwithstanding any provisions of law, rule or regulation to the contrary, every policy of insurance insuring against loss or damage to property, which includes the loss of use and occupancy and business interruption, shall be construed to include among the covered perils under that policy, coverage for business interruption during a period of a declared state of emergency due to the coronavirus disease 2019 (COVID-19) pandemic.”

The obvious benefit of asking insurers to help is that businesses in need can receive the monetary relief quickly from a channel that is conventional and familiar to them, so they need not worry about looking and applying for governmental assistance.  Some commentators also urge that a mandate will resolve the disputes between insurers and policyholders regarding whether a claim is pandemic-related and whether it should be reimbursed.

However, this mandatory approach also raises some major concerns about the short-term and long-term impacts on the insurance industry.  The most immediate concern is, can the industry afford to pay these BI claims without hurting their own solvency?  On March 26th, the American Property Casualty Insurance Association (APCIA) estimated that the monthly business interruption costs for small businesses with fewer than 100 employees could be between $220-383 billion.  In April, that estimate was further increased to $431 billion.  As a point of reference, the surplus (owners’ equity) of the entire property and casualty (P&C) industry was $780 billion by the end of 2018, and the net loss, including BI costs and many other types of losses, was $366 billion in the same year.

Thus, a total BI loss of $431 billion is enormous and unprecedented.  Although insurers are protected by coverage limits, their capacity can be depleted in no time.  Some insurers may be in distress if many of their policyholders file claims simultaneously, since it is very likely that their pool of policyholders is not well-diversified for pandemics.  Existing commercial policies are not designed to deal with pandemic-related losses, which are highly correlated.  Foreseeably, the insurance industry will experience a very challenging market if those pandemic-related BI claims are paid.  Not only is the insurance industry affected, but also because insurers will have to reduce capacity and raise premium rates, the entire economy will experience some long-term impact.

A federal insurance backstop is proposed as a solution to this problem, which is analogous to the Terrorism Risk Insurance Act (TRIA) after 9/11.  Certainly, this is a significant risk sharing mechanism between the federal government and the insurance industry, and it can lift some burden off insurers, but the issue that business owners exhaust their BI coverage still remains, which leaves them unprotected for the remainder of the policy period.  If many states try to make insurers cover pandemic-related claims, the federal backstop should be in place to at least provide some stability and sustainability to the market.

A more far-reaching problem associated with this mandatory coverage is the damage that it does to the contract law.  It may be a bad precedent for state legislatures to nullify a provision agreed by both the insurer and the policyholder at the time of signing the insurance contract.  Insurance trade groups who oppose the bill have stated that mandating coverage “…would amount to an unconstitutional abrogation of insurance contracts and end the very existence of the business interruption insurance market as we know it.”

Of course, these mandatory orders are created in good faith to help policyholders who often lack the bargaining power when negotiating policy terms with their insurers.  It is also problematic when insurers try to broaden the interpretation of the virus exclusion to deny claims, even though this provision is inapplicable in some specific situations.  Therefore, a more constructive action guide would be something like the notice issued by California Insurance Commissioner Ricardo Lara, which states:  “[A]ll agents, brokers, insurance companies, and other licensees (should) accept, forward, acknowledge, and fairly investigate all business interruption insurance claims submitted by businesses.”

To make sure that insurers comply, there should be a collaborative effort between the public sector and the insurance industry on the investigation of claims.  For example, if a claim is jointly determined by the insurer and a public oversight agency to be pandemic-related, the insurer can rightfully deny the claim if there is a virus exclusion and let the public sector provide the necessary assistance.  This might be a better solution than mandating coverage and creating a backstop.

In addition, the insurance industry can also offer monetary relief to businesses by refunding premiums.  Many auto insurers have been doing just this since people are driving less, thus presenting a lower risk.  Similar programs can be adopted by commercial insurers as well.  For example, brick-and-mortar businesses like restaurants and malls currently have fewer customers physically on site, thereby having a reduced risk of premises liability.  Insurers can refund a part of the collected premiums in accordance with the smaller exposure.

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