Actuaries Group Offers Guidance on Federal Pandemic Risk Backstop

The American Academy of Actuaries has suggested that existing US insurance backstop programs like the Terrorism Risk Insurance Act (TRIA) and the National Flood Insurance Program (NFIP) may provide insights into crafting a federal pandemic risk backstop.

In a letter to the leaders of the House Committee on Financial Services, the group noted that pandemics are typically excluded from business interruption (BI) coverage because they affect a large number of people over an extended period of time and that insuring pandemics is complicated by their low frequency and high severity.

The expected cost of a pandemic is difficult to determine, according to the letter, while adding pandemic coverage to existing BI policies could make them unaffordable. Meanwhile, pandemics are correlated to a decline in the value of assets, which could impair insurers' claims-paying ability while the global nature of such events makes geographic risk distribution impossible.

Both TRIA and the NFIP help the insurance marketplace provide coverage for the risks they backstop by capping the risk that the market is expected to handle and providing a federal backstop for the rare event of losses exceeding that cap, the actuaries group said.

In contrast, an existing discussion draft of a Pandemic Risk Reinsurance Program takes a different approach, the academy's letter said, calling on the Treasury Department to act as a reinsurer for primary insurers writing pandemic BI coverage, with a cap on its own exposure. The letter notes that the draft suggests that the secretary of treasury "shall charge the insurer a premium for reinsurance coverage … based on the actuarial cost of providing such reinsurance coverage."

"Loading the estimated full cost of pre-funding payment of claims for business interruption in the next pandemic event—including the proposed new Pandemic Risk Reinsurance Program—onto the BI insurance contract would grossly distort the cost of that product and make it impractical for consumers," the letter said. "We do not think this is your intent so we recommend revising the draft language."

In order to foster coverage of pandemic risk in future BI policies, a good approach would be to follow the pattern of existing backstop programs like TRIA and the NFIP, the actuaries group said. Such a program would cap the amount of financial risk to the insurance and reinsurance industry, create a mechanism for the US Department of Treasury to provide temporary unlimited funding if claims exceeded the cap, and provide a plan for the Treasury to potentially be reimbursed after an event, the letter said.