Supporting global recovery andresilience for customers and economies
The insurance industry response to COVID-19

Sharing risk to create a braver world

Open source
frameworks for
systemic risk

Lloyd’s. Open source frameworks for systemic risk

02

Contents
Open source frameworks 	

03Open source framework 1: ReStart 06
Open source framework 2: Recover Re 09
Open source framework 3: Black Swan Re 21

Disclaimer
The conceptual frameworks and proposals set out inthis paper are designed to bring consumer and publicbenefit by promoting competition and innovation of
initiatives that could be developed through appropriate
partnership between the insurance industry, governmentand customers. The proposed solutions are intended forconsideration where particular cover for large scale
systemic risks is not commercially available to customers
in any particular jurisdiction and pooling and othercollective action is therefore necessary to create thecapacity to provide solutions to customers. Structures
given are by way of illustration or example only. Any
solutions would need careful competition law considerationin the relevant jurisdiction and discussion with relevant
regulators before any steps were taken to implement theconsultation proposals.

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Lloyd’s. Open source frameworks for systemic risk

Open source frameworks

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Lloyd’s. Open source frameworks for systemic risk

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ReStartOverview

Open source frameworks
This document outlines open source frameworks for three ofthe potential structures outlined in Supporting global recovery
and resilience for customers and economies, the paper developedby Lloyd’s in response to the COVID-19 crisis and in preparation
for future systemic risks.
These open source frameworks provide a blueprint
for the insurance industry to help strengthen societal
resilience in the face of black swan events.

This paper sets out a conceptual framework foreach structure to support discussions in different
jurisdictions across the globe, including:

The three frameworks are as follows:– An overview of how each framework could work,
key benefits, and the role of the insurance industry
and government (where applicable)– Open source framework 1: ReStart– Open source framework 2: Recover Re– Open source framework 3: Black Swan Re– In addition, the Recover Re section includes anillustrative example of how the framework could
work in practice, with example cashflows andaccounting and capital implications, because these
are important components of the feasibility andattractiveness of the structure

Insurance pool tooffer non-damage
business interruption
coverage for future
waves of COVID-19
		

Recover Re

Black Swan Re‘After the event’ insurance
product, providing immediate
cover for non-damage businessinterruption, including COVID-19,
with premiums charged overthe long term

Government-backed
industry pool for systemic
risk, reinsuring commercial
non-damage businessinterruption cover

Coverageoffered– Non-damage business– Non-damage businessinterruption coverageinterruption coverage forfor potential future
potential future waves ofwaves of COVID-19
COVID-19 where commercial
		cover is not available		– Non-damage business		interruption cover for		future pandemics
		– Could include cover for		other systemic events
		
			
			
			

– Government-backed
reinsurance of nondamage businessinterruption cover for
future systemic events
where commercial
cover is not available– Could also provide coverfor secondary impactsof future events such as
supply chain disruption– Would enable greater
provision of non-damage
business interruption coverPricing and– Premiums charged
affordability
upfront for annual policy
		
		
		
		

– Full risk cost may
not be passed tocustomers given
government backstop

Structureand funding
mechanisms

These frameworks could be implemented nationallyor regionally, and would need to be adapted for
local regulatory requirements and standards, andare, of course, subject to local competition law
considerations on which advice should be taken.

Risk borne by
government

Scale, target
segments– A flexible pricing mechanism
would allow insurers torecover upfront claims
costs over a long period(e.g. 10-15 years), ensuring
affordability for customers– Pooled capacity from– Recover Re is a direct– Industry-pooled capitalinsurers to provide
non-damage businesswould reinsure
targeted non-damage
interruption productinsurers offeringbusiness interruption cover
aimed directly at
primary cover for
directly to businesses
businesses
future systemic events– Participating insurers– Multi-year contract– Backed by a government
could ensure the productwith requirement forguarantee should the pooled
is affordable to customers andmandatory premium
assets become exhausted
manage their own exposure
payments over the full
through a number of measures,term, or cancellation
including risk pooling, variable,
penalty to ensure insurers’		
limits and industry or
claims costs are recovered
geographical diversification				– No requirement
for a government
backstop
		
		
		
		
		
		
		
		
		
		
		

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Comparison of proposed features of the three frameworks– Government may be– Government would takerequired to guaranteeon the excess claims forpolicyholders’ future premiums
non-damage businessto mitigate the risk of theminterruption beyond
defaulting on payments
an agreed insurance– If early event of significant
industry retention
scale, government may berequired to provide initial
cashflow to cover claims
payments in the earlypart of the policy term
– Option for credit risk
mutualisation to minimise
government contingent liability		– Relatively small scale– Targeted at specific SME
and targeted initially at
economic segments tosmaller SMEs, with scope
manage liquidity
to expand over time
– Would either need to be– Optional for customers
a compulsory or long		term contract
		
			
			
			
			
			
			

– Broadest coverage –reinsuring all national
systemic risk non-damage
business interruption cover
beyond agreed retentions– May need to be either 		mandatory to offer or to
obtain, to ensure meaningful
take up, otherwise there
may be a presumption thatgovernment will continue
to provide implicit coverLloyd’s. Open source frameworks for systemic risk

Open source framework 1: ReStart

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Lloyd’s. Open source frameworks for systemic risk

07Open source framework 1: ReStart

Lloyd’s. Open source frameworks for systemic risk

1. Considerations for coverage offered and risk covered

Overview of the framework
ReStart is a commercial structure for pooling risk between insurers
to support SMEs with their return to work. It is currently being
developed within the Lloyd’s market to pilot with UK SMEs.

