Insurers shouldn't be forced into coronavirus relief

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(Bloomberg Opinion) -- With the shutdown causing business losses to spiral — the National Restaurant Association, for instance, estimates that the shutdown will cost the industry some $225 billion through May — companies are naturally looking to their business interruption insurance for relief. What they’re discovering is that the typical policy excludes losses stemming from pandemics and, often, infectious diseases or new viruses.

This is a problem, but we have to careful not to “solve” it by making things worse. A number of states are considering legislation that would order insurers to pay for businesses’ coronavirus losses no matter what the policy seems to say. President Donald Trump has hinted that he might be in support. But this would be a terrible response to a genuine crisis.

Typical of this legislative blunderbuss is a bill recently introduced in South Carolina. The proposal, which makes no bones about its intention, would provide that all policies in the state that insure against “a loss of use and occupancy, or business interruption” must cover damages caused by the Covid-19 pandemic “notwithstanding the terms of the policy.” In plain English, the bill would rewrite the existing insurance contract. Other states considering similar legislation include Louisiana, New Jersey, New York, Ohio and Pennsylvania.

Nobody disputes that business are suffering, and if a state chooses to mandate that going forward all business interruption policies sold within its borders must cover pandemic losses, that’s its privilege. But when the government instead purports to rewrite the terms of policies already in force, serious problems arise.

In the first place, as the legal scholar Michael Krauss has pointed out, a statute mandating so drastic a change in the meaning of an insurance policy’s language would probably be held to violate the U.S. Constitution’s contracts clause. The clause has been interpreted to prohibit “substantial” impairments of existing contracts, except in cases of necessity. It’s hard to imagine a more substantial impairment than rewriting a contract to force a party to pay money the contract says isn’t due. And as to necessity, the courts say it doesn’t exist when the state can accomplish its purpose through a more moderate means that doesn’t interfere with contracts. In this case, an alternative exists: a state can offer its own subsidies to cover losses the business interruption policies exclude.

The U.S. Supreme Court has held that the clause “does not operate to obliterate the police power of the States,” but federal courts have on a number of occasions used it to invalidate state legislative efforts to alter the terms of existing insurance contracts. Even so, as far as I can tell, the wholesale rewriting of insurance agreements now under consideration would be unprecedented.

Even during the Second World War, with patriotic fervor at its height, no state gave serious consideration to nullifying the then-common clause in life insurance contracts that excluded deaths during “military or naval service in time of war.” The clauses sparked litigation aplenty, resulting in some important cases construing “time of war,” but nobody argued that the exclusion itself was somehow impermissible.

Even if we put aside the constitutional question, making pandemic exclusions in insurance contracts unenforceable would also be unwise. If insurers are forced to pay for what their policies expressly exclude, they’ll have no reliable way of knowing what they must cover, and therefore no reliable way of pricing their coverage.

People buy insurance because they are risk averse. They transfer a part of the uncertainty about the future to a company that accepts the risk because it can make a profit doing so. The profit comes from the insurer’s ability to project likely payouts under its policies. Nowadays, insurance companies pay analysts to develop complex algorithms to help them make wise decisions about whom to insure and how much to charge.

But it’s hard to predict your losses when the government can willy-nilly rewrite your contracts. The entirely foreseeable result of such rewriting would be an across-the-board increase in the price of at least business interruption insurance and possibly other categories as well, to cover the risk that when the next disaster strikes, legislatures will decree that some other policy exclusion also cannot be enforced.

Supporters of the legislative proposals have argued that the losses from the coronavirus and the resulting shutdown were unforeseeable, but insurers did foresee them. Policies protecting businesses against pandemic interruptions are available. There simply haven’t been many takers. We might expect more buyers going forward, but that depends on what happens next. If the states rewrite business interruption policies, potential buyers of pandemic policies may be dissuaded on the theory that if another pandemic arrives, the government will do the same thing again. Why pay for extra insurance when the insurers will be forced to cover your losses even at the lower price?

There’s an obvious alternative. Congress could enact a national pandemic insurance, on the model of the federal flood insurance program. Businesses wanting protection would pay in; the federal government would backstop the payouts. True, one hesitates to support creation of yet another new federal program, but it’s a far better idea than telling the insurance industry that its policies don’t mean what they plainly say.

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