About once a generation, the U.S. insurance market encounters a crisis that demands a federal response. In the 1960s, it was severe uninsured flooding. In more recent memory, it was the catastrophic terrorism of September 11th. Yet another protection gap has been revealed in recent weeks, as the COVID-19 pandemic shutters thousands of businesses across the country.
Business owners have responded to the unexpected — and, in many cases, mandated —interruption in business by filing claims on their business insurance policies. However, most of these have been denied, as existing policies simply don’t include coverage for cases like this.
Certainly, some of those denied claims will be disputed. In fact, a spate of lawsuits has already been filed. Ultimately, it will be up to the courts to scrutinize the nuances of contractual exclusions for pandemics and determine whether a virus can count as a “physical loss.” Even if some of these suits prove successful, insurers will simply redraft their policies to make the exclusion more explicit in the future.
This may be the reality, but it cannot be the end of the story. If private insurers won’t provide businesses with this sort of protection in future pandemics, then the federal government must.
It may be tempting to fault insurance companies for refusing to include this coverage, but the reasons are straightforward. For a risk to be insurable, it must be possible to manage it through careful underwriting and diversification. Global pandemics make that exceedingly difficult, if not impossible. Business interruption claims from a virus like COVID-19 hit every sector and every region simultaneously, meaning all the insurance contracts all around the world have claims at the same time. Worse still, pandemics degrade the invested assets insurers use to back up their promises. In a scenario where half the global economy shuts down overnight, there is no way the insurance industry can singlehandedly carry the other half on its back.
Even if private insurance could provide this coverage, it is not clear its incentives would align with the public good. Government-provided insurance schemes often pose moral hazard concerns, subsidizing coverage in ways that allow private actors to avoid having to account for the full cost of risk. The National Flood Insurance Program, for example, guarantees cheap, subsidized coverage to all participating communities, which has the effect of encouraging development in regions that see flooding year after year.
In contrast, there is likely nothing at all a business owner could do to avoid a pandemic. What they could do — what risk-based private insurance might encourage — is to avoid making a claim by refusing to shut their doors and by pressuring local leaders not to issue mandatory shutdown orders. That is the opposite of what we want to happen.
Private insurance markets also are often bedeviled by the problem of “adverse selection,” in which those most likely to make claims are also most likely to buy coverage. Here, that concern is flipped on its head. To the extent that restaurants and movie theatres — the sorts of businesses most likely to be vectors of viral transmission — would have a safety net that allowed them to close their doors, it would alleviate the pain that comes from mandatory shutdowns. The dynamics make for an unsustainable private insurance product, but wise public health strategy.
The only entity with the financial resilience, the balance sheet and the risk tolerance to offer such a product is the federal government itself. Rather than the complicated and bureaucratic ad hoc programs set up in recent stimulus bills to aid the business community, we should prepare for the next pandemic by allowing the government to offer a transparent, straightforward and affordable insurance policy for pandemic business interruption.
There would be a number of details to consider. Instead of pricing coverage based on how likely a business is to make a claim, premiums should be set as a small proportion of whatever revenue the business would need to replace. Because an insurance contract is an arm’s-length transaction, churches and other religiously affiliated institutions could take part without triggering First Amendment concerns.
Businesses might seek to game the system by only buying coverage when they see an emerging epidemic. But, to counter that, available benefits could be increased gradually the longer a business continues to participate. Rather than drawn-out procedures of claims adjusters trying to assess how a pandemic affects a particular business, payouts could be triggered immediately by declaration of a public health emergency, thereby functioning as compensation for what is, in effect, a regulatory taking.
Getting these details right, however, means this is not legislation to rush through in the middle of an emergency. It will require hearings and public input and thoughtful deliberation, all things that are difficult in the current crisis. But it is a proposal that Congress should consider as preparation begins for the next one.
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