ReStart could specifically target future waves of COVID-19 to protect SMEs
Consideration

Design options

Types ofrisks covered

Many industry segments - and SMEs in particular have suffered significantly since the onset of the
COVID-19 pandemic. Lockdowns have restricted
the ability of SMEs to operate. The smaller natureof these businesses means that recovery will bechallenging and heavily dependent on cashflow.
A second wave of COVID-19 would exacerbate
this situation and could lead to insolvencies.

The key benefits of ReStart for customers include:

1. Pandemic-related non-damage
business interruption – differencein conditions with existing businessinterruption
2. Potential to include Employers
Liability or Public Indemnity cover,given emerging concerns aroundreturn to work liabilities
		–R esilience for a key sector of the economy andsupport for the recovery from COVID-19

Approach todefining triggers

Going forwards, customers will seek competitive
insurance solutions which protect them from thefinancial consequences of business interruptions
caused by a second and subsequent waves of thepandemic. If cover cannot be provided affordably
then many businesses are likely to operate without it.

–C ontributes directly to customers and theirrecovery from COVID-19, helping strengthen
customer relationships over time

The insurance market needs to respond to this needeven though there are several challenges to doing so.

–C ertainty of business interruption coverage for asecond wave of COVID-19 to customers where
few alternatives are available–M anages customer affordability and insurers’
exposure through risk pooling, variable limits andindustry or geographical diversification
Developing a ReStart product should beachievable in 2 to 3 months from commencement,
though a launch could be aligned with 1/1 renewals
once the likelihood of further waves of COVID-19
becomes clearer.
It will still be subject to the usual Lloyd’s performance
management requirements and competition law
considerations. This structure is given by way of
example only and all insurers are of course free toprovide cover on any terms they wish.

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08

1. Evidence of specific event:international body or government
announcement (e.g. local lockdown
due to COVID-19)
2. Evidence of business disruption:business metrics such as a drop in
economic activity or an increasein absenteeism rates, or a government/
regional mandated lockdown

Implications– The product should provide certainty ofbusiness interruption coverage for any future
waves of COVID-19– Could be offered as standalone or as an extensionof existing products– A clear definition, trigger and wordings are vital
to avoid potential disputes around claims– Potential lack of diversification, high correlation withmarket risk and increased exposure to a live risk
– A trigger should be designed which ensures claims
are paid when affected policyholders need it
most, while avoiding those that are unaffected– The trigger should remain relevant after the
first year of policy (i.e. beyond any potential
second wave of COVID-19)– Future lockdown restrictions may be applied
at a local level as opposed to the current
national lockdown

2. Additional considerations
By targeting smaller SMEs, ReStart could benefit a large number of customers while diversifying risk
Consideration

Options

Target customer
1. Defined by geography, industry or
basecustomer sector
		
		
		
		
		
		
		

The insurance response to COVID-19

Implications– Product should provide protection to key sectorsof the economy. Smaller SMEs are obvious
candidates given the issues this sector has faced
and the lower capacity they require compared tolarger businesses– A broader geographic and sector scope offers
larger potential diversification benefits to insurers,
but requires larger capacity and is more complex
to launchLloyd’s. Open source frameworks for systemic risk

Open source framework 2: Recover Re

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Lloyd’s. Open source frameworks for systemic risk

10Open source framework 2: Recover Re

Lloyd’s. Open source frameworks for systemic riskA graphical representation of how Recover Re could work:

Overview of the conceptual framework
Recover Re is an ‘after the event’ insurance product, which
could provide immediate relief and cover for non-damage
business interruption, including the current COVID-19 pandemic,
over the long term.
This could be an efficient way of getting commercial
and government capital into the economy, providing
relief to those customers with limited borrowing
capacity and providing cover where it cannot be
offered on commercial terms.

Role of the insurance industry: to provide the risk
management expertise and infrastructure to inject
capital into the economy by directly supporting SMEs
affected by the current pandemic and which are likely
to be impacted by future waves.

The key benefits of Recover Re for customers
include:Role of government (if required): provide initial
cashflow to cover claims payments in the earlypart of the policy term, and well as guarantee
premiums to mitigate the risk of customers
defaulting on payments.

– Immediate cash injection and recovery support,
paid for over the long term
– Non-damage business interruption coverage for
future waves of the COVID-19 pandemic should
disruption continue past a specified time period
or when losses exceed a specified excess– Non-damage business interruption cover for future
pandemics; it could also include other systemic
events, but this would add complexity and could
delay launch– Cover against secondary impacts of future events,
such as supply chain disruption

There are numerous design options to consider,with implications for fairness, affordability andattractiveness for customers, as well as potential
accounting and capital benefits for both customers
and insurers. Designed correctly, Recover Re avoids
the insured’s balance sheet from being negatively
impacted by ongoing liabilities and provides animmediate cash injection at the time of thecustomer’s need.

11– Payspremiums
over policy
term (e.g.
10-20 years)– Pooling ofpremiumand risk

Individual
insurers

Policyholder(business)– Payment for
credit risk
guarantee

Transmission
vehicle– Claims
payments
for current
disruption– Cashinjection
to coverimmediate
losses– Claims
payments forpossible future
disruption– Guarantee
againstpolicyholder
default– Guarantee
againstpolicyholder
default

Government– Cashinjection
to coverimmediate
losses– Performanceequalisation

Illustrative timeline for implementing Recover Re
ReCover Re
3-6 months
Broader industry and customer consultation
Establish working
group (including
SME insurers andbrokers, customers,
government andregulators)
Agree designprinciples and target
segments
Detailed design of proposed solutions including policy
terms and legal structure
Establish Recover Re structure and update
legislation, if required
Implementation

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Lloyd’s. Open source frameworks for systemic risk

12Open source framework 2: Recover Re

As part of the proposed framework, a pricing mechanism would be in place to allow insurers torecover upfront claims costs over the length of the policy term (circa 10-15 years), ensuring
affordability for customers.

