Megacatastrophes, or megacats, as they're known in the insurance industry, are events that hit millions of people at once and cause hundreds of billions of dollars in damage.
- The COVID-19 pandemic is much worse than a megacat — it has hit billions of people and is causing tens of trillions of dollars in damage. But don't worry about the insurers. They're doing just fine.
Why it matters: As far as insurers are concerned, this is not some kind of unprecedented giga-catastrophe. In fact, it's not even a megacat. We still don't know what kind of non-pandemic disasters 2020 might yet bring, but so far this year is tracking well behind 2017 in terms of economic harm to insurers.
The big picture: The first purpose of insurance is to insure against calamity. Insurers make money in quiet times, taking in more money than they pay out in claims — but then, in bad years, they are expected to lose billions.
- COVID-19 will probably cause some losses for the industry. Insurance brokerage Willis Towers Watson estimates that the losses might be $30 billion under a "moderate" scenario featuring six months of social-distancing controls and 3 million total deaths. That's about the same amount of insured losses as Hurricane Irma caused in 2017, while causing 134 deaths.
How it works: Insurers are happy to cover uncorrelated risks, where the majority of unaffected businesses and individuals paying premiums can easily cover the costs associated with the minority of claimants. A pandemic is a classic case of a highly correlated risk that hits everybody at once — and no insurer can afford to pay out on all of its policies at the same time.
- The vast majority of policies therefore explicitly exclude pandemics, and organizations like Wimbledon that do have pandemic coverage pay large sums for having it.
The other side: Even if insurers have avoided paying out on things like business interruption insurance, some hits are unavoidable.
- The money from premiums is invested in the market, so when the market falls, insurers lose money.
- Life insurers have to pay out on excess mortality — people dying before they were actuarially expected to — although the insurance industry as a whole sells about twice as many annuities as it does life insurance policies, and annuities stop paying out when covered individuals die.
- A bigger problem for the insurers is the interest rates that they have promised on annuities: Those look harder to obtain in the market now that rates in general have plunged.
- Other losses are likely to come from worker's comp insurance, especially in the healthcare sector, as well as insurance against cyberattacks, which are likely to increase now more people are working from home.
- Future total premiums are also going to fall, especially for things like travel insurance.
Insurers are meanwhile seeing gains, especially on auto policies. With the number of cars on the road down by 50% or more, the number of accidents has similarly plunged. Some insurers are rebating a portion of those gains — but only about 40%, according to Willis Towers Watson. The rest is excess profit.
- Health insurers are also making profits, at least for the time being. Doctors' visits have been canceled, and elective surgeries — a lot of which cost much more than a two-week stay in the ICU — have been postponed, many indefinitely.
- Rebates and other financial support from insurers remains relatively small, at least so long as the long-term health implications of the pandemic remain unknown. Insofar as Americans avoid doctors and hospitals in general, that will benefit health insurers.
- Insurers might be able to raise rates for 2021, given that the chances of the industry facing a pandemic next year are close to 100%.
The bottom line: The world's greatest all-time insurance executive, Warren Buffett, said in his 2018 annual letter that every year there's a 2% chance of an event causing more than $400 billion in insured losses. Even given the current crisis, however, the industry has never come close to seeing a hit that big.