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A Coming Collapse in Insurance?

Jeff Remsburg

Someone has to pay for coronavirus damage. Insurance investors need to be on high alert today

Imagine you’re a restauranteur …

You spend decades building your business … perfecting recipes … nurturing relationships with customers … enduring rough economic spells that hurt your razor-thin margins … yet all-the-while, making it work.

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And then comes the coronavirus.

Overnight, the authorities order your business closed. Revenues slow to a trickle forcing employee layoffs.

The losses begin skyrocketing since your fixed costs haven’t changed — rent, loan payments, license fees, insurance premiums …

Wait — insurance! That’s your way out!

All those years of paying your insurance premiums will finally bear fruit.

So, you file for damages with your insurance provider … only to have your claim promptly denied.

This is what recently happened to one of America’s most-decorated chefs, Thomas Keller, the famed restauranteur behind The French Laundry and Per Se. He’s the first American-born chef with two restaurants simultaneously achieving three-star Michelin ratings.

Keller is now suing his insurer, Hartford.

Of course, he isn’t the only business-owner getting denied by his insurance company and deciding to take the matter to court. And it’s pointing toward a grim reality …

***We’re about to see a tidal wave of insurance litigation that threatens the entire insurance industry … and investors need to watch out

The above scenario was written with a tone that’s a bit more sympathetic to the restaurant owner.

But this is not a black-and-white issue where “evil” insurance companies are denying claims based purely on abhorrent greed.

In most cases, these insurance policies did not include any specific clause representing a “pandemic.”

Is that covered?

Pained business owners will argue “yes,” it’s covered by “business interruption” clauses, and any argument pointing toward the absence of the word “pandemic” is just semantics.

Insurance companies will argue, “no” you can’t insure against a pandemic because you can’t diversify away the risk. After all, the word “pandemic” comes from the Greek word “pan” meaning “all-inclusive.” And the insurance business-model doesn’t work when it has to cover losses suffered by just about everyone.

It’s a massive gray area … it also has the potential to be a massive economic tinderbox.

***Let’s look at the economic fallout from both sides

If courts decide that insurance companies aren’t responsible for damages, then countless restaurants will likely close their doors.

So, what’s the economic damage of that?

Many people would say “the owner and his employees lose their jobs.”

A more thoughtful response would add on how the investor (a bank or private lender) behind the restaurant now has a substantial loss on its balance sheet which it has to absorb.

But an even more-forward thinker would see additional damage … farmers and fisherman that sold to the restaurant will be hurt … there will also be lost business to the general contractors, plumbers, HVAC specialists and electricians who service restaurants … and what about the florist, designers, and artists who contribute to the design aesthetics? Those revenues dry up too.

And as to the lending institution absorbing the loan-loss, how might this impact its willingness to lend to the next restaurant? If 10 more restaurants fail, what then?

How might tighter lending restrictions prompted by the restaurant-bankruptcy reduce new loans … which would slow a community’s overall economic growth?

Bottom-line, there are economic ripple effects that extend far-beyond just a closed restaurant.

Now, let’s say the courts side with the restaurant owners, forcing insurance companies to cover losses, regardless of whether “pandemic” was written into their contracts or not.

Well, back in March, the American Property Casualty Insurance Association estimated that small business’ potential continuity losses could total $220 billion to $383 billion per month.

What does that really mean?

When you factor in how U.S. insurers only have an estimated $800 billion pool for payouts, simple math suggests insurers would run dry in a few months.

David Sampson, president of the American Property Casualty Insurance Association, put it this way:

If policymakers force insurers to pay for losses that are not covered under existing insurance policies, the stability of the sector could be impacted and that could affect the ability of consumers to address everyday risks that are covered by the property casualty industry.

***Now, let’s add an additional wrinkle …

It would be one thing for a court to side with restauranteurs, leading to insurers having to begin paying out claims effective immediately going forward.

But seven states currently have proposed bills that would require insurers to retroactively cover all accumulated losses.

