Many people have vivid memories of where they were when COVID-19 became “real” for them.                

It was the moment that the pandemic evolved from an intangible topic on the news impacting people somewhere far away to something that directly affected daily life in their own communities—and for an a seemingly indefinite period of time. Much in the world has changed as a result of the pandemic, some of it perhaps permanently. In the captive insurance world, coverage for business interruption (BI) may be one of those changes.

Standard Captive BI Coverage

In the traditional market, BI is often part of a property policy and only covered following a covered property loss. In the captive world, BI coverage is frequently purchased for a wide variety of causes of loss: regulatory or administrative actions, supply chain interruption, loss of a key employee, or loss of a key customer or contract, to name a few. Note that COVID-19 could have plausibly caused a loss under any or all of these example policies for a given business: e.g., a government-ordered shutdown, a shortage of supplies because of a supplier’s switch to manufacturing personal protective equipment (PPE), the illness of an important rainmaker or a shutdown to a primary customer’s business. 

There’s a potential catch, however. Is BI caused by a pandemic included under standard captive BI coverage policies? Naturally, it would depend on the policy language itself, which can vary widely between different captive managers. Some captive managers developed coverage forms from commercial policies with explicit pandemic exclusions, while others designed coverage to have as few exclusions as possible to offer very broad coverage to captive owners. We have also seen coverage form design changes as captives and society move forward and past the pandemic.

Policy Expansions

Some captives and captive managers are revising their BI policy language to be more expansive. Insureds’ demand for BI coverage that extends to pandemic and other catastrophic events is unmistakably higher. Pandemics and shutdowns that result are now proven to be very real risks in modern life, and the number of business owners who are conscious of the risk and willing to pay to transfer some of it is greater than in the past. The supply side of things may be even more complex. 

The captive industry can be internally competitive, with multiple captive managers offering similar policies and programs. Therefore, a good argument exists to make sure a captive manager attempts to structure policies to meet client demand. In other words, if current BI policies cover pandemic, they should not be changed. If the policies do not, they should be expanded to cover pandemic BI in the future.

Captive Approaches

There are, understandably, captive managers who are not comfortable with that approach. Some captive programs may have had significant losses, and some may have paid numerous high-severity claims. Captive managers in this camp might decide that they want to specifically exclude, or limit through deductibles or sub-limits, pandemics from being covered under some or all of their BI coverages. They may be worried about captive solvency issues if these losses are covered in the future. After all, the COVID-19 pandemic is ongoing, and there are newer variants causing concerns among health officials. What if the current vaccines don’t work against some of these variants, and we go back to square one in 2022 with new shutdowns? 

Following this line of thought, a question may be raised related to the affordability of including this coverage in captive BI policies. Even if a captive or captive manager wished to respond to demand and include it, the premium that actuaries determine may be prohibitive. In some ways, pricing for this risk could be compared to catastrophe modeling.  It has high severity potential (a loss event could completely ruin a business), high volatility (anything from no loss to limits loss and above are within the reasonable range of possibilities, with frequency factors difficult to estimate), with many assumptions and variables. Some modelers may even consider the frequency to be relatively high under current circumstances, compared to what they may have thought two years ago. 

So it could be decided that even if a captive manager wished to offer coverage, increased indicated premium for pandemic BI may cost them more business than excluding the coverage. For instance, some potential clients may accept coverage excluding this risk. Perhaps they are an essential business not materially impacted by shutdowns. As a result, such a business might work with a different captive manager that excludes pandemic BI and has significantly lower premiums, rather than paying a high premium for a low-priority coverage.

Meeting Market Demand

Luckily the captive industry is, if anything, innovative. It will likely continue to develop a number of solutions, depending on the needs of the captives’ insured(s). Besides strictly including or excluding pandemic as a peril from the existing BI policies, there are two potential and simple approaches to try to meet demand for coverage and protect the solvency of their captives. 

First, a captive manager could specifically exclude pandemic from all BI policies, and create a new policy covering only pandemic BI. This new policy could cover some or all BI and related expenses, including any of the examples above. 

An important detail in this instance is that this approach removes the potential for a situation in which one pandemic results in claims under multiple captive policies, exposing the full per-occurrence limit multiple times over. If pandemic is exclusively covered under a pandemic BI policy, the limit would only be hit once. This is an advantage from a solvency viewpoint, but potentially a flaw from an insured’s viewpoint, since they want as much coverage as possible. 

If the above approach is taken, and we are fortunate not to have a major COVID-19 resurgence or another pandemic in the next few years, it would be interesting to see if demand for this coverage persists or if it would fall every year subsequent to the worst years of COVID-19. 

Another possible simple solution is to include the coverage but require a relatively high self-insured retention (SIR). The SIR could be structured in such a way that only severe losses are net to captive, saving captive reinsurance pools from a situation where all members have moderate pandemic losses that, in aggregate, are severe to the pool. (An SIR could also be applied to the first approach mentioned.) 

However, the SIR approach probably would not completely satisfy demand, as many insureds will desire first-dollar coverage. It also doesn’t necessarily add any protection to the captive or to reinsurance pools in a severe scenario. In a situation with prolonged shutdowns, for example, limits losses may emerge, regardless of the SIR layer below the captive layer. 

Both of these ideas are imperfect, and solving this problem may be tricky. The captive industry will likely provide a number of solutions for this particular peril, which is doubtless on the minds of countless business owners following the pandemic’s emergence. It is also likely that captive managers have already made, and will continue to make, changes to the BI policy language in their various policy forms. 

While we all hope an event like COVID-19 never recurs, the captive industry is in a unique position, if it does, to continue to help businesses survive.

Nick Gurgone, a consulting actuary with Pinnacle in the Bloomington, Illinois, office, began work in the property/casualty insurance industry in 2015. He has experience in assignments involving loss reserving, funding studies, loss cost projections, captive feasibility studies, commercial lines ratemaking, and group captives. Nick is a Fellow of the Casualty Actuarial Society (FCAS) and a Member of the American Academy of Actuaries (MAAA).