The “other perils” conundrum for reinsurance & ILS on coronavirus

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With the traditional reinsurance industry and insurance-linked securities (ILS) market working hard to identify any routes through which unexpected claims from the Covid-19 coronavirus pandemic could leak, it’s perhaps worth looking at one obvious area of uncertainty, the growing in prevalence “other perils” category and similarly worded contract terms.

question-mark-questions-reinsurance-ilsFor us, with our coverage focused on insurance-linked securities (ILS), catastrophe bonds and other areas of interest where the capital markets and reinsurance collide, the use of “other perils” within cat bond contract arrangements has proliferated over the last few years.

The “other perils” bucket was originally introduced to catastrophe bonds by the most prolific sponsor of those bonds, USAA, back in 2016, we believe.

It is seen as a way to expand the coverage from only providing reinsurance or retrocession for named major perils, the usual suspects of hurricane, earthquake, severe thunderstorm etc., so that cat bonds also provided coverage for severe weather losses and other natural perils that can also cause significant impacts to their sponsors.

In fact, the “other perils” peril descriptor makes some cat bonds protection as good as an all natural perils cover, which is another way that cat bonds have been stretched to provide protection that is more closely matched with the traditional reinsurance market cedents are more familiar with.

The specific question with “other perils” and the ongoing coronavirus pandemic, is whether a pandemic could ever be construed as a natural peril event.

Of course, this what’s covered question is a topic of much discussion across insurance and reinsurance right now. Particularly due to the now numerous legal actions that try to force coverage of pandemic business interruption related claims within property and other classes of business.

In the main the industry expects the success of such cases will come down to wording, as insurance or reinsurance should not cover something that is not contractually included.

But if it’s not excluded and the wordings around what is included are loose, or too weak, there will be a chance of some claims from the coronavirus pandemic cropping up as losses in an interesting range of places.

In the case of catastrophe bonds that feature an “other perils” bucket within the covered perils definition, in the main they are the Residential Re cat bonds since 2016 sponsored by USAA, the Caelus Re cat bonds since 2017 and the Sanders Re cat bonds sponsored by Allstate since 2018.

In the main, these cat bonds describe “other perils” as being any naturally occurring loss event, outside of any named perils, and that is not man-made or resulting from a man-made event.

In all cases it is down to the ceding insurer to define what is a natural peril loss event.

In the case of USAA’s Residential Re cat bonds and possibly Allstate’s Sanders Re deals, PCS designation of a catastrophe is required for an “other peril” loss event to qualify under the terms of the transaction.

With the Caelus Re transactions sponsored by Nationwide, there is no third-party designation of a catastrophe required, just that the insurer need to assign a catastrophe code to the loss event.

Could coronavirus pandemic claims be included under the “other perils” bucket? It’s very uncertain at this time.

It would require one of these cat bond sponsors to suffer sufficient losses due to the coronavirus under the covered areas of its portfolio, which are generally personal and commercial, largely property focused lines of insurance business, but also include some auto and E&S risks in the case of Caelus and some auto in the cases of Residential Re and Sanders Re.

Were one of the sponsors of these cat bonds to suffer enough claims that they thought could qualify under the subject business of their cat bonds, would they then look to try and classify the pandemic as a naturally occurring loss event and so fit it within the “other perils” bucket?

At the moment this does seem unlikely, as there would be a tremendous amount of push-back from investors and ILS funds, but it is certainly a possibility and something to perhaps keen an eye on.

It’s worth noting that at least one of these catastrophe bonds features wording that warns “other perils” loss events “could include unforeseen events”, which would certainly be the case should the coronavirus pandemic be construed to fit.

It seems a stretch of the imagination to think that a catastrophe bond designed to cover natural perils ends up facing potential impacts from a pandemic. But the coronavirus is identified as a naturally occurring virus and while a stretch to think these repeat cat bond sponsors would seek to gain coverage for it, if the proverbial really hits the fan in terms of pandemic industry losses who’s to say how they would respond.

In the same vein it’s also worth looking to other transactions, such as retrocession, which also loosely often try to cover all natural perils and often feature similar wordings on natural events that could qualify.

Another angle to consider, on the coronavirus impact in general and in particular retro, is strike, riot and related civil disturbance claims that could emerge as a result of the global lock-down of populations.

There is some concern over the potential for certain countries to see some civil unrest and claims from these could, in some cases, qualify under the terms of some reinsurance or retro contracts, we’re told by sources.

In fact, one of these catastrophe bonds would cover some strike or riot related claims that came about as a result of a qualifying natural event, we’re told. It’s not clear which at this time, but it throws up another avenue for potential concern.

The thing all of this has in common, is that for any coronavirus pandemic claims to leak into cat bonds, retrocession, or other types of reinsurance contracts, it will need the overall industry loss from this outbreak to escalate significantly.

However, some of our sources warn us that senior leaders in the industry are nervous over the potential aggregation of coronavirus claims to be unprecedented, in terms of loss events.

Which, if that turns out to be the case, means all bets are off as to precisely where claims will eventually land and leak to.

The use of words like “other” which are then perhaps not as fully defined as some may like, or not matched with full lists of exclusions, can leave some contracts at risk of picking up coronavirus claims.

This applies right across insurance, reinsurance and ILS and the inclusion of something that wasn’t underwritten for can be as detrimental to all, no matter which side of the market you sit on.

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