Recover Re would provide non-damage business interruption coverage for a potential future waveof COVID-19, as well as for cover for future pandemics and other systemic events.
Design options

Types ofThe cover for non-damage businessrisks covered
interruption could be triggered:		
1. In the case of pandemics only
2. Could also include broader
systemic events						
Approach to1. The use of dual triggers for claim payments
defining triggers
is one potential option, for example:
		– Evidence of specific event:World Health Organisation pandemic
declaration, utility capacity drops by x%,
global crop yields drop by x%		– Evidence of business disruption:
an x% drop in economic activity or agovernment-mandated lockdown

Design options– A mechanism that is flexible and allows premiums toadapt after a loss is incurred makes the productmore affordable and spreads costs over a longer
period for the policyholder

		
		
		

– Adapting premium post-event rather than fixing
premium upfront, requires far less modelling andpricing expertise for these risks

Premium over time

– Given the variety and nature of systemic risks,setting the appropriate triggers to identify whenclaims should be paid is invariably going to
be complex

The premium amounts paid
over time could:		
1. Remain level
2. Step up over time as businesses
recover– Premiums could be increased over time to make thepolicy more affordable upfront and avoid additionalstrain during the recovery. However, weighting thepremium payments during COVID-19 recovery to
be greater in later years could increase the levelof credit risk

Payment frequency– There should be a way of identifying both what iscovered in the insured’s policy and what is passed
through to a reinsurance pool		

– Administration costs could be impacted (asmonthly payments could mean more administrativecost) but should largely be a matter of policyholder
convenience and required cashflows to meet 		necessary business obligations– There is an opportunity to broaden the scope of
this product beyond pandemics. However, careful
thought will be needed to define the triggers of futuresystemic risks, which are hard to define or anticipate.
This could delay the launch of a product which has
immediate application– Cover could be limited (e.g. to staff costs) to makethe premiums more affordable– It is likely that both a ‘waiting period’ and loss limit
per event or in aggregate would be required to makethe product viable for insurers to offer. However, thisneeds to be balanced by its attractiveness andusefulness to customers

Claims payments– Simplicity is likely to be key to making this productsuccessful, particularly for use in the current situation.
However, several nuanced caveats may be helpful toconsider in order to enhance the attractivenessand/or usefulness of the product1. Premiums paid monthly
2. Premiums paid annually		

Policy term
The policy could be designed as either:		
1. Fixed term
2. Fixed term, which is extended upon
future claims event
3. Compulsory, annual renewable cover
		
		
		
		
		
		
		
		
		

– The suggested structure and long-term natureof the policy, including the ability of the policyholder
to switch insurers, is likely to have competition law
and customer fairness implications which would
be the material and would need to be addressed– A mechanism must be put in place to allow insurers
to recover upfront claims costs over a long period toensure the affordability and viability of the product– The ‘compulsory’ nature of the cover, in light of atargeted rollout, raises further considerations, but
this could be managed by making it compulsory
once customers have opted in– Finite (re)insurance products (such as mortgage
indemnity) were popular in the past, but resulted in
tax and accounting complexities		

If a simple approach was taken, there would
be the option to reconcile it against actuals
afterwards

The insurance response to COVID-19

Implications

1. Fixed premium
2. Variable premium with anincrease following loss payment
		

1.‘Waiting period’ before claims payments
kick in and/or
2. Meaningful limit (individual or aggregate)
on losses
		The benefit amount or loss amount for
claims could be based upon:		
1. Prior years’ accounts
2. A formulaic approach e.g. % of
rateable value
3. An option to make partial payments forpartial business interruption, e.g. if thebusiness can operate at 20% capacity,
payments would be made at 80% of fullbusiness interruption

Consideration
Pricing considerations

Implications

2. An alternative or parallel approach would
be to allow government to trigger or
certify a loss event. This approach has
precedent in some jurisdictions - forexample, terror events in the UK
Excess and limits

13

2. Approach to pricing and affordability

1. Coverage offered

Consideration

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14Open source framework 2: Recover Re

The Recover Re framework may require government to guarantee policyholders’ future premiums
to mitigate the risk of them defaulting on payments. If of significant scale, government may be required
to provide initial cashflow to cover claims payments in the early part of the policy term.

Recover Re would be a non-damage business interruption product for pandemics aimed directly
at businesses. The contract would be a multi-year or compulsory product, allowing insurers to recover
their positions over time. There would be a requirement for mandatory premium payments over thefull term or a cancellation penalty to ensure costs are recovered.
Design options

Portability
Valuation		
1. How will the contract be valued? How arepremium payments run-off against theexperience account whilst allowing insurers
to be compensated for carrying risk, forgone
investment income and expenses?
2. How will the settlement take place in caseof defaults, discontinuance of business etc?
Frequency
1. How often can the provider be changed,
given the long-term/compulsory natureof the product?
		Additional considerations

Implications– The portability of the product between insurers
will be important to address any competition
law or customer fairness concerns– Additional considerations around pricing,insurer expenses and profitability will need to
be worked through to determine how portability
would work
– A clear, well-governed methodology forbalances applied to the experience accountto facilitate portability– A mechanism and/or body to facilitate andadminister transfers as well as adjudicate
transferring balances would be required
should the policyholder go insolvent before
losses are recovered

1. Adjustment for investment income andunderwriting loss
Where risk sits
within theindustry

1. The insurance contract could be between
individual policyholders and the insurer;
thus, the risk would sit on the individual
insurer’s balance sheets– The accounting and capital implications resulting
from the rest of the design may impact how insurers
wish to manage this risk - on their balance sheet
or otherwise

Consideration

Design options

Transfer of risk
to government

Risk borne by government
1. The credit risk of Recover Re would besignificant and would need to either bemutualised or passed to government.
It is expected that government would
provide a backstop such that when businessis declared insolvent, government pays
the outstanding balance due

2. Recover Re could mutualise the credit rather
than passing it to government, to make it moreclearly an insurance product and to reduce thefor carrying risk burden on government
		Entity taking on the credit risk		
1. Will an existing structure be used e.g. in
the UK Government’s Export Finance?
		
