The United States has witnessed unprecedented economic disruption due to COVID-19. State and local governments closed thousands of “nonessential” businesses. Now, businesses have filed over 1,000 lawsuits against their insurance companies to collect for COVID losses. What should we make of this litigation?
The businesses suing insurers include the NBA’s Houston Rockets, Minor League Baseball, clothes maker Ralph Lauren, the Century 21 retail companies and celebrity chef Wolfgang Puck. The suits seek coverage of lost revenue while closed from business interruption loss policies.
Business interruption coverage is generally a wise investment. Property insurance will cover tornado damage to the building and contents. Yet while closed, the business still must pay its loans. Interruption coverage is an important element of continuity planning.
Insurance contracts cover many potential losses. Economists understand that contracts are often incomplete, meaning they will not cover every possible contingency. A failure to envision a circumstance is one reason contracts are incomplete. And sometimes the parties will decide that writing a provision for a very unlikely event is too costly.
A market economy needs a court system to resolve such contract disputes. Once a loss happens, insurance disputes are particularly likely. The policyholder will naturally read the contract as providing coverage while the insurance company will want to deny coverage.
Two factors suggest that insurance companies did not intend interruption policies to cover pandemic losses. First, insurers could never afford to cover every business loss. Interruption loss coverage usually requires physical damage, as this distinguishes tornadoes or fires from poor planning by the business. Second, after the SARS outbreak, the Insurance Services Office crafted a “virus and bacteria” exclusion for business interruption loss policies. Not all insurers adopted this language, but it suggests intent to not cover pandemic losses.
Numerous suits against insurers have already been dismissed, although courts in Missouri and New Jersey have allowed cases to go forward. Several state legislatures considered measures this year forcing insurers to cover COVID losses, suggesting that the exclusion was recognized. We can empathize with business owners who thought they were covered, but the exclusion seems valid.
Perhaps you might think that insurance companies should be less greedy and cover COVID-19 losses. Payment could help businesses suffering through no fault of their own stay open.
Such generosity would itself cause significant financial harm. The potential losses to insurers have been described as comparable to a Hurricane Katrina each month. Forcing insurance companies into bankruptcy to cover businesses’ losses might deepen the recession. Beyond this, a responsible insurance company must ensure it can pay customers’ potential claims.
The exclusion of certain categories of losses is common in insurance. Small risks are typically covered under “all hazards” coverage, but when a loss category becomes too large, insurers frequently exclude it from basic coverage. Policyholders can still get coverage by paying an extra premium.
Some industry experts have speculated that insurers may not wish to cover “virus and bacteria” interruption losses at all. This seems prudent. Insurance companies are businesses, not charities, and are ultimately in the trust business. We pay premiums every month and trust the company will have the resources to pay our claims. A company betrays this trust by writing additional coverage without charging adequate premiums.
Actuaries attempt to determine an adequate premium. Determining the adequate rate for pandemic losses seems particularly daunting given the governmental response to COVID-19. Insurers must answer: What is the probability of another pandemic like COVID-19? And will governments respond similarly to the next pandemic? This is as much an exercise in political prognostication as number crunching.
Several experts argue that the Federal government will have to offer pandemic insurance. This is a topic for another day. Given the poor job Washington has done with the National Flood Insurance Program, I am not enthusiastic about Federal intervention. But forcing insurance companies to risk bankruptcy by writing coverage on charity terms might be worse.
Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. The opinions expressed in this column are the author’s and do not necessarily reflect the views of Troy University.
