In Allianz’s Risk Barometer 2020, 17 years after the SARS outbreak, risk professionals ranked pandemics 17th on their list of top global risks for the year. Business interruption, including supply chain disruption, ranked second. By the end of the first quarter, countless companies found themselves squarely at the intersection of these threats, as the novel coronavirus COVID-19 spread into a global pandemic, leaving worldwide chaos in its wake.
COVID-19 has quickly taken a dramatic toll on the global economy. Around the world, markets have grown extremely volatile, leaving companies and consumers alike acutely uncertain. In the United States, the Federal Reserve slashed interest rates in an unexpected emergency cut for the first time since 2008, attempting to allay some investor concerns, instead sending stocks and bonds tumbling further amid recognition of the potential widespread vulnerability. On March 9, the stock market had its single worst day since the 2008 financial crisis, quickly surpassed by another plunge on March 16, in which the Dow Jones Industrial Average dropped more than 12%—its third-worst day ever. With factories shuttered, oil consumption also decreased, and falling demand set off a March price war between Russia and Saudi Arabia. In a single day, prices fell 25% to the lowest point in over 20 years, showing no sign of imminent rebound as both countries instead expressed plans to increase output to remain competitive.
Businesses are increasingly facing existential risks from volatility in the global economy, and on an individual level, they are confronting business interruption and disruption up and down the supply chain, demonstrating the extent of interdependencies in modern business and the risks of overdependence on key suppliers or regions. Strict quarantines in key manufacturing hubs began making a significant dent in the global supply chain in January, particularly hitting the manufacturing, automotive, oil/gas, and consumer products industries. Many mid-sized companies that are struggling to resume operations in China, for example, manufacture component parts, causing an outsized impact on even the largest companies. Companies that do resume operations face longtail interruption the longer it takes to ramp back up.
Global Supply Chain and Business Interruption
In a Gartner survey in early March, 56% of the 1,500 respondents rated themselves as somewhat prepared for the impact of the coronavirus, but just 12% said their business was “highly prepared” and 11% admitted they were either relatively or very unprepared. “Just 2% of respondents believe their business can continue as normal, highlighting the huge range of businesses that could be affected by the outbreak,” Gartner reported. “Twenty-four percent of respondents expect little disruption, while the majority expect business to continue at a reduced pace (57%), to be severely restricted (16%) or to be discontinued altogether (1%).”
According to Suki Basi, CEO of risk modeling firm the Russell Group, “What we are seeing in our analysis is that, for corporates, ‘the ground zero’ of the coronavirus outbreak is supply chain disruption, as all companies are impacted in one way or another from a slowdown in the Chinese economy.”
Even relatively early in the outbreak, companies began bracing stakeholders for material impacts on business. MarketWatch analysts found the word “coronavirus” in 38% of transcripts from earnings calls among the S&P 500 between January 1 and February 13.
Indeed, in the time since, business interruption and lack of business have begun dramatically impacting companies across a wide swath of industries. A week before shutdowns began across the United States, the National Retail Federation reported on March 9 that 40% of their members had experienced disruptions and 26% expected to see them. While most of its locations had reopened, Starbucks said in March that January closures in China alone would cause a notable hit to second-quarter earnings, reducing same-store sales by 50% and cutting revenue by up to $430 million.
Both supply chains and consumer demand have impacted the tech and consumer products industries. For example, Apple began warning shareholders in February that disruption and a slower-than-expected transition back to business among component manufacturers and producers of consumer goods could reduce worldwide supply of consumer electronics, including iPhones.
The rapid spread of the pandemic has also ravaged the travel industry. After passengers on multiple Princess Cruises suffered coronavirus outbreaks and quarantines, shares in parent company Carnival Corp. plunged almost 50%, and companies across the cruise industry saw both share prices and bookings plummet by more than 35%, year over year. In early March, the International Air Transport Association estimated airline losses could total up to $113 billion, and that was before President Trump restricted travel between the U.S. and Europe, which could result in the cancellation of another 7,000 flights, according to flight data company OAG.
In an effort to contain the pandemic, countries enacted widespread shutdowns and quarantines, and worldwide exposure to claims for insurers and reinsurers increased as countless events were cancelled and businesses closed. Fitch Ratings warned that insurance companies will be especially vulnerable in the coming months both directly via a potential spike in claims and indirectly due to market vulnerability. Moody’s analysts similarly noted, “An economic slowdown triggered by the outbreak will crimp business volumes for insurers and also lead to higher claims for certain types of insurance, including trade credit and event cancellation insurance.”