2. What will the new structure look like?
3. Who will manage this mechanism ingovernment?

Implications– Given the target market and long-term nature ofthis product, a government guarantee of the futurepremium flows will be critical to make this affordable
for the customer– The ability of the policyholder to annul their liability
in the scheme as a matter of last resort should
allow them not to have to recognise the full futurepremium costs on their balance sheet as a liability– As government would carry the credit risk, there
would need to be the relevant legal and administrative
mechanisms in place to compensate the insurer– Depending on the size and scope of the scheme
there may also be a requirement for government
to provide liquidity support to the industry,
although this this would only be expected in
the case of a large scale roll-out– Government is likely to expect to be compensated

Administration			
1. How will defaults under the scheme be
adjudicated, valued and administered?
2. Will payments be made directly fromgovernment to the insurer or via an

2. Alternative structures could be explored toallow insurers to carry this risk off theirbalance sheets

The insurance response to COVID-19

15

4. Risk borne by government

3. Structure and funding mechanisms

Consideration

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Lloyd’s. Open source frameworks for systemic risk

16Open source framework 2: Recover Re
5. Scale, target segments and compulsory nature
Given the immediate liquidity considerations it is likely that Recover Re would need to be targeted at
specific economic segments, such as the worst-affected SME sector, to provide immediate cashflow relief.
Consideration

Design options

Implications

Target customer
base

1. SME businesses are one logical target for
Recover Re as they are likely to be more
vulnerable to some of the systemic risks
highlighted. This is due to potentially having
relatively lower cash reserves and less ability
to adapt quickly to the challenges posed bysystemic risk events– Targeting subsets of the economy may present
implementation challenges and the potential
to unintentionally exclude certain at-risk areasof the economy– A less absolute way to target support could beto design claims pay-outs in such a way thatthey disproportionately benefit smaller businesses

2. There is also the potential for this type ofstructure to support the economy more
broadly and offer support to mid tolarge-scale businesses
Compulsory
nature andinteraction
with othercovers

1. There may be a demand for Recover Re
without any compulsion– Uptake of cover could present a challenge as
government has already set a precedent tointervene in the occurrence of a systemic event.
This means incentives to buy cover will need to
be well thought through2. Alternatively, offering coverage could be
mandatory, with clear guidance on how
insurers and intermediaries must present
and offer coverage. This could potentiallybe attached to existing compulsory covers,
for example, Employer’s Liability		– Making the purchase of cover mandatory could
raise competition law and customer fairness
issues, although different jurisdictions takedifferent approaches to mandatory cover				– Interactions with other government stimuli
should be considered

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Lloyd’s. Open source frameworks for systemic risk

17Open source framework 2: Recover Re
Recover Re in practice
The case study below uses an example of a restaurant potentially covered by ‘after the event’ insurance.
A restaurant with a rateable value (or equivalent commercial tax banding measure) of $20,000, currently
closed due to lockdown measures, purchases a Recover Re policy on 1 July 2020. The policy covers
50% of rateable value ($10,000). Premiums would also be paid monthly and adjusted over time,depending upon the accrued losses, subject to a minimum and maximum premium, and paused during
periods of disruption/loss events.
This policy begins while lockdown is still in place for the restaurant sector and continues for five months until
30 November. During the first month a waiting period applies in which no claims payment can be made (and,equally, no premium is collected), after which time the policyholder receives their monthly claims payment for
the following four months.

Payments topolicyholder

31/07/20

31/08/20

30/09/20

31/10/20

30/11/20

31/12/20–$10,000$10,000$10,000$10,000–

First payment
made after
waiting period

Payments
stop after
lockdown

When the lockdown lifts on 1 December, the restaurant owner begins paying compulsory premiums of$272 per month (the rate required to pay back claims costs over the policy term of 15 years).
31/07/20

31/08/20

30/09/20

31/10/20

30/11/20

31/12/20

Pure Premium

$0

$0

$0

$0

$0

$228

Expense andprofit loading

$0

$0

$0

$0

$0

$44

Premium paid

$0

$0

$0

$0

$0

$272

Premium payments
paused during
disruption

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18Open source framework 2: Recover Re
Recover Re in practiceOn 1 April 2033, the insured is affected by another black swan event that triggers a four-monthlockdown. During this time their premiums are paused and claims pay-outs resume at a
inflation-adjusted amount of $13,785.

Payments topolicyholder

30/04/33

31/05/33

30/06/33

31/07/33

31/08/33–$13,785$13,785$13,785–

One month
waiting period
applies again

Claim payments
inflated overtime

Post lockdown, the premiums are adjusted to reflect the increased level of accrued losses (reflecting
premiums already paid to date for the 2020 event); this results in an increased premium amount of$320 per month.
31/07/20

31/08/20

30/09/20

31/10/20

30/11/20 31/12/20 –31/03/33

30/04/33 31/05/33

30/06/33

31/07/33

31/08/33

30/09/33

31/10/33

30/11/33

Pure‘premium’

