Pandemic: Should Government Ordered Shut Downs Be Government Backed “Business Interruptions”?

There will, no doubt, be several rounds of body blows to the U.S. economy as the result of an unprecedented shut down of business activity–ordered by the government, be it federal, state or local.  This will send insurance agents and underwriters scurrying to their policies to see if there’s a way to deny coverage for business interruption.  Both government and the insurers are acting rationally–one is trying to prevent the spread of the virus, the other trying to avoid massive claims.  But why is this government-ordered shut down not a “business interruption”?  And why shouldn’t the taxpayer in the government unit ordering the shut down also guarantee business interruption coverage payments?

Small business, including restaurants, festivals and live music venues are caught in the middle in a sudden contraction that they no doubt thought they were insured for under overlapping policies that included losses from business interruption.  We are already seeing small businesses–which are something like 90% of all jobs–lay off employees.  This creates the kind of demand side collapse that leads to a true depression and unemployment at 30%.

Beware the Ides of March

So far all of this has happened in March.  April is just around the corner and on April 1, rent or mortgages are due.  When businesses are ordered to shut down, they will have to start depleting their cash reserves or drawing down on credit lines.  When employees are laid off, they will do the same.  When April 1 comes, both employers and employees will need to make some hard choices, and thus the cascading effects of the denial of coverage really begin to accelerate.  It is only a matter of time before they will fail to pay their credit cards or loans or rent (some states are passing emergency rules that prohibit eviction for the duration), and when that happens on this scale it can have catastrophic  effects.

Because guess what?  All that debt is still being sold in a very similar way to the commoditization that lead to the 2008 financial crisis.  If your business loan or mortgage was with the local bank and you couldn’t make your payments, you could go sit with your banker and figure it out.  Your banker wants to keep you in business, and you want to keep being able to borrow from your banker.

But when your loan is sold as part of a financial instrument, there’s no one to talk to and you either make your payments or the loan defaults.  Green light or red light.  No amber.

The challenge then today, and I do mean today, is to get cash into the bank accounts of small business so they can keep at least some of their staff and pay their rent.  Ideally, this needs to be done by April 1.

No Live Music Capitol With No Live Music

Assuming of course you want them to reopen at some point in the not too distant future.  As I am regrettably fond of saying to people in Austin, it’s kind of hard to be the Live Music Capitol of the World when there’s no live music.  And without venues, there’s no live music, and without live music there are far fewer bars, restaurants, condos, Uber, or increasing property values, not to mention far fewer hotels, airline tickets and rental cars.  So all of those intricate economic relationships come down to musicians, songwriters and venues.  (See the Austin Music Census.)

You have to be pretty naive to think that you can just put all that on hold and then weeks or months later it will just snap back to where it was before the government shut it down.  So do we agree that the situation is beyond dire?  It is life changing.  Perhaps for all the right reasons, but that doesn’t make it any less life changing.

Austin, San Francisco, New Orleans, Memphis, lots and lots of cities outside the “centers” need to solve this problem right away.  Otherwise, Austin will just be another college town with a Google campus.  I promise.

Solving for Business Interruption Coverage

Solving this problem will require different tools for different reasons, but on the small business side, one way to do it would be for the federal government to deem the shutdowns ordered by various levels of government to be a business interruption covered by business interruption insurance and to guarantee payments under those policies.  There is already a billing relationship between those carriers and their insureds and the transaction costs of handling it this way will be far less than the government essentially re-creating the exact same financial structure.

Along the way, thought can be given to how to solve for those who are ordered to shut down who do not have business interruption coverage.  Some strings could be put on the use of funds, so that the payments must be used to pay rent, suppliers and employees.   Insurers should be prevented from price gouging and should be required to cap their administrative costs.  This would not be a loan, it would be a direct payment of an insurance casualty benefit.  We may need to look into special bond offerings to finance these payments.  (For comparison, the World Bank issues a parametric catastrophe bond that covers pandemic risks as part of its Pandemic Emergency Financing Facility.)

Making America Creditworthy Again

Alongside this type of bold move would be a requirement that any defaults on credit following a government ordered shutdown cannot be reported to the credit reporting agencies or taken into account for a borrower’s creditworthiness in the future.  That step needs to be covered, too, because that’s just exactly the kind of kafka-esque shenanigans that these people would come up with if left to their own devices.

I want to encourage everyone to read the op-ed by Ben Bernanke and Janet Yellin in the Financial Times. You may have to register to read the post, but it’s a vitally important step to understanding the real issues with the current crisis.  Here’s the key paragraph from the FT post:

If critical economic relationships are disrupted by months of low activity, the economy may take a very long time to recover. Otherwise healthy businesses might have to shut down due to several months of low revenues. Once they have declared bankruptcy, re-establishing credit and returning to normal operations may not be easy. If a financially strapped firm lays off — or declines to hire — workers, it will lose the experienced employees needed to resume normal business. Or a family temporarily without income might default on its mortgage, losing its home.

To avoid permanent damage from the virus-induced downturn, it is important to ensure that credit is available for otherwise sound borrowers who face a temporary period of low income or revenues.

I’d add that to avoid permanent damage from the government-ordered downturn, it is also important for the government to ensure that cash is available before April 1 for business interruption losses that would otherwise be denied because of unseen underwriters denying coverage.

 

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