Richard Hartigan discusses the possibility of an insurance policy without exclusions
An insurance policy with no exclusions – impossible?I don’t think so. This idea formed one of the central planks of a presentation I gave to the Actuaries Institute of Australia in May 2021, called A Grand Proposal for Uninsurable Risks.
As industry practitioners, it’s all too easy to let the raison d’être of insurance slip away from our minds. The three parties (insured, insurer and government) have a shared interest in ‘getting insurance right’. Insurance is the oil that lubricates the economy. The government has a strong interest in fostering a healthy, fair and competitive insurance industry as ‘good’ public policy.
Insurance allows the insured to bounce back after a fortuitous loss. The insured is primarily interested in protecting their balance sheet. How or which fortuitous loss impacts their balance sheet is of little interest. If a fortuitous loss occurs, the insured has an immediate need: to repair their balance sheet.
If insurance does not respond, then the insured will naturally view insurance as poor value. This serves neither the insurer nor the government. This is not ‘getting insurance right’. It seems obvious, but seeing various UK insurers resist claims (particularly from small businesses) during the COVID-19 pandemic caused me to pause and think.
Why do insurance policies have exclusions?
Exclusions may be the choice of the insured, in order to save money – for example, the insured may buy a travel insurance policy covering the world excluding the US, rather than the entire world, or that foregoes winter sports coverage. More often, though, exclusions are to protect the insurer from a collective event loss that would exceed the capacity of its balance sheet.
The insurer’s action is understandable, but does not help the other two parties: the insured and the government.
How can we resolve this tension?
One way forward would be for the insurer to offer the insured an insurance policy with no exclusions. The quid pro quo is that, if a collective event loss is large enough, the insurer is legally permitted to pay out less than 100% of the insured’s claim. This may be achieved through robust (and clear) insurance policy language, and/or legislation that supports this initiative.
The insured ‘knows’ that, in all fortuitous loss circumstances, its balance sheet is protected. Very occasionally, should a large collective event loss occur, the insurer pays out less than 100% of the insured’s claim (the alternative, of course, being that no cover at all is offered). As long as the loss is demonstrably a fortuitous loss, there will be no squabbles with the insurer over coverage.
“As long as the loss is demonstrably fortuitous, there will be no squabbles over coverage”
From the insurer’s point-of-view, should a large collective event loss occur, the insurer is legally permitted to pay out less than 100% of the insureds’ claims. This strengthens the insurer from a prudential point of view (large collective event ‘catastrophe’ tail risk is reduced). The risk posed by ‘black swans’ is eliminated: the insurer does pay for them, but exposure is capped. In this way, insurance is ‘lifted’ to become a product of good value. This is good public policy.
How would it work in practice?
It could work in any number of ways. The presentation A Grand Proposal for Uninsurable Risks suggests one way: the exposure cap(s) would be directly linked to the insurer’s own balance sheet.
Is this idea fully formed?
No. For example, would legislative support be required, or could this idea be effected through insurance policy language? Could uncertainty over the quantum of the ultimate collective event loss (slow claims development) be an impediment? Are there challenges to setting the exposure cap(s) on a calendar year basis when most insurance policies misalign to the calendar year? Could exposure cap(s) for various perils and various insurers confuse potential insureds?
These are all good questions, but the alternative is that no cover is offered at all. The exposure cap(s) would be set to be used relatively infrequently. A sensible trade-off is accepted to achieve a higher good.
Richard Hartigan is an actuary at the Financial Reporting Council
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