$0

$0

$0

$0

$0

$228

–

$228

$0

$0

$0

$0

$270

$270

$270

$270

Expenseand profit
loading

$0

$0

$0

$0

$0

$44

–

$44

$0

$0

$0

$0

$50

$50

$50

$50

Premium
paid

$0

$0

$0

$0

$0

$272

–

$272

$0

$0

$0

$0

$320

$320

$320

$320

Premium payments
paused during
disruption

Premium payments
calibrated to recoup
claims costs over time

The insurance response to COVID-19

Premium payments
paused during
disruption

Premium stepped up toreflect updated
experience balanceLloyd’s. Open source frameworks for systemic risk

19Open source framework 2: Recover Re
Recover Re in practice
The insured continues paying premiums at this level until the total cost of claims previously paid is reached(which could be over the 15-year policy term). After this point the customer pays a lower premium to accrue abuffer for future events and retain cover. If the customer goes out of business before the end of the policy
term, government would step in to provide the shortfall to the insurer.
31/07/20

31/08/20–

30/11/20–

31/12/25

30/04/33

31/05/33

30/06/33–

31/07/37

Cumulative‘pure
premium’

$0

$0

–

$0

–

$13,943$34,057$34,057$34,057–$47,030

Cumulative
claims paid–

$10,000–$40,000–$40,000$40,000$53,785$67,570–$81,355

Total value$0-$10,000–-$40,000–-$26,057-$5,943-$19,728-$33,513–-$34,325

In this case there is no time tobuild up a surplus before the first claim
is paid because the policy starts
during a lockdown

The insurance response to COVID-19

Government repays
deficit from theexperience accountwhen insured defaults

Lloyd’s. Open source frameworks for systemic risk

20Open source framework 2: Recover Re
Accounting and capital implications
The Recover Re framework could have thefollowing accounting implications for the insurer
and the customer:
For the insurer– On profit and loss: whilst the contract in the firstyear is likely to be loss-making, the insurer will notnecessarily need to recognise this in the P&L inyear one, depending on the accounting treatment
adopted (e.g. they may be able to recognise thefuture premium income stream, and thus not haveto recognise an unearned loss)– On the balance sheet: future premiums still to bereceived could be recognised on the balance sheet.
In terms of regulatory capital, insurers may be able
to recognise future profits from future premium
streams and use them as an offset against capitalrequirements– On liquidity: whilst not a significant strain on theirinitial balance sheet (in fact potentially the opposite)
there will be a significant liquidity strain upfront if
claims are immediately payable before insurers
receive any premiums

For the customer
Accounting treatment will depend on the detail of any
contractual obligation, obligating events, and the levelof uncertainty over timing and amount of premiums.
– On profit and loss: structural arrangements toachieve recognition of only current year premium
outflow and claims inflow is to be exploredand may be possible– On the balance sheet: structure and contractual
arrangement to be explored that will enable balance
sheet liability recognition of only the current year’s
premium (rather than recognise future year
obligations to pay for coverage). Such a treatment
would not put the same strain on the balance sheet
as a loan agreement
In order to avoid incurring liability for future premiums,
the insured would need to be able to avoid paying thepremiums or only have the obligation to pay thepremiums as business is conducted in future years.
Note: the accounting treatment is highly judgmental,
given there is no IFRS accounting standard that
addresses policyholder accounting (it is scoped out
of IFRS 4 and IFRS 17).
Therefore, it needs to be determined whether theaccounting treatment should apply the principles in
IAS 37 or those in IFRS 9. There is a risk that thefactors required to ensure that the SME would notrecognise a liability for all future premiums, could be
the factors that would work against the insurer being
able to recognise an asset for future premiums. A
key next step is to perform detailed assessment tovalidate that the product can be designed in a way
such that the above outcomes are achievable.

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Lloyd’s. Open source frameworks for systemic risk

Open source framework 3: Black Swan Re

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21

Open source framework 3: Black Swan Re
Overview of the conceptual framework
Black Swan Re is an open source framework which would provide
coverage for future systemic risks through insurance industry-pooled
capital, with a guarantee from government to pay out if ever the pool
had insufficient funds.
The losses arising from systemic risks aggregate
across policies and are often difficult to predict ormodel, and as a result they are largely uninsurable
within the existing infrastructure.

– Food or critical resources supply chain failure:
this could be a significant supply chain shock forcritical resources that could have major global
economic, political and social effects

Lloyd’s. Open source frameworks for systemic risk

23

By definition the costs of these types of events would be in the trillions of dollars and, as such,the contribution from any indusry partnership would be relatively small in the short term.
However, it would provide some buffer and the pool would increase in time.
... but over time the pool will growand industry’s ability to write
commercial cover could increase

Government contribution to
the risk will always be a large
proportion of an event ...

Government layer

22

Government layer

Lloyd’s. Open source frameworks for systemic risk

Pool layer

In identifying the protection gaps an insurance
industry and government partnership could address,
there are two risk areas to consider:– Risks excluded by commercial covers– Key risks on a government’s risk register
It is important to consider both factors in turn,both in order to create an efficient use of thecommercial market and to avoid competition
law issues by demonstrating there is market failure
before considering collaborative industry solutions.
These systemic risks could have major economic
impacts or cause civil disruption. Such risks can
include, but are not limited to:– Major public health emergency: causing mass
lockdown, resulting in a significant fall in economic
activity and lost revenue– Widespread telecommunications or utilities
failure: this could take the form of a global cyberattack impacting millions of devices across multiple
industries and critical infrastructure, or space
weather in the form of an extreme geomagnetic
solar storm shutting down critical electricity, GPS
and transport infrastructure around the world fordays or possibly months–A ccelerated climate change: this could act as arisk multiplier, amplifying the effect and frequency
and severity of events such as wildfires, flooding
and other natural perils, whilst extreme local
temperatures could lead to permafrost melting
or damage to infrastructure. These events could
cause widespread environmental harm as well as
disruption to food, water and other critical services.
This would lead to geopolitical tensions, andeconomic and investment market damage
In any of the scenarios above, the aggregate losses
could exceed multiple trillions of dollars. Using agovernment and industry partnership, a robust
infrastructure could be built to cover a reasonableproportion of similar future losses. This concept ofa public/private partnership is well-established inmany jurisdictions around the world.
Through a partnership with the insurance industry,
a portion of systemic risk could be covered
commercially with a government backstop. This covercan either be built up over time through contributions
from insurance policies, paid back after the event or
be funded through taxation.
It is expected that the pool would grow over time andbe able to absorb larger risks. An insurance industry
vehicle would also share knowledge and expertise tosupport risk mitigation, loss adjusting and, where
possible, enable it to take on more of the risk.

