Double Indemnity for Insurers: Pandemic Flu and Earthquake in Mexico

Double Indemnity for Insurers: Pandemic Flu plus an Earthquake

Double Indemnity is defined as an accidental death benefit that is equal to the face amount of a life insurance policy’s basic death benefit and is paid when the insured’s death is the result of an accident as defined in the policy.

With current news about the potential for pandemic flu and a 5.6 magnitude earthquake hitting southern Mexico, one could certainly be reminded of how uncorrelated events can sometimes happen at the same time. Now that stress-testing is being done for the banks, it is clear that the job of insurers is to make certain that they are prepared as best as possible for dual events that can cause financial stress.

Economic Impact of Pandemic flu

Pandemic is defined by Webster’s dictionary as an epidemic “occurring over a wide geographic area and affecting an exceptionally high proportion of the population”. By this definition, we are still very far away from pandemic flu in the current situation. Nonetheless, while mortality has generally been improving over many decades, pandemic flu still poses the potential to cause a one-time mortality shock to life and health insurers. With insurers already reeling from weakened investment portfolios, any pandemic would certainly have the potential to further weaken company financials.

Fortunately, flu epidemics occur infrequently, and sanitary conditions are generally better today than in years past. However, it remains to be seen whether or not the current swine flu making the rounds globally will emerge into something greater. The scare is that any flu epidemic might resemble the 1918 Spanish flu, the largest outbreak in the 20th century, which led to over 40 million deaths worldwide.

The last major flu scare occurred in early 2003, with the outbreak of SARS. It was first reported in Asia, and over the next few months, the illness spread to more than two dozen countries around the world before the global outbreak was contained. In total, 8098 people world-wide became sick with SARS; and of these, 774 died.

The 3 types of flu – SARS, avian and swine flu -- come from different viruses and present different danger depending on ease of transmission and virulence. The Spanish flu was so deadly because it spread so widely. The World Health Organization learned a great deal about containment with SARS, and there is no indication at this time that the current swine flu cannot be contained.

However, with new insurance regulation likely to be forthcoming, it is possible that the current flu outbreak could lead to additional capital requirements for life and health insurers. The broader economic impact would depend on the severity and spread of any epidemic. The effects of a serious pandemic would tend to be deflationary in global terms. On the positive side, life and health insurance premiums continued to grow following the SARS scare, and are likely to do the same in the current situation, particularly as the economy recovers.

Earthquake in Mexico

As for the earthquake, it was considered moderate, and there were no reports of death or injury. While a significant earthquake could potentially affect property-casualty insurers, the degree of earthquake property coverage in emerging markets is limited. Although there could be substantial losses for business interruption from both the quake and the flu, Mexico has low insurance penetration, so most economic losses will not be insured losses. In the aftermath of the major earthquake that struck Mexico City in 1996, the Mexican government formed FONDEN, a natural catastrophe fund. But fiscal resources were limited, and in 2006 the government pursued a capital markets solution. As such, hits to any US insurers and/or reinsurers as a result of the earthquake are likely to be limited.

Disclosure: No positions in any insurance stocks.

Comments

[aequi-libria:]

rather than accepting ever increasing capital requirements to cover potential mega-catastrophic events, insurers would be well advised to insert market loss limits into their direct policies. Should the market loss exceed US$ x billion, then all claims would be proportionally capped. This is already being applied in the Japanese and Swiss markets.

Philipp Thomas

Apr 28 10:44 AM