Ottawa in talks with Lloyd's of London for insurance partnership to withstand 'black swan' events

The Canadian government is interested in an “exploratory discussion” with the Lloyd’s of London about creating a public-private insurance partnership to help withstand systemic risks to the economy from “black swan” events such as the coronavirus pandemic, says John Neal, chief executive of the U.K.-based global insurer.

In an exclusive interview with the Financial Post, Neal said Lloyd’s, which counts Canada among its top three markets with about $4 billion in business, has been in touch with the Department of Finance Canada about the reinsurance model that aims to avoid a repeat of the billions of dollars in emergency aid governments were forced to commit on the fly to prop up their economies as businesses were forced to shut down to contain the fast-spreading coronavirus pandemic.

There’s “interest in an exploratory discussion in Canada,” Neal said, adding that a handful of other governments have also expressed interest in Lloyd’s pitch to find a shared way to deal with future systemic issues triggered by events such as a pandemic, a cyber attack, or a large-scale power grid or supply chain interruption.

“The Canadian government is one of them,” and others include Britain, the European Union, and Singapore, he said.

A Department of Finance spokesperson was unable to provide comment by deadline.

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Under the scheme, which was detailed in a white paper this month, the government would provide a guarantee or backstop and would be “two layers away” from initial capital outlays, which would largely be taken care of by pooled insurance industry funds and private capital, said Neal.

“But it (the government) becomes the insurer of last resort, which of course it always is.”

To illustrate his point, he said governments around the world have committed an estimated $16 trillion in emergency pandemic aid — ranging from loans to wage and rent supports.  

Neal said the partnership model Lloyd’s is pitching offers governments a more controlled method of managing events when claims outstrip available funds to cover them.

“The longer there isn’t a loss, the bigger the float is underneath” the government backstop, he said.

Part of the drive behind this new model is that the pandemic has exposed a shortcoming in traditional insurance to cover business interruption. The wording of conventional policies does not generally contemplate shutdowns without damage to the premises.

“The fundamental difference in this situation is that most insurance policies provide business interruption coverage when there is physical damage,” said Anne Kleffner, a professor at the University of Calgary’s Haskayne School of Business, whose areas of research include the insurance industry.

“Being closed due to pandemic therefore isn’t covered.”

Neal said his “rough guess” is that 80 to 90 per cent of businesses won’t be covered for business shutdowns mandated by governments to try to slow the spread of COVID-19.

However, Lloyd’s expects to pay out about US$4.3 billion in insurance claims globally as a result of pandemic-driven shutdowns, which the insurer has estimated will generate insured losses of US$107 billion across the entire global property and casualty insurance industry. He said some payments are being made to cover cancellation or rescheduling of large-scale events such as the Tokyo Olympics because such policies tend to include coverage if they are cancelled or postponed for any reason.

But with widespread denial of coverage during the pandemic, Lloyd’s and other insurers are facing lawsuits in Canada, the United States and Europe. In some U.S. states and in the United Kingdom, there have also been discussions about drafting bills that would compel insurers to retroactively cover business interruption losses regardless of policy wording.

“Clearly there’s a huge community out there that felt it could have been protected (by insurance) and wasn’t,” Neal said.  

Kleffner said the pandemic has made a strong case for some form of shared private-public insurance because the claims involved — if they were to be paid out — would be “so enormous the insurance industry could not cover it.” Government would still need to step in, she said.

The American Property Casualty Insurance Association has estimated closure losses just for businesses with 100 or fewer employees are in the range of US$255 billion to US$431 billion per month. *
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Kleffner, whose research has drawn attention to the fact that Canada is the only G7 nation that doesn’t have a public-private partnership between the insurance industry and government to backstop large natural catastrophes such as earthquakes, is now arguing that Canada should adopt such a model to finance future catastrophic losses whether they come from a natural disaster or something like a large-scale disease outbreak.

“Would (it) be beneficial for the Canadian government to participate in or develop these kind of structures to address systemic risks and improve resilience in the long term? My answer is yes,” she said.  

In an article she co-wrote in Canadian Underwriter last month with Mary Kelly, a professor at the Lazaridis School of Business and Economics at Wilfrid Laurier University, Kleffner went further, saying Canada needs a robust public-private partnership “to respond to catastrophic losses, whether they result from pandemics or natural catastrophes, to mitigate the inevitable negative consequences that will follow a significant disruption to the insurance industry.”

In the aftermath of the initial virus-driven shutdowns in March, insurers, including Lloyd’s, which is the largest commercial insurer in Canada, are gearing up to sell specific pandemic insurance and other products that would help companies weather a second wave of the virus. Before COVID-19, there was little appetite for such products, Neal said, noting that after an Ebola outbreak in West Africa in 2014 threatened to spread widely, German reinsurer Swiss Reinsurance Company Ltd. offered a pandemic product that got no uptake whatsoever.

“Nobody bought the coverage — not a single customer,” Neil said.

Part of the reluctance might be cost, he said, while another factor is that people tend to resist paying for coverage for conceivable but possibly distant events. By way of example, he noted that in California — home of the San Andreas fault — earthquake coverage is purchased by only 13 per cent of homeowners.

A further challenge for individuals, the insurance industry and governments is to prepare for trigger events that may not even be known.

“The idea with black swan (coverage) is let’s not solve yesterday’s problem, let’s solve tomorrow’s problem,” said Neal.