Pool layer
Commercial layer

There are several benefits to such a public
private partnership:– Ensuring that incentives are aligned and society’s
perception of systemic risk improves will prompt
customers to introduce behaviours that mitigate
their exposure to these risks– Brokers can help customers visualise risks not
immediately apparent to them and encourage
greater protection– Transferring risk to the commercial sector
reduces government’s exposure to thesesystemic risks over time
– Access to proven global insurance expertise toassess and better manage these types of risks
and provide loss adjusting capability in times ofcrisis – presenting the opportunity for a more
equitable solution– Alignment with broader industry products
available to policyholders– Availability of a ready-made infrastructure to
funnel government funds to affected partsof the economy

The insurance response to COVID-19

The insurance response to COVID-19

Commercial layer

Lloyd’s. Open source frameworks for systemic risk

24Open source framework 3: Black Swan Re
Illustrative timeline for implementing Black Swan Re

Black Swan Re
6-12 months
Broader industry and customer consultation
Establish
working group(including
insurers,
brokers, relevant
existing vehicles,
customers
government andregulators)
Detailed desipn of proposed structure
including scope and triggers
Systematic risk modelling and pricing

Establish legal structure, state aid clearance and update legislation
if required
Implementation

The insurance response to COVID-19

Lloyd’s. Open source frameworks for systemic risk

25Open source framework 3: Black Swan Re

Lloyd’s. Open source frameworks for systemic risk

26

Systemic risk considerations from existing pooling frameworks (continued)
Structural aspect

Options (and example)

Systemic risk considerations

Systemic risk considerations from existing pooling frameworks
Primary orreinsurance

Structural aspect

Options (and example)

Scope– Single risk pools are fairly common
for terrorist attacks
		– Multiple peril pools have a broader scope,
covering a variety of different risks – often
plugging gaps in commercial provision				Poolingmechanism– Single risk pool absorbing multiple
risk types– (e.g. Consorcio de Compensación deSeguros – Spanish catastrophe insurer
for risks arising from several defined‘extraordinary events’ – including
earthquake, flood, terrorism, ‘popular
tumult’, and acts of the armed forcesin peacetime)		– Single pool for single risk type,managed independently(e.g. EXTREMUS Versicherungs-AG,
German terrorism risk pool - commercial
property damage and business interruption)

Systemic risk considerations– Single risk pools solve a particular problem ata point in time. The challenge is then returning thoserisks to the commercial markets to ensure therisks can be reserved and mitigated appropriately– If the scope of risks covered is too broad, it risks
crowding out the commercial sector – effectively
subsidising businesses at the expense of 		other taxpayers– Primary (e.g. Elementarschadenpool –Swiss Nat Cat pool, offers cover for‘elemental perils’, such as flood, storm,
hail, avalanche, rockfall - included inproperty policies)		– Reinsurance (e.g. Pool Re – UK terrorism
pool – mutual reinsurer with government
surety meeting losses in excess of its
capacity)
Extent ofgovernment
liability– A multiple peril pool offers potential
diversification benefits		
– A single pool including multiple risks amasses
capital from a broader base and is therefore
able to offer more protection than any single
risk pool alone– Single risk pools ensure individual businesses’contributions are allocated to the specificrisk covered, and can be more attractive tocommercial reinsurers or capital markets taking
on risk from the pool

– No government liability (e.g. Österreichischer
Versicherungspool zur Deckung vonTerrorrisiken - Austria terrorism pool);capped government liability (e.g. TRIA –US terrorism risk backstop: $100bn perannum aggregate cap)

– Ex ante/pre-funding (e.g. US National
Flood Insurance Programme – offers
flood cover to US property owners, up
to a maximum insured value)– Ex-ante funding can reduce the burden on
the state, but actuarial pricing and risk mitigation
incentives are needed to ensure a meaningful
buffer before government incurs liabilities– Ex post/post funding (e.g. TRIA –US terrorism risk backstop – recoverable
federal support provided once industry
losses reach a pre-determined trigger level)– For a systemic risk pool this could mean very
high contribution requirements – particularly
difficult in recessionary conditions

		
		
		
		
		

The insurance response to COVID-19

– Reinsurance-based pool structures enable
commercial pricing of the underlying risk andthus incentivise risk mitigation - as well as
facilitating retention of risk by insurers– In theory, capped liability schemes offer ameans to incentivise policyholders as well as
insurers to mitigate their losses from a major
loss event; in practice, especially for systemic
events, it is questionable how differently theywould act

– Unlimited government liability (e.g. Pool
Re –UK terrorism pool backed by unlimited
government surety for losses exceedingc. £6.5bn capacity)
Participation– Mandatory (e.g. Consorcio de Compensaciónde Seguros – compulsory contributions forvarious policy types to compensate for losses
from specified ‘extraordinary events’)		– Elective (e.g. EXTREMUS Versicherungs AG,
German terrorism risk pool – cover can also
also be offered without cession to the pool)		– Multiple pools managed collectively,
but each for a different risk type(e.g. GAREAT – French terrorism risk pool– separate pools for large risks, and small
and medium-sized risks)
Fundingmechanism– Primary cover provided by the state pool candirectly ensure provision at an affordable price– For ex-post structures, it is critical to identify
the right level and parameters for industry liability
in order to maximise the level of risk that canbe viably absorbed by the insurance industry, and toprovide clarity on the level of exposure that 		
participants will incur

