How to Prepare for the Next ‘Black-Swan’ Event? Lloyd’s Has Some Suggestions.

July 2, 2020 by

Lloyd’s of London is proposing solutions that could provide customers with greater protection against a future wave of the COVID-19 virus or future systemic – “black swan” – catastrophes, such as another pandemic, a global cyber attack or a solar storm that shuts down electrical grids across the globe.

Lloyd’s framework proposals include Recover Re (a government-backed vehicle offering long-term, after-the-event cover that could insure against COVID-19 as well as future pandemic risks), Black Swan Re (a government-backed vehicle to insure against future systemic risks) and ReStart, a pooled non-damage business interruption product that would cover clients against future waves of COVID-19.

Lloyd’s acknowledged that customer attitudes to insurance have deteriorated as a result of the COVID-19 crisis because “some business interruption policies have not performed as expected.”“The insurance industry must develop new products and structures in those areas where protection gaps exist today to support business recovery over the short-term post lockdown, and provide greater resilience over the medium to longer term,” said the Lloyd’s report.

These three proposals are discussed in a white paper published this week by Lloyd’s, titled “Supporting global recovery and resilience for customers and economies: the insurance response to COVID-19.” (See below for details of the proposed solutions).

While the insurance industry has been and will continue to pay hefty claims during the current black swan event – the coronavirus crisis – it has come under fire because of pandemic exclusions in property business interruption policies. Many insurers, including Lloyd’s insurers, are facing litigation in the U.S., Canada and Europe as a result of these pandemic exclusions.

Lloyd’s has estimated that the industry’s overall losses from the COVID-19 pandemic will be $203 billion, which will include underwriting losses of approximately $107 billion and decreases in investment portfolios of an estimated $96 billion.

In its report, Lloyd’s acknowledged that customer attitudes to insurance have deteriorated as a result of the COVID-19 crisis because “some business interruption policies have not performed as expected.” To identify customer priorities, Lloyd’s said it interviewed executives and experts across key global industries including travel and hospitality, healthcare and pharmaceuticals, retail, automotive, supply chain and transportation, energy, and construction.

Lloyd’s found during its research that companies were increasing the amount of risk they self-insure through captives, while others said they were taking the first steps in this direction. (Editor’s note: This could indicate a worrying trend, because many buyers view insurance as being unresponsive to their needs, even before the COVID-19 crisis).

“COVID-19 has demonstrated that there is much more we can do to support our customers by providing protection for the changing risks they face,” said Lloyd’s Chairman, Bruce Carnegie-Brown, in a statement. “Some of these risks are of a scale that require partnership with governments globally and this report identifies ways in which the insurance industry could work with governments to share risk and create a braver, more resilient world.”

“[T]he insurance industry must develop new products and structures in those areas where protection gaps exist today to support business recovery over the short-term post lockdown, and provide greater resilience over the medium to longer term,” the report continued.

But how can the industry insure systemic risks that are difficult to predict and model? The report noted that these risks “are so large in scale they render traditional risk mitigation and transfer methods unfeasible, requiring financial resources far in excess of the global non-life re/insurance industry’s $2 trillion asset pool.”

“As thoughts turn to restart and recovery, society needs solutions that can offer protection in the new risk landscape and, in the short term, from a second wave of the pandemic,” Lloyd’s said.

To illustrate the scale of the current crisis, the report pointed to the fact that global government fiscal support packages in response to the pandemic totaled $9 trillion as of May 2020 but could reach up to $15 trillion by the end of 2020. Both these figures came from International Monetary Fund reports, said a Lloyd’s representative.*

(Editor’s note: In a worst-case scenario, the Judge Business School at the University of Cambridge, has estimated the global economy could take a hit of some $82 trillion over the next five years, or $16.4 trillion per year.)

The current pandemic has exposed the limitations of existing risk transfer structures for systemic risks of this scale, said the report. “As thoughts turn to restart and recovery, society needs solutions that can offer protection in the new risk landscape and, in the short term, from a second wave of the pandemic.”

Lloyd’s emphasized that close collaboration among insurers, brokers and customers, and between the global insurance industry and governments, is necessary to create new vehicles that combine insurance capital with sovereign capacity to develop protection against systemic risks.

To accelerate this process, Lloyd’s is suggesting three framework solutions, which could provide protection for customers’ shorter-to-longer-term needs. (These are “open source” frameworks, and therefore are freely available to use around the world). Lloyd’s describes the solutions as follows:

  • Recover Re would be a government-backed vehicle offering after-the-event cover, which could provide small and medium size enterprises (SMEs) with immediate relief for non-damage business interruption losses, including the current COVID-19 pandemic. Premiums would be charged over the long term to recoup costs. This could be an efficient way to inject commercial and government funds into the economy, providing relief to customers with limited borrowing capacity. This framework could be implemented in any country where the government has the resources and industry commitment to support it.
  • Black Swan Re would provide reinsurance for commercial non-damage business interruption cover for future systemic events through industry pooled capital, backed by a government guarantee to pay out if ever the pool had insufficient funds.
  • ReStart is a commercial structure for pooling risk capacity between insurers to support SMEs with their return to work. A short-term response to the current pandemic, ReStart would offer non-damage business interruption cover for future waves of COVID-19. This solution is currently being developed by several Lloyd’s market participants to pilot with UK SMEs.

“Delivering these initiatives at the pace and scale needed to help customers and wider society will require close collaboration between the insurance industry, governments, customers, and, in some cases, the capital markets and non-governmental organizations,” said the report.

Lloyd’s said these frameworks will take time to develop: ReStart will take two to three months; Recover Re will take three to six months, while Black Swan Re will take six to 12 months.

(Editor’s Note: Several countries, such as the U.S., UK, France and Germany, are currently in the process of developing government-backed industry pools to protect commercial customers from future pandemic non-damage business interruption risks).

For its part, Lloyd’s said it will provide seed funding of up to £15 million to support the development of its suggested frameworks. Further, Lloyd’s will use its marketplace “to act as a convenor and incubator to develop some of these initiatives.”

* The two IMF reports cited by Lloyd’s are:

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