A pandemic business interruption insurance

Abstract

We analyze how pandemic business interruption coverage can be put in place by building on capitalization mechanisms and a portfolio management strategy. As evidenced with COVID-19, pandemics affect economic sectors in differentiated ways: some are very severely affected because their activity is heavily impacted by travel bans and constraints on work organization, while others are more resistant. This opens the door to risk-coverage mechanisms based on a portfolio of financial securities, including long-short positions and options in stock markets. We show that such a strategy allows insurers to offer business interruption coverage in pandemic states, while simultaneously hedging the risks associated with alternating bullish and bearish non-pandemic states. These conclusions contrast sharply with the idea of governments being the only solution to the pandemic insurability problem. They are derived from a theoretical model of corporate risk management, and their practical relevance is illustrated by numerical simulations, using data from the French stock exchange.