Chubb’s Pandemic Insurance Proposal — Key Risks
Chubb released its Pandemic Business Interruption Program proposal on July 8. This article highlights several key risks introduced by the concept.
A brief overview of the proposal is available as a video and PowerPoint.
Risk #1: Regulatory Mismatch
The proposal contemplates a “parametric” product for small businesses and a “business expense reimbursement” product for medium and large businesses. A government issued pandemic lockdown order would trigger payouts under either of these business interruption coverages.
Business interruption insurance is almost always sold as part of a commercial property insurance policy. Under state insurance law, “property insurance” is typically defined as “insurance on real or personal property … against loss or damage … and against loss that is consequential to that loss or damage.” In short, a product that pays out without the need for property damage is rather unlikely to be “property insurance.” For just this reason, there are dozens of lawsuits pending throughout the country right now where businesses claim COVID-19 causes property damage and insurers contend that it does not.
If the proposed products are not “insurance,” selling them would seem to fall outside of an insurance company’s statutory authorization and an agent or broker’s license issued by the respective state departments of insurance. Moreover, state insurance commissioners would have no authority to oversee the underwriting, marketing, and sale of these products or the insurance company’s capital and risk management backing up this exposure.
There is a serious risk the existing state-based insurance regulatory framework could not reach pandemic parametric or expense reimbursement products. To fill this gap, insurers, brokers, and agents may find themselves forced to submit to additional (likely federal) licensing and regulatory requirements that potentially conflict with state insurance regulations.
Risk #2: Basis Risk for Small Businesses
Insurance products are meant to indemnify the insured. That is a fancy way of saying insurance only pays out to make good an actual loss.
With the sensible objective of speeding along the claim administration process, the Chubb proposal contemplates a parametric product for small businesses. A parametric product pays out only upon the happening of an event or satisfaction of a set of parameters without regard to any loss or damage the holder of the product may have incurred.
Under this proposal, a small businesses would receive an amount equal to 3 months of payroll (as established at the time the contract was purchased) if a governmental authority issues a pandemic lockdown order — no matter the business’s actual loss or financial need. Successful and expanding businesses are more likely to experience a shortfall. Failing and contracting businesses are more likely to over-recover. Some businesses, such as specialty cleaners or home delivery services, may see revenue increase during the lockdown but would still get paid the same as if they were completely shut down.
The mismatch between payout and actual loss is known as “basis risk.” The program would shift basis risk to small businesses. However, insurance companies and the federal government would take care of the basis risk in products sold to medium and large businesses. We would typically expect the opposite whereby the sale of derivatives and other products with basis risk is accompanied by a heightened degree of consumer protection for less sophisticated buyers.
While a parametric approach can simplify and speed payouts, there is a serious risk some small businesses would buy a sophisticated financial product that does not meet their needs while other small businesses may find the product delivers a windfall.
Risk #3: Overwhelming Exposure for Regional Insurers
Under the Chubb proposal, small business insurers must participate in the small business program. In total, these insurers would face an exposure of $15 billion in the first year and then expanding to $30 billion over the life of the program.
The small business insurance market is made up of some household names like Nationwide, State Farm and Travelers — but also well over a hundred regional and niche players. According to the NAIC, the top 25 writers of Commercial Multiple Peril (package) policies command 70% of the market. The next 100 make up 26%.
Size (really, diversification of risk) matters. Under this proposal, Iowa Farm Bureau (#81) would be required to manage a $25.5 million annual exposure. That amount is 5 times its own payroll. The Alabama Municipal Insurance Corporation (#109) would manage a $15 million annual exposure — about what it has paid out in cumulative dividends to its members over the last 22 years.
In contrast, Chubb would be on the hook for $765 million based on its CMP market share. While an enormous number, it represents only 26% of the amount Chubb paid to its shareholders through dividends and share buybacks — last year — and just 5 times the amount of compensation approved for its top 4 employees since 2017.
Large diversified insurance groups — like Chubb — operate at a scale and with a degree of financial and risk management sophistication giving them options to handle their allocated burdens under the proposed program. In stark contrast, regional and specialty insurers risk being undone by their mandatory exposures and forced to abandon the small business market.
Chubb’s proposal is a thought-provoking contribution to the broader discussion of the role of insurance in future pandemics. As these three key risks highlight, there is a long road ahead to ensure any pandemic risk insurance program works for all stakeholders.