The insurance response to COVID-19

– Elective schemes can be structured to incentivise
risk mitigation while offering affordable coverthat would otherwise not be available– However, for systemic risks, unless there
is mandatory participation, the scheme may failto garner sufficient funds/take-up to provide ameaningful level of insurer loss absorption prior togovernment support		Lloyd’s. Open source frameworks for systemic risk

27Open source framework 3: Black Swan Re
1. Coverage offered
Black Swan Re could provide non-damage business interruption cover for future systemic events
only. It could also be used to provide cover for secondary impacts of future events, such as
supply chain disruption.

Lloyd’s. Open source frameworks for systemic risk

2. Approach to pricing and affordability
Black Swan Re would only price for future risks, so immediate premiums would likely be smaller
than those of the other frameworks. It is likely the full risk cost may not be passed to customers,
given the government backstop.
Consideration

Options

Pricing approach
Consideration

Design options

Implications

Types ofrisks covered

1. Example systemic ’black swan’ events that
could be covered are outlined earlier in thisdocument– Black Swan Re presents an opportunity to create
resilience to a broad set of systemic risks that
present severe economic and civil disruption
threats to a country

2. There is potential to develop the Black Swan Re
solution for one risk at a time, beginning withpandemic risk, and expanding the coverage toinclude additional risks over time				

– An industry partnership would give governments
the opportunity to add additional mitigations
and risk management approaches to managing
some of the key systemic events on nationalrisk registers

		
		
		
		
		
		

– There is a trade-off between how broadly Black
Swan Re is used to build economic resilience,industry appetite and the complexity inherent in
implementing it. Building infrastructure to coveradditional systemic risks, beyond pandemics, would
take longer and add to the complexity

Approach to1. The use of a dual trigger for claims payments
defining triggers
is one potential option, for example:
		– Evidence of specific event: World HealthOrganisation pandemic declaration, utility
capacity drops by x%, global crop yields
drop by x%– Evidence of business disruption: a x%
drop in economic activity, or governmentmandated lockdown– Given the variety and nature of systemic risks,setting the appropriate triggers to identify
when claims should be paid is invariably going
to be complex

2. An alternative or parallel approach could be
to allow government to trigger or certify a loss
event. This approach has precedent in somejurisdictions e.g. terror events in the UK

The insurance response to COVID-19

28

Implications

For the primary non-damage businessinterruption:
		
1. Relative risk pricing could be set by the
primary insurer based upon the commercial
risk retention. Retention levels could be set
to ensure affordability for the customer– Different jurisdictions and pool structures takevery different approaches to funding, and these have
impacts on individual incentives and behaviour

2. Alternatively, a fixed premium relative tocoverage provided could be charged to allpolicyholders		
For the Black Swan Re pool funding:		
3. A relative risk pricing could also be applied,
recognising the challenges in pricing thesekinds of risks, particularly initially as capability
is built. The price could deliberately be set
below the full risk cost to ensure it remains
affordable for the end customer		
4. The pool could be funded by a levy acrossa range of insurance policies– Cover would need to be affordable so the costsof primary cover would need to be monitored,
retentions set carefully, and potentially capped if
there was not sufficient competition– Charging a fixed price regardless of risk factors
could miss the opportunity to incentivise risk
mitigation behaviours

		
		
		
		

– There are examples of different approaches being
taken within a single country (e.g. UK Pool Re vs
Flood Re). The adopted structure and pricing 		
approaches vary due to different target markets– There should be a way of identifying both what
is covered in the insured’s policy and what ispassed through to the reinsurance pool
– The structure should not aim to pass all risks
through to a reinsurance pool, although it may
want to offer a broader product to customers– There is potential to develop an index thatgives early warning indicators of the societal
impacts, and could also be designed in such a way
to act as a trigger, loss estimation or pricing tool

The insurance response to COVID-19

– Relative pricing could encourage the insurance
industry and businesses to assess the risks betterand encourage risk mitigations to be put in place– A risk-based pricing approach would be expected
to encourage better risk management and risk
behaviour but is likely to make the productunaffordable. Using technical risk modelling to
inform relativities in pricing could provide an
optimal trade offLloyd’s. Open source frameworks for systemic risk

29Open source framework 3: Black Swan Re

Lloyd’s. Open source frameworks for systemic risk

30

4. Risk borne by government
Black Swan Re would require government to take on the excess claims for non-damage
business interruption beyond an agreed insurance industry retention.

3. Structure and funding mechanisms
The Black Swan Re reinsurance structure would provide insurance industry-pooled capital toenable insurers to provide coverage for future systemic events. This framework would provide
an initial commercial and industry-pooled layer of funds, backed by a government guarantee
should the pooled assets become exhausted.
Consideration

Design options

Fundingmechanisms

1. The Black Swan Re structure could be
funded, at least in part, through a poolof capital built up by the industry tocover losses		
2. Alternatively, government could coverlosses on a pay-as-you-go basis, fundedthrough premium increases or taxes after
the event. In the latter, case the industry
and Black Swan Re would be acting purely asa transmission vehicle for government funds
Proposedstructure

Implications– In the short term it would be difficult to build up
enough funds to provide a meaningful buffer,
relative to the overall cost of these systemic events;
however, the capital pool would provide some
contribution to losses that would grow over time
– Including a commercial layer could encourage
further industry participation over time andprovide a centre of excellence for risk
management solutions

