The basics of insurance

Sure, we all know this, but for those at the back of the class, here are the basics. Insurance is the idea of pooling risks so that any individual who suffers the unlikely can be either paid for or compensated out of the premiums of the rest of us. When this is done commercially, the insurance company is collecting the premiums and setting the rates but that is what is being done. Tens of thousands of us pay in premiums so that the individual whose house burns down, or gets that ridiculously expensive to treat cancer, can either get the treatment or another house out of those pooled funds.

Note that this only works with rare events. It’s not possible to use the insurance model on those that are likely to happen – that is what is called assurance, economically at least a different thing. That being a way of saving for something that is likely to happen, not a method of spreading the risk of something unlikely.

Given this distinction between likely and unlikely, there are some things we cannot insure against. This is obvious – or at least should be. One example is flood insurance for a house. There are large areas of the US where no commercial insurer will do so given that the odds of the flood happening are so high. The only way anyone can get such flood insurance in those areas is by buying it off the government.

OK, so, some things can’t be insured against. The things that can be are detailed in the contract for the insurance that is taken out. The premiums are set on what it is that is being insured. Sure, people sometimes get these things wrong but that’s the basics. The insurance company usually does make money on the deal if we include the investment gains on the premium income before it becomes claims payments.

But money is made only if the premiums charged are adequate to cover the risks being insured. This stops being possible if politics or the courts decide that events which were not insured, and thus not paid for, should in fact be covered. The insurance company then finding this out retrospectively.

The coronavirus problem

Business interruption insurance is a usual thing. Some measure of it is present in just about every business insurance contract – if you’re insured against the ceiling falling in, then this will cover some portion at least of the consequential losses of having to wait until that ceiling is dealt with before reopening.

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However, what sorts of interruptions to business are insured depends upon the specifics of the contract – different prices being charged for contracts which cover different risks.

Our coronavirus problem is that both politics and, in some cases, the courts are extending the definitions of the interruptions that should be covered under policies written and priced well in the past. This has at least the possibility of being horrendously expensive for insurance companies. Extended as widely as at least one case seems to be indicating then it would eviscerate large portions of the industry.

AXA(AXA SA share price from Seeking Alpha)

OK, so we see the same swoon in the stock price as the markets in general suffered. With an insurance company, with so much of the profits coming off the investment of the float, perhaps rather larger than the general swoon in fact. But there’s a bigger problem here:

“The firm had refused to pay compensation to Stéphane Manigold, whose four Paris restaurants include the Michelin-starred Maison Rostang. It argued that his policy did not cover the emergency lockdown.

But the Paris Commercial Court ruled this weekend that Axa France must make an initial payment of €45,000 (more than £40,000) to Mr. Manigold while a court-appointed expert assesses the extent of his losses.”

The problem here is not with this one policy. Rather, it’s that the court – and it’s not a junior one – has insisted that the policy covers what the insurance company says it didn’t. For our interests here, it covers what the insurance company was not charging a premium for.

“The court said the administrative decision to close the restaurant qualified for insurance cover as a business interruption loss.

“This means that all companies with the same clause can appeal to their insurers,” Manigold’s lawyer, Anais Sauvagnac, said.

AXA said a small number of its clients in the French hospitality sector were covered for COVID 19-related losses because they bought a special policy. But most clients in the sector did not have that policy and did not quality for compensation, AXA said.”

Our interest, as capitalists, isn’t with whether the court’s claim is righteous or not. It is only with the fact that the insurance company was not charging premiums to cover the losses which it is now stuck with – well, barring a successful appeal that is. The industry itself is indicating that if this new rule is applied more generally, then the industry is on the hook for some €20 billion a month. Which will hurt even for the insurance giants, even if some portion is reinsured up the line.

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This is bigger than just France and AXA

OK, none of us are all that surprised by a French court going slightly off the rails, but this is a larger thing than that. The emotional appeal of “Hey, but we had insurance!” is up and running now. Take this from this morning’s Times in London:

“Insurers certainly have a duty to do their due diligence on all claims submitted to avoid the spurious or the fraudulent. This is in the interests of their shareholders and good business. But it is also incumbent on them to act responsibly to protect their reputation and the long-term health and standing of the insurance industry.

I cannot see a quick solution unless the insurance companies are shamed into facing up to their liabilities, as they have already done in the US and Germany, and settling now in order to salvage our priceless live arts infrastructure before it is too late.”

Other than the rare occasions they get me to do that specific column, The Thunderer is where important people say important things to other members of the establishment. Here it’s that theatres in London had insurance cover and why won’t it pay out? The insurers saying that a government shutdown of everything isn’t an insurable event and anyway it wasn’t in your policy and you didn’t pay the premiums for it. The counter to these truths being that it’s not fair so give us money.

And my estimation of this is that this could indeed be enough to loosen those checkbooks. Or perhaps that the political pressure to do so will become intolerable. Or even, that it will come close enough to that for the regulator to insist that greater reserves must be made against such claims. Any and all of which will damage the finances of the insurers.

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Do note

The point here is not that anyone at all is right or wrong here. I’ve made it plain, in the language used, where my sympathies lie and it ain’t with the uninsured. But we are capitalists here looking for investment opportunities. And when insurance contracts are retrospectively rewritten to include risks that premiums have not been paid upon, then insurance companies begin to look like markedly less attractive investments.

My argument being that sure, this is one court case and a bit of shouting from the aggrieved so far. But I can see the political head of pressure building up here. It wouldn’t surprise at all to find the demand becoming more general, that business interruption claims for the coronavirus will be deemed insured whatever the premiums that were paid or the policies laid out, plain and simple, in the contracts.

My view

I’m thus suddenly wary of the European insurance companies. At the very least, I’d not put more money into them until this is all clarified one way or another. If I had substantial holdings in them, then I’d be looking to make a sideways move to something without this problem hanging over it.

The investor view

In one way, this is just a heads up. Politics is intervening in these business interruption insurance contracts. If everything moves to that current French court interpretation, then there’s a whacking great underwriting loss on the way. Large enough to eviscerate the industry in fact.

I don’t think that all jurisdictions will do so and I doubt even that this will stand upon appeal, entirely as it is, even in France.

But we can see the way the politics of this is moving. Be very wary of those insurance giants at present. The political impetus is to stick them with compensation bills for things they didn’t agree to insure. And here’s our problem, politics sometimes does win out over the law and contracts.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.