We’re almost two months into the pandemic crisis and I thought it would make sense to do another video on the insurance implications many business owners are asking about. Specifically, is business interruption covered, and if it’s not, why isn’t it. My objective is straight talk about what I see as realistic and not promote a sense of false hope. I have extreme empathy for all business owners going through this crisis, so here are my insights.
First, it’s important to state that all business insurance policies are different. What I’ll speak about here are broad brush strokes and what is considered the norm – but it’s important to read your policies – if you need help, ask your broker for help, or of course, you can contact me!
Let’s go back to the basics of how business income or interruption insurance works.
There are three basic issues that most policies say must occur for a business interruption claim to be covered:
- There must be direct physical damage to your premises described in the policy.
- The physical damage must be caused by a covered peril.
- The damage must cause you to fully or partially shut down, and you suffer a loss of income.
Another coverage part in most policies is something called civil authority. Under this coverage part, your insurance will cover your business if it is shut down by a civil authority (such as the mayor of your city) and ingress/egress is prevented because:
- Another business within a certain distanced area (typically 1 mile) has suffered a physical damage to their premises, caused by a covered peril;
- And to safeguard the public it’s necessary to prevent public ingress and egress from that area.
- Coverage typically lasts for 2 weeks, depending on the policy form.
On top of the physical damage requirement, many property policies also contain exclusions for viruses and bacterium.
So, the first question I’m asked often is, Why are viruses excluded from property insurance?
The answer is that the insurance industry has been watching the potential impacts of pandemics for decades and they chose to specifically exclude it from many policy forms for a very clear reason. Insurers have finite balance sheets, so they must cover risks which have boundaries in both geography and time.
Let’s take an example, if a hurricane hits the New Jersey coast, the event may be catastrophic. It could destroy property, take lives, and disrupt the region. But it wouldn’t be catastrophic to most insurers because they have built that risk into their balance sheets and charged appropriately for that potential impact. Also, that hurricane is bound to a certain geographic region and its impact is time limited.
A pandemic is very different, as we’re seeing. It hits not just a community, state, region, or country. It has the potential to impact entire countries and in this case, the entire world. The potential risk is so large that insurers can not charge an appropriate premium for it, and if they did, most businesses couldn’t afford to purchase the coverage. As I mentioned earlier, insurers have finite balance sheets, and pandemic risk has a rather infinite reach in both geography and time. Who knows when this will be over?
The only entity in the United States with an unlimited balance sheet is the federal government, and we’ll talk about that in a minute.
Now to wrap some perspective around this, let me introduce the second most common question I get:
Is it true that the states and maybe the federal government will force insurers to pay my business interruption claims?
Yes, it is true that legislation has been introduced in several states that would require insurers to pay business interruption claims. What I find interesting is that most of the legislative bills are very similar in their wording to each other, so it seems to me to be a politically motivated pile on, rather than a well-reasoned response to the disaster.
Remember I mentioned above the finite balance sheets? Here are the numbers:
An insurance trade group has estimated that the monthly business interruption claims potential just from small businesses could be as high as $431 billion. To wrap some context around that number, it’s important to understand that the total surplus of all U.S. insurers is just around $800 billion.
Policyholder surplus is the fund from which insurers pay their claims.
So, that means paying just 2 months of business interruption claims just for small businesses would bankrupt the insurance industry. It also means that all the other claims that are covered would go unpaid.
Your house burns down? Sorry, can’t pay that claim. Get injured in an auto accident, sorry can’t pay that claim either. Your factory burns to the ground, workers get injured, you’re sued for a product liability claim, or an employment liability claim, or cyber hack, yep, those claims aren’t going to be paid either.
This is a problem that a lot of lawmakers aren’t thinking about.
I’ll leave the legality of forcing insurers to amend their contracts to provide coverage to the lawyers, but most experts are saying that the move is plainly unconstitutional.
The third question I often get is:
There’s a lot of news about restaurateurs and other businesses suing their insurers for business interruption coverage. Is this something I should consider?
There is a lot of litigation and tons more to come over this. I’m not going to comment on whether these suits will go anywhere or not, but only say that in most instances it’s likely going to cost a fair sum of money to litigate these cases, so you’ll need to carefully evaluate whether this is a path you want to take. My read on the issue is that most insurers who have firm footing and are confident in the policy forms and exclusions will not back down so litigation will take time. That means money, probably lots of money, with an unknown result at the end of the journey. My advice is that you read your policy – again – and speak with a knowledgeable practitioner in this area. Don’t just jump on the bandwagon.
So what’s the solution retrospectively and moving forward?
Looking backward, my opinion is that the only response can be a government response. I hate to even say that because I understand the long-term implications of that and its impact on the deficit and the overall health of this country’s economy.
The Payroll Protection Program, of course, is a step in the right direction, but so far that’s been a big disappointment for a lot of business owners so it’s difficult to imagine how the government can sustain any sustained assistance program.
Moving forward though, I think this is a risk we’ve got to deal with. Covid and its potential variations could be dogging us for quite a while into the future.
So how do we insure against this risk?
Because the potential for loss is so catastrophic, I think, and many in the insurance community do as well that we need to establish a federal backstop to pandemic risk like we did for terrorism risk following 9/11.
The Terrorism Risk Insurance Act or TRIA is a good model to follow and some have dubbed a new model as PRIA or Pandemic Risk Insurance Act. Pricing for coverage would be a bit tricky, but I think we’ll see it added as an option to most business policies. To make it work, it will need to be relatively affordable for businesses to actually purchase it so pricing may be subsidized a bit to get it going. If losses occur in the future, insurers will be responsible for some amount and then federal reinsurance will step in to cover the rest of the risk similar to TRIA. Businessowners would have some skin in the game in the form of deductibles and coverage caps.
Could the global insurance market absorb some or all of the risk and not need federal backstopping? I don’t think so. The volume of premium required to fund this form of risk is too huge and I just don’t think available from policyholders to raise the sort of capital we would need.
The bottom line is that I think it’s important to set realistic expectations for everyone. These are claims that are not going to be settled easily, if at all. But we will stay on top of progress in this area and communicate them if and when we see a shift in the landscape.
Until then, if we can provide answers, help you better understand your coverage, and assist with reading your policy forms, please don’t hesitate to reach out and contact me. Stay healthy and try and stay positive, like you, I’m hoping we’re through the worst of this and starting to see a return to some normalcy soon.
