Business interruption insurance and pandemics

Not surprisingly, many business owners are upset to discover that their business interruption policies do not cover losses due to pandemics.  Although it is easy enough to understand their frustration, it is important to understand the underlying economics.  (Full disclosure, I worked in the property casualty industry for many years.)

The main business of insurance companies is risk pooling.  They take premiums from (say) large numbers of drivers, and then use those premiums to pay claims for the small number of drivers who have accidents each year.  What is essential to the viability of this business model is that risks are uncorrelated or independent:  the chance that you have an auto accident must be largely independent of the risk that your neighbors do.  If everyone has an accident at the same time, the premiums everyone pays will not come close to covering the accident losses.  To some extent, of course, losses are correlated, and this can result in losses to insurance companies and their investors.  For example, when it snows accidents go up and losses rise.  Insurance company investors can bear these risks.  Some losses that are correlated locally can be spread globally.  This is what happens with the losses caused by hurricanes and earthquakes – they are pooled across the globe by reinsurance companies.  But if losses are too widespread, large, and highly correlated they cannot be insured using the standard logic of insurance.  My guess is that pandemic losses from business interruption fall into this category.

I haven’t seen an analysis, but I suspect that an effort to force companies to pay business interruption claims would impair or bankrupt many insurers and reinsurers.

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