1. Existing market structures that have been
set up for other types of risks could bebroadened to serve a wider set of riskse.g. nuclear pools, terrorism pools or
catastrophe pools		
2. An independent entity or structure could
be established to provide a dedicatedblack swan solution– Many jurisdictions already have some form ofgovernment and industry partnership structure
or pooling arrangement that could be expanded forfurther perils

3. Where multiple risks are covered by asingle pool, consideration should be given
to ringfenced balance sheets or otherwise,
as well as diversification and access tofunds by those who have contributed				– Utilising existing structures could acceleratedelivery and provide administrative synergies
and efficiencies. Given the cost of an insurance
solution versus other approaches, using existingpools would minimise implementation andincremental running costs, and could make theproposal more attractive to government

The insurance response to COVID-19

– The feasibility, governance provisions andpolitical appetite in a particular jurisdiction will
determine whether expanding existing structures ispossible or new structures are required

Consideration

Options

Risk borne by
government

The level of risk passed on to government
would be significant, and could be structured
in different ways to manage how risk ispassed through:		
1. The Black Swan Re pool could provide an
Excess of Loss (XoL) cover beyond a preagreed point (per insurer) for non-damage
business interruption, with insurers having
the ability to opt in or out		
2. The risk that could be passed through tothe government layer could be defined by
specific perils causing the non-damage
business interruption losses, with anattachment point fine-tuned to optimise
based on industry appetite
3. Risks taken by government could be
unlimited or capped, as has been
proposed in some jurisdictions
4. Alternatively, Black Swan Re infrastructure
could be used simply to deploy government
funds but without a financial pool. This issimilar to the Fonden approach in Mexico
which is used to pay out government funds in
response to natural catastrophe events

The insurance response to COVID-19

Implications– It is important to design and evolve a structurethat optimises the balance between government
and industry risk-taking– Over time, insurance industry retention could
increase as risks become better understood andpotentially become more readily insurable– It is possible that industry funds would represent
a relatively small portion of overall costs, at least
initially, but would still provide the ability to
rapidly pay claims to those in need through its
existing infrastructure– Government is likely to expect to be compensatedfor carrying risk

Lloyd’s. Open source frameworks for systemic risk

31Open source framework 3: Black Swan Re
5. Scale, target segments and compulsory nature
Black Swan Re could have a broader coverage and scale, given government backing and the ability
to build up a pool ahead of the next systemic event. It may need to be made mandatory (or at least
mandatory to offer) to ensure meaningful take up, otherwise there may be a presumption thatgovernment will continue to provide implicit cover.
Consideration

Options

Implications

Target
1. Black Swan Re could be targeted atcustomerthose most in need, like SMEs
base		
2. Or made widely available– Targeting subsets of the economy could present
challenges in implementation and the potential tounintentionally exclude certain at-risk areasof the economy

		
		
		
		

– A less absolute way to target support could
be to design pay-outs in such a way that theydisproportionately benefit smaller businesses
to a greater extent

		
		
		
		
		

– The self-employed have been identified as
being particularly vulnerable during COVID-19
and consideration should be given to whether thisapproach would cater to this section of the economy.
An alternative approach may be better suited

Compulsory
1. Non-damage business interruption covernature andbacked by Black Swan Re could be optional,
interaction
relying on insurers to offer itwith other 		covers2. Alternatively, offering non-damage businessinterruption coverage could be mandatory forthe insurance industry, with clear guidanceon how insurers and intermediaries must
present and offer coverage. This could
potentially be attached to existing copulsory
covers e.g. Employer’s Liability in the UK		
3. Another approach could be to mandate
the purchase of non-damage businessinterruption cover, ensuring all businesses
are covered. This could also be limited to aparticular size or type of business– Uptake of cover could present a challenge as
government has set a precedent to intervene in theevent of a systemic event. This means incentives tobuy cover will need to be well thought through4. The non-damage business interruption
cover could be an extension to existing
coverage (e.g. existing non-damage
business interruption policies) or could beconsidered as a standalone cover
		
		
		
		
		
		
		
		
		

The insurance response to COVID-19

– The purchase of terrorism cover for SME businesses
in the UK is currently less than 5%, which highlights
the challenge in ensuring demand and that theuptake of cover is meaningful– Without meaningful take-up from customers
or participation from insurers, the pool would struggle
to build up any kind of reasonable buffer of funds– Irrespective of take up, government would still
likely intervene in the event of a systemic risk
occurring, raising issues about the value of theinsurance product– If all businesses are made aware of the option topurchase cover and it is offered at a reasonable
price, it would be easier for government to relyon the commercial sector for future cover, or
act as a distribution mechanism for government
funds– The cost of using the insurance industry will be a key
consideration for government in deciding if it is anefficient vehicle to support with these risks. If thecover provided is an extension of existing covers
rather than a new product, or an existing vehicle isused, the incremental distribution costs should
be reduced

© Lloyd’s 2020 All rights reserved
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The material, information and ideas contained inthis report are for general information purposes.
While Lloyd’s has made every effort to ensurethat the information contained in this report has
been obtained from reliable sources, Lloyd’s is
not responsible for any errors or omissions or forthe results obtained from the use of thisinformation. Lloyd’s and members of the Lloyd’s
community accept no liability whatsoever for any
direct, indirect or consequential loss or damage
arising out of the use of all or any of the material
or information in this report. Nothing in the reportshall to any extent substitute for the independent
investigations and the sound technical businessjudgment of the reader. Any solutions would needcareful competition law consideration in therelevant jurisdiction and discussion with relevant
regulators before any steps were taken to
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securities or insurance, or distribution of
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