Insurance, business interruption & distributed force

Mar 17, 2020
Insurance, business interruption & distributed force

Economists were pointing at another economic crisis by the end of 2020 for a while now, especially since CAT losses put a toll on property & casualty (P&C) insurance markets. Although in Q1 of 2020 businesses had a lot of cash available on their balance sheets, executives were still hesitant to engage in M&A transactions, which is usually a marker for the healthy economy (one of many). I remember reading a report by World Economic Forum in Q4 of 2019 that predicted an increase of environmental threats to global economies. It was the first report that brought up a spread of infectious diseases as a high impact threat. 2 months later, Wuhan was hit by a highly infectious virus.

Neither our healthcare system, nor businesses were prepared for a hit by an unexpected enemy. P&C markets are not only recovering funds spent on CAT losses, but they are being hit by a pandemic as well. And although many insurance professionals might argue that pandemics/epidemics are usually excluded by most policies, I do wonder about it.

How the insurance industry affects the global economy

Commercial P&C market offers business interruption insurance that usually covers losses associated with “direct physical loss of or damage to” company’s assets. Pandemic doesn’t really fall under that definition. Another option might be to look at your contingent business interruption coverage (if you have it). Although it is triggered by disruptions to the business’s customers or suppliers, it might cover some estimated losses if the company’s suppliers could not deliver their items and/or customer demand went down due to unforeseen circumstances. However, there are a lot of limitations that can prevent this coverage from triggering. There is a great article published by the Insurance Journal that talks about Ins and Outs of Contingent Business Interruption if one is interested.

My point is that regardless of coverages you have, the insurance market will be hit and not necessarily by indemnity payments, but more so by legal expenses associated with claims/law suites either against the company’s suppliers or against insurance companies themselves. As an example of the latter, there was a case of a French restaurant suing their insurance company for not covering losses associated with coronavirus:

“Because the coronavirus contaminates surfaces, it’s property damage,” Houghtaling said.

I am afraid that this epidemic will speed up the hardening of the insurance market and P&C premiums will go up in an attempt to recover losses paid by insurance companies. Back in the 80x when P&C premiums went up, it gave birth to the Captive insurance market. Captive insurance aims to insure the risks of its owners, and its insureds benefit from underwriting profit:

Many captives are established because insurance in the commercial market is prohibitively expensive, poorly matched to the insured’s needs, or not available at all.

It is clear now, that the global economy needs to brace for impact. There is a high probability that companies will dive into negative or neutral cash flows. Balance sheets are not going to look that balanced anymore, as liability payments will override income from the company’s assets. On top of it, traditional corporate entities will be tested and challenged, as most of corporate America does not encourage remote employment. It will be a true testimony to human resilience if employees of those companies maintain their productivity levels. On top of these psychological challenges, there are technical aspects, like the availability of 24/7 technical equipment and support for those working from home. Most enterprises can provide technical equipment but can they guarantee the availability of technical personnel to continue their tasks, achieve product development milestones, manage onshore and offshore rotating teams, or ensure uninterrupted supply of goods that their businesses depend on?

I am seeing that more and more companies are diversifying their partnerships to avoid a complete lockdown due to a disaster. The law of large numbers applies to the diversification of risks in the technology industry as well. I would encourage all companies that issued a “work from home” policies to look through the list of their technology vendors and their geographies to understand their own risk of losing a technology partner. There are multiple papers and ideas on how to find reliable experts when economies are slowing down.

Outsourcing as a business resilience strategy

The typical manufacturing company now outsources 70 to 80% of the content of its finished product. For a long while many companies have outsourced professional services to accountants, lawyers, advertising agencies, consultants.

There is a huge misconception that outsourcing takes jobs away from local residents. But when it comes to diversifying risks, can we say the same about the manufacturer that has manufacturing facilities across the region? Outsourcing goes hand in hand with business processes and enables companies to increase the speed and flexibility to carry their vital operations. Assignment of tasks in non-key areas to offshore teams gives more freedom for key personnel to innovate, experiment and reinvest freed resources back into the business. Historically outsourcing succeeded in areas like legal, accounting, IT, research & development, advertising, etc. Many enterprises to this day are heavily dependent on Chinese and Indian markets for their administrative and technical personnel. And these were the businesses that were hit the most. It is definitely not an easy task to find reliable partners and vendors that will enable businesses to lower their liabilities and avoid negative cash flows, and I’ve seen millions of articles helping companies to make better decisions when hiring outsource vendors. One of the articles published by management and technology consulting company Eleks skillfully explained all Ins and Outs of Outsourcing, arguing that according to Harvey Nash/KPMG CIO Survey 2019, skills shortages are at an all-time high with 67% struggling to find the right talent. The top three scarcest skills are big data/analytics, cybersecurity, and AI. Cybersecurity should be of the biggest concern especially right now, as remote workers are most vulnerable to cyberattacks when they are outside of their secured networks.

These and so many other concerns must be addressed now, as the U.S. economy cannot afford a complete shutdown. We need to recover, and we need to recover fast.

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