The $2 trillion stimulus package — amounting to roughly 10 percent of GDP — represents a prodigious attempt at addressing a severe economic downturn and assisting struggling Americans amid the COVID-19 pandemic. Now, lawmakers are considering a follow-on stimulus, which reportedly would include infrastructure spending on top of more payments to individuals, expanded unemployment benefits and much-needed support for small businesses.
But another stimulus won’t work as intended — unless Congress and the White House include in the package a modification to a 2002 law that provides a government reinsurance backstop.
To understand why, it’s necessary to first examine the central role that business interruption insurance plays in the U.S. economy. These policies protect against events, such as property damage, fire, floods and similar catastrophes that interrupt businesses’ ability to stay open and make money. The system is straightforward: after an occurrence, the insurance company indemnifies a business for lost profit — meaning the business receives a payment from the insurance company after filing a claim. With these guarantees in place, banks are willing to lend, entrepreneurs are willing to start or expand their enterprises and the virtuous cycle of the American economy takes hold.
There is one catch. Over the years, most business owners chose to buy insurance policies that explicitly excluded viruses and communicable diseases, as well as other catastrophic events. It’s hard to blame them: shelling out a high premium, every month, for what seemed like a low probability occurrence wasn’t worth it.
Now, as coronavirus spreads rapidly, some politicians are trying to retroactively insert pandemic risk into business interruption contracts — even when the contracts explicitly exclude these risks. It makes for a good soundbite to pin the business interruption costs associated with COVID-19 onto insurance companies, but it defies the fundamental tenet of contract law. More importantly, it gets the math wrong: the total surplus for auto, home and business insurers in the U.S. is about $800 billion, while COVID-19 losses could be in the many trillions. (In fact, by some estimates, losses just for companies with fewer than 100 employees will be around $380 billion per month.)
Simply put, such drastic action against insurers would effectively shut down the American insurance industry overnight, and by extension, the U.S. economy. It would prevent families from buying cars, taking out mortgages to purchase homes and even protecting their pets. Credit markets would freeze. And individuals and companies would be on their own to confront the worst effects of climate change, from hurricanes to wildfires to other extreme weather events.
The good news: we’ve seen this movie before, and we know what to do.
After the tragic events on 9/11, when nearly 3,000 people lost their lives, the economy was badly damaged. On top of a recession and widespread fear, there was $40 billion in insured losses. To keep operations going, companies needed not only for demand to pick back up, they needed insurance for future terrorist attacks. But reinsurers, who bore most of the responsibility for financial losses in the wake of the attacks, did not have the capital to assume the entire financial exposure.
Washington stepped in and provided a federal backstop. In 2002, through the Terrorism Risk Insurance Act, the federal government provided reinsurance in the event of another terrorist attack. This made it economical for primary insurers to offer terrorism insurance, and for businesses to pay for it. And it kept other insurance policies — for automobiles, houses, floods — affordable for families and businesses.
President Trump, and Democrats and Republicans in Congress, need to build on TRIA and broaden federal reinsurance to encompass not only terrorism, but viral pandemics, new types of cyber-attacks and other rare but catastrophic events. This model of shared public and private compensation for certain losses is transparent: using what the industry calls parametric triggers, there would be a clear-cut way of determining how much a business recoups for a given amount of financial damage. And this wouldn’t be a handout, since companies would still need to contribute. In fact, the cost to taxpayers could be zero (TRIA, to date, has never paid a claim).
In the context of a warming planet, an increasingly globalized world and the ubiquity of the internet of things, we need to be prepared. Right now, governments are making the right decision to close non-essential businesses, which is why government needs to be part of the solution. Providing the guarantee of federal reinsurance for exogenous occurrences would inject confidence into the economy today, and create an effective framework for when we emerge from this crisis.
It would also give the next stimulus package a fighting chance at success.
Mark E. Watson III is the founder and principal of Aquila Capital Partners, an investment firm. From 2000-2019, he was CEO of Argo Group, an international underwriter of specialty insurance.
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