Nudging the Protection Gap closed

Insurance is fundamentally a behaviour-driven industry - built on fear and trust. Buyers of insurance fear the unknowns of risk and "transfer" that uncertainty for a measure of certainty - paying for the privilege and trusting the promise be kept.

How does behaviour come into play when considering an Insurer of State model? What if those insured were the first to receive their support?

Covid Messages and lessons

There's an elephant in the room when it comes to insurance - the "Covid Precedent". During Covid, the government stepped in and underwrote entire payrolls, underwrote loans to society and dished out grants through councils (almost like an indemnity).

Yet, at no point - even whilst the maelstrom of legal rancour rumbled on in the background between insurer and policyholder - did anyone who "held" insurance in [Utmost Good Faith] get any kind of preferential government treatment. Nor did anyone in the market ask. How could they? The Brokers who'd placed these coverages were blushing - because their advised capacity was more tortoise than shield - and the Insurers were lining up their litigators to deny the coverage entirely. This wasn't the case everywhere - but enough for the news to cover the tortoises and enough for the rumour that the then Chancellor was heard to say "F*ck Insurance". Indeed. Well more fool him.

the then Chancellor was heard to say "F*ck Insurance".

These policyholders were already alarmed and confused by their Insurers' reactions - now the government was effectively saying "don't worry - we've got you, ignore them". Who needs insurance for the very worst case? Government does that! Does it? Where does it say that? With what tools and institution? Credit? Say that again?!

It was a fundamentally self-defeating precedent for Government in the medium to long term. Particularly when you consider how much fiscal stimulus the State threw at the pandemic response.

No lower interest rates for CBILs, no larger Grants... the State ignored the effort many had made to transfer risk and reduce state contingent liability.

The Insurer of State addresses this.

Not one gap, many gaps

Let's first consider what insurance behaviour creates. When real risks are not "transferred" by businesses and people, a "protection gap" begins to emerge between insurable losses and insured losses. When perils strike, the gap between the indemnity brought to bear and the economic loss is realised.

Swiss Re notably estimated the size of this "gap" to be roughly £2.4tn, in the UK alone. That is more a chasm than a gap. These gaps are everywhere - lending, income protection, natural catastrophe. With the economic loss being uninsured its cost is felt by all society - as the government suffers either GDP loss, or the contingent costs of fixing the losses.

The Shadow of the Gap: This is exacerbated in situations where the pool model cannot or will not transfer risk - excluding activity. The grey zone being where it is not "expecting" to accept liability and transfer risk.

The Insurer of State, as we've considered previously, re-orders the anarchy of the insurance market - by becoming the indemnifier of last resort. Its utmost credibility is instilled by its ability - similar to sibling, the Bank of England - to create capital on behalf of the state. Unlike in Monetary Policy, the liquidity here is solely flowed downstream through the insurance sector.

In simple terms - created capital is administered by insurers on behalf of the Insurer of State (and therefore His Majesty's government.)

It insures all at its discretion, and may primarily choose to insure what has been excluded or unexpected. This is critical and has a definable market effect.

So, where's the nudge?

Thankfully, we have a very recent case study in just this. During Covid, the Government stepped up, providing a series of policy patches. Furlough, BILs, CBILs, "Eat out to help out", grants (to cover cashflow or costs of working), and extra institutional budget contributions.

Many companies had diligently "closed their protection gap" by purchasing Business Interruption insurance. A product designed to cover income loss, or costs of working. Covid, as is well publicised, was deemed to be covered in court - in many cases - but insurers did not often or immediately assume liability, or admit they even intended to cover it. Limits of coverage also likely did not account for the quantum of the losses - nor the fact the entire pool would be hit.

To make matters certain for themselves, insurers either moved to price a repeat of the peril properly, or remove and exclude cover altogether.

Sadly, the news cycle has moved on - so lessons have not been learnt from this historic passage of time. It was, and remains, the insurance industry's greatest lobbying failure - in so much as it did not spot the lobbying opportunity at all.

When it came to accessing or receiving Government remediation; Insured parties gained no priority, no preferential terms for "closing their protection gaps" and attempting to alleviate society's contingent liability.

Insurance buyers were therefore - through Covid remediation measures - trained to expect that insurance was a dubious engagement. Trust was undoubtedly affected between all stakeholders. That risked a widening of the protection gap through reduced coverage and risk transfer. The system is exposed to similar outcomes for any similar future issues - the precedent of Covid now set.

The Magic Money Tree caveat

A business, entity, or person that does not possess related insurance to the peril at hand may not receive indemnity from the indemnifier of last resort.

Unlike a loan, which can be arranged on-demand, an insurance contract has to exist already in order for a liability to be admitted by an insurer. It would therefore be totally spurious and near obtuse for an Insurer of State to ever attempt to indemnify a party that had not first attempted to transfer risk.

Instead of nudging the protection gap closed - this would create a macroeconomic moral hazard to widen the gap. It is therefore critical that this caveat be in place.

This simple but ironclad behavioural premise offers seismic economic theory potential. It creates a "mega-nudge" - pushing societal stakeholders to buy cover, even for seemingly unlikely or hard to perceive risks.

It implies a choice for consumers to avail themselves of the benefits from the indemnifier of last resort. If they choose not to buy insurance from the non-exhaustive examples on the National Risk Register - perils like Solar Flares, Mass Cyber Attacks, Pandemics, Near Earth Objects, Climate Change and Catastrophe; then they have no means by which to make a claim in the event the Insurer of State assumes liability.

A nudge of this kind also allows those manufacturing, and distributing insurance, to offer lower "entry level" limits, which begin to build pools that make future large losses addressable in some manner.

And so, in conclusion, a simple hypothesis: The very existence of a "so-called" magic money tree for insurance actively pushes closed the protection gaps across many classes of business.

For all those choosing not to adopt this protection - there lies the remediation offered by precedent during covid. Loans and grants. One hopes that for policymakers in the future - with the existence of the Insurer of State - such measures do not undermine the potential of this nudge, but rather emphasise its power.