From the National Law Review:

In recent weeks, an increasing number of state legislatures have taken drastic measures to force the insurance industry to shoulder much of the burden of the economic downturn brought on by the global COVID-19 pandemic …

These bills would force many commercial property insurers to provide retroactive coverage to insureds for losses resulting from the COVID-19 pandemic regardless of the policies’ exclusions and the existence of physical damage to the insured’s property and regardless of premiums charged and the underwriting considerations made by the insurance companies when they issued these policies.

The seven states are New Jersey, Ohio, Massachusetts, New York, Louisiana, Pennsylvania, and South Carolina.

If this legislation is enacted, and other states follow, that would mean insurers would be on the hook for billions in losses.

In a recent Reuters article, attorney Steven Badger, a specialist in this type of coverage, describes the outcome of this scenario:

The entire concept of insurance depends upon just a few people having losses that everyone contributes to with their premiums. The concept doesn’t work when everyone has the very same loss …

That will completely disrupt and could bankrupt the insurance industry.

If the entire insurance industry fails, what happens when you get in a car-wreck next week? When your neighbor’s house catches on fire next month? When your office building is destroyed by a hurricane next fall?

***Collective sentiment is in favor of the struggling businesses

From Fortune:

The attorney for the Billy Goat, which expanded from its flagship site to include establishments around Chicago, says he has little sympathy for insurers.

“They are in the business of selling people insurance for exactly this kind of situation,” Esbrook said. “They can’t now cry they’re poor when the very situation they are insuring arises.”

President Donald Trump recently expressed sympathy for businesses asking insurers to pay up for business interruption coverage.

“When they finally need it, the insurance company says, ‘We’re not going to give it,'” he said at a coronavirus task force news conference. “We can’t let that happen.”

***Meanwhile, Wall Street doesn’t appear to be fully factoring-in this looming threat of lawsuits and billions in payouts

For context, let’s start with the airline industry. It’s in an equally-precarious spot today, with some carriers facing an existential crisis. Yet with airlines, investors seem to be reflecting the risk in the airlines’ share prices.

We’re not seeing this nearly to the same degree with insurance stocks.

Below, we compare JETS, which is the U.S. Global Jets ETF with KIE which is the SPDR S&P Insurance ETF.

JETS holds majors including American Airlines, Southwest, Delta, and United, while KIE holds insurance heavyweights including Progressive, Allstate, and Willis Towers Watson.

As you can see below, while airlines are down a collective 62%, insurance companies are only down about half that, at just 32%.

It’s the same if we compare KIE to KBE, which is the SPDR S&P Bank ETF.

KBE is down 43%.

While KIE’s 32% decline is nothing to sneeze at, the question is “does it reflect a sector that might be on the hook for hundreds of billions of payouts … or possible bankruptcy?”

Lloyds’s of London projects insurance sector losses will hit $107 billion. And when you factor in the losses in insurance companies’ investment portfolios, that number is likely to climb to $203 billion.

***Will the government backstop the insurance companies?

There’s the potential for a white knight (of sorts) in all this — government bailouts.

From Forbes:

Congress is considering a proposal called the Pandemic Risk Insurance Act, or PRIA, which would require insurers to cover business losses due to a pandemic. The federal government would serve as a “backstop” that provides funds as insurance company reserves run dry.

While insurance companies aren’t excited by this, it would — in theory — prevent them from going bankrupt.

But if PRIA isn’t enacted, insurance investors need to watch out.

Earlier in this Digest, we noted how the American Property Casualty Insurance Association estimated that small business’ potential continuity losses could total $220 billion to $383 billion per month.

That’s 10 times the amount in claims ever handled by the industry in a year.

From CFO.com:

For the insurance industry to pay these claims would necessarily require insurers to liquidate their assets, a firesale that would likely precipitate a market crash.

Let’s hope it doesn’t come to that.

We’ll be watching closely and will update you on any updates about PRIA as they unfold.

Have a good evening,

Jeff Remsburg

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