Insurance Implications
Few insurers offer commercially available products to specifically cover pandemic risks. Indeed, Fitch Ratings noted in mid-March that the nature of insured commercial exposures and restrictive policy language adopted in the wake of the SARS outbreak would likely help limit the impact of COVID-19 on U.S. property/casualty insurers. At the time, the firm did not believe carriers would be exposed to enough claims from the pandemic itself to cause material impact on financial results. As Marsh explained in the report Outbreaks, Epidemics, and Pandemics: Preparedness and Response Strategies, “Under standard property policies, insured physical damage is necessary to trigger a covered loss. If the novel coronavirus were to manifest at an insured’s premises, through people becoming ill, insurers could contend that contamination is not physical damage and also may maintain that possible contamination, proximity to other contaminated premises, or fear on the part of the public do not amount to physical damage. Property forms also typically contain ‘contamination’ exclusions that insurers may seek to invoke.”
Some insurers have started to see claims come in, though with losses still rapidly mounting, many businesses have simply begun issuing first notice in advance of claims. “Allianz Global Corporate and Specialty currently has received some initial claims notifications from companies around the globe,” according to a statement from the insurer, noting approximately 20 claims had been filed as of March 9. “Most of these claims have been notified under business interruption extensions of property policies. Additionally, we are seeing first notifications of event contingency claims. Loss investigation has started; it is currently being examined whether coverage for communicable disease exists in the respective wordings.” Allianz would not yet estimate any financial losses, given the continuing and evolving situation.
While many business interruption policies may not cover—or outright exclude—pandemics, some will likely be triggered by the continuing widespread supply chain disruption. Additionally, some companies with more manuscripted policies or with alternative risk transfer programs such as captives may have secured coverage for business disruption or loss of customers or revenue. Allianz’s Alternative Risk Transfer team reported a notable increase in inquiries from corporate clients about such products for pandemic risks.
Other specialized coverage may also kick in. Contract frustration insurance, for example, may offer some relief for those that have purchased it. “Countries affected by the spread of infectious disease could see ancillary economic effects, including employee absences or closures of major ports. This could increase the risk that businesses in these countries cancel contracts with or default on payments or deliveries to their foreign counterparties,” Marsh explained. “Such policies can be designed to cover nonpayment, non-delivery or contract cancellation for any reason, including the potential economic effects of an outbreak.”
According to Willis Towers Watson, trade disruption insurance may offer some relief for companies suffering supply chain interruptions, such as losses related to government-mandated emergency closure of ports and transportation centers, quarantine, confiscation or seizure of a product in transit, or embargo on potentially contaminated product. Unlike standard business interruption coverage under marine cargo or property forms, the firm noted trade disruption insurance does not require “direct physical loss to goods or their conveyances.”
Companies that cannot fulfill contracts as a result of supply chain disruption should be looking at force majeure, or “act of God,” provisions in their business contracts, which may offer some relief from contractual obligations. According to Neil Thomas, head of claims for Asia at Willis Towers Watson, “Clauses and jurisdictions will differ in the consideration and treatment of the situation, but the China Council for Promotion of International Trade is issuing force majeure certificates to Chinese companies recognizing the outbreak as a triggering event, which also appears to be the position of the National People’s Congress.”
Key Roles for Risk Professionals
Looking ahead, risk professionals may need to consider their strategies to position corporate risk for renewals, which could prove especially critical in placing risk amid such volatility. “The longer the period of outbreak, the more likely a pandemic would be active during an insurance buyer’s renewal time,” Willis Towers Watson advised. “It is important to position your risk strategically with underwriters and be aware of changing market conditions or exclusions that arise as a result of the outbreak.”
“Risk managers should stay aware of the global situation, monitor health advisories from world health organizations and, most importantly, maintain a dynamic business continuity model that addresses the concerns and wellbeing of the organization’s employees as well its physical and financial assets,” the firm added. “These are powerful weapons against potentially catastrophic consequences.”
As the pandemic and resulting interruption impact businesses worldwide, risk professionals’ past work will come under additional review as crisis response and business continuity plans are put to the test. Risk professionals can expect scrutiny of their preparation and response, from providing for their employees and communicating with key stakeholders to having strong response procedures and enterprise risk programs in place.
For many organizations, one of the key challenges is determining when to begin implementing these plans, particularly in the face of such a rapidly evolving risk. “Organizations often have policies in place to deal with most risks, but they don’t activate them until it’s too late because no one is owning the risk or taking it seriously until it is fully manifested,” Gartner reported. “The threshold for a risk to generate executive action is often too high to enable an effective response.”
Using an impacts-based method can help risk professionals assess a crisis and determine when response plans are triggered and when to act to mitigate specific effects. “Also having response plans that react to specific impacts means it is simpler to communicate the plan to staff, so that all employees can play a part in managing risk. In fast-moving situations such as this, the more people who are owning risk, the more likely it is that an organizational response will be timely,” the firm noted.
“Avoid constructing elaborate ‘what if?’ scenarios and focus on what is known,” said Matt Shinkman, vice president of Gartner’s risk and audit practice. “Many organizations likely already have plans in place to deal with the types of disruption they are facing because of the coronavirus. The job of risk management is to ensure the right plans exists and make sure they get used at the appropriate moment.”