Geneva Association highlights massive protection gaps for business continuity risk

The shutdown measures adopted by many governments to contain COVID-19 have exposed massive protection gaps in the area of business continuity risk, according to the Geneva Association (GA).

According to a new report released by the body, Public-Private Solutions to Pandemic Risk Opportunities, challenges and trade-offs , less than 1% of the estimated $4.5 trillion global pandemic-induced GDP loss for 2020 is likely to be covered, reflecting pre-COVID-19 coverage exclusions and restrictions as well as the niche character of business interruption (BI) insurance which accounts for less than 2% of the world’s property & casualty (P&C) insurance market.1

It adds that commercial insurers have always sought to push the boundaries of insurability by developing innovative and viable approaches to new and emerging risks of major severity such as natural disasters or changes to liability regimes; for example, through Alternative Risk Transfer (ART) solutions.

These efforts notwithstanding, the GA says, pandemic business continuity risk was, in general, never possible nor intended to be covered by the private sector:

“To some extent, this reflects demand side reasons such as an endemic underestimation of the frequency and severity of pandemics. However, the shortage of supply primarily results from the high level of embedded risk and, therefore, prohibitively high amounts of capital needed to underpin credible insurance commitments, attributable to the unique correlation in the frequency and severity of pandemic business interruption losses.”

“Coverage for pandemic business continuity risks with meaningful limits, therefore, will remain unavailable from the private insurance market as a result of prohibitively high capital requirements.”

The report notes that, in order to harness insurance as a proven pre-event mechanism for managing and mitigating catastrophic risks, governments need to involve themselves as ‘insurers of last resort’. Also, it suggests, their power to borrow funds and levy taxes is a prerequisite for economically viable risk pooling over time:

“In light of gargantuan loss exposures, government backstops are indispensable to nurturing even small-scale, private-sector coverages which may develop over time, as happened with terrorism risk following 9/11. The case for government involvement is further corroborated by increased urbanisation and global interconnectedness, which will make pandemic risk more acute going forward.”

However, it notes that any form of government involvement in pandemic risk management comes with major trade-offs. For example, the GA suggests, mandatory social insurance schemes may have a significantly positive impact on the overall economy, in addition to being very cost-efficient. However, social insurance largely fails in the crucially important contexts of incentivising risk mitigation and matching the funds distributed with actual losses incurred by businesses.

Government reinsurance backstops of private-sector solutions are another example of difficult trade-offs, it adds: “They score well in terms of incentivising risk mitigation and indemnifying losses that were actually incurred. However, such schemes are not expected to be effective in maximising coverage and macroeconomic benefits.”