AM Best believes proposed public-private partnerships to address the disastrous effects on businesses related to COVID-19 are warranted, given the systemic risk posed by the pandemic.

In its new Best’s Commentary, “Retroactive Legislation, Social Inflation: Credit Negatives for Insurers,” AM Best states that it expects significant reserve uncertainty arising for the current accident year given the challenge for insurers to estimate ultimate losses resulting from the COVID-19 pandemic and the related shutdowns. Social inflation, combined with lawsuits addressing liability policies, will drive defense containment costs significantly higher. Court decisions will influence actual claims payouts, creating challenges in determining prudent reserve estimates and payout patterns. In addition, a number of legislative and policy measures are being contemplated that would nullify business interruption coverage exclusions in commercial property policies and force insurers to compensate policyholders for risks that were excluded during underwriting. Insurers with smaller capital bases in particular would be more vulnerable to these measures. AM Best previously has discussed the potential threat to property/casualty insurers’ solvency should legislated policy changes force them to pay retroactive coverage (see related Best’s Commentary).

AM Best believes any public-private partnership adopted to fill this protection gap should take into account the capital supporting all risks insurers bear, which is critical due to the uncertainty inherent in taking on those risks. As insurers consider the level of capital they should hold, they factor in the demands that each risk poses, as well as assumptions about the level of diversification among these risks. In addition, rating agencies and regulators require a specified level of capital commensurate with the level of risk the insurers have on their books.

“Pandemic risk does not afford insurance companies any geographic diversification due to its global nature,” said Stefan Holzberger, AM Best chief rating officer. “Diversification by line of

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New York Federal Reserve President John Williams said the seizure in the $20 trillion U.S. Treasurys market in March underlined the importance of central banks as a backstop of liquidity.

He was speaking at the virtual Treasury market conference on Tuesday where investors, Fed officials and other regulators are expected to discuss ways to insure against a similar seize-up in short-term repo lending, Treasurys and mortgage-backed debt markets.

“If these critical markets break down, credit stops flowing, and people can’t finance the purchase of a car or a home, businesses can’t invest, and the economy suffers, resulting in lost jobs and income,” he said.

The Fed said it needed to take stock of the changes also sweeping through the Treasury market including the rise of financial institutions outside of the banking sector, the emergence of proprietary trading companies, and new regulations affecting the market’s middlemen.

“This is an opportunity to think hard about what changes will help fortify the financial system against future shocks,” he said.

At the same time, Williams cautioned no private institution could replace the Fed’s ability to provide massive amounts of liquidity and prevent further financial distress.

“We should not fool ourselves that we can design a system that is bulletproof against every circumstance,” said Williams.

Back in March, forced selling by investors who needed to get rid of their most liquid assets to raise cash combined with an unwillingness by bank trading desks to act as middlemen led to the usually liquid Treasury market breaking down.

Highly levered hedge funds that betted on a narrowing of prices between virtually identical Treasury securities were also forced to unwind their positions, adding to the intense bout of selling.

The 10-year Treasury note yield BX:TMUBMUSD10Y briefly spiked to 1.27% in mid-March only days after