Insurance is something we love to hate. But in the back of our minds (even mine!) we know we need insurance because, without it, our businesses live on the edge of bankruptcy at the hands of an accident. It’s this fear (and the money we pay) that makes us seethe with anger when insurance companies deny claims.
The universal denial of coverage in response to government-ordered closures because of the COVID-19 pandemic is the most recent example of course.
But why did the industry universally deny coverage and why is every court backing them up? I’ll try to explain in as simple terms as I can. On a foundational level, insurance only operates successfully if two core assumptions are true:
- The accident you’re insuring against occurs with reasonably predictable frequency
- The accident does not affect all people in the pool of insurance at the same time
The accident frequency must be reasonably predictable so you can forecast approximately how often you expect a claim. Thunderstorms, for instance, have decades of historical data that nerds can use to statistically predict the frequency of a storm. In order to pay for those predictably frequent damages, insurance companies collect money from customers across the country (even those at far less risk of storm damage). They collect a little cash from as many people as possible so that the unlucky guy whose bowl got torn in half by a tornado can be written a cashable, big fat check to rebuild. Hurricane season is insurable because they can collect money from people all along the Gulf and eastern coasts even though the hurricane will only hit a specific section of the coast in any one storm.
But if the company only collects money from people in the foothills of Northern California (as was the case of the now insolvent Merced Mutual) and a wildfire wipes out an entire NorCal town…well, the company now has claims, at the same time, from nearly every customer they collected money from. And if they didn’t build up a war chest of cash, then they become insolvent and the state seizes their assets.
To flip the example around: pretend your bowlers are premium dollars and that your slow summer times are claims. You have to take money from enough bowlers in the busy season in order to make it through the summer “claims.” Your slow period is predictable in both duration and severity, making it manageable to save up a bank of cash to weather the slow times. But if the “premiums” dry up, or the slow times go longer, then insolvency comes knocking on the door.
Not all losses are insurable.
Government closures in response to a pandemic were never insurable because they’re fundamentally unpredictable and because they affect everyone at the same time. The entire insurance industry worldwide does not have enough money to replace the lost income caused by the shutdowns—which is why the only possible help could come from those who control the money printer.