The potential for systemic loss

Under Solvency II an insurance company must have sufficient capital to survive a 1-in-200 year loss event (or 0.5% probability of ruin) over a one year time horizon. In addition, correlating risks and systemic losses that could expose a (re)insurer’s capital base may adversely impact their credit ratings agency’s assessment, resulting in downgrades or other punitive measures – these can have significant financial and non-financial consequences. Any underestimation of these exposures potentially leaves the insurer, at best, undercapitalised and, at worst, ceasing to trade. 

This fear of systemic loss is invariably the driver for many current market exclusions (for example Radioactive Contamination and Cyber). The introduction of these exclusions is usually insisted upon by two main parties: namely the reinsurance market and senior management.

Reinsurance market – “the reinsurance tail wagging the insurance dog”

As risks correlate, a more significant share of any large loss shifts from the direct market to the excess of loss reinsurance market. In order to protect its position from unmanageable and systemic risks, the excess of loss market imposes exclusions, such as that for communicable diseases.
  
With reinsurance cover removed for individual perils, if no action is taken the direct underwriters must retain the exposure to loss from the difference in conditions between risk cover given and risk cover reinsured. For the reasons touched upon above, if there is a difference in conditions then direct underwriters must fill that with an increased level of capital. If, however, the direct offering is in alignment with the reinsurance coverage then no increased capital is required. For this simple reason, the direct market can be forced to adopt and embrace exclusions principally designed to protect the reinsurance market.

Senior management influence

To ensure no systemic risk exposure, senior management instruct their underwriters to add a Covid-19 exclusion to most, if not all of their policies, irrespective of exposure to a Covid-19 related loss. This enables them to report to their stakeholders that any Covid-19 exposure is either minimised or at least managed.

Current market application 

For these reasons, the majority of underwriters are insisting upon a Covid-19 exclusion clause whether or not there is significant exposure to Covid-19 related claims for any specific policy.  Brokers can try to argue the exclusion out, but the pressures from senior management, the reinsurance market and the rating agencies are often too great. Underwriters at the coalface will be working to an instruction, having to report by exception, leaving them less room to manoeuvre.

Underwriters may be prepared to assume some Covid-19 exposure, but that exposure needs to be controlled and managed as it may be the case that their own reinsurances contain exclusionary language. To be able to remove the exclusion, underwriters may need to demonstrate to themselves and to senior management that for the perils insured against, the ship is single risk exposed and there is no potentially huge accumulation of exposure.

So far, we have not seen the frequency or severity of Covid-19 related losses in the marine industry that would suggest the risk is systemic and uninsurable. However, it will be paramount to have data to support this and work with reinsurers to ensure that insureds continue to have the full scope of coverage that marine liability insurers have provided for many years.