Commentary: A lesson for America from the COVID-19 crisis – think like an insurer

We will get out of the COVID-19 pandemic. But we've been caught flat-footed. How did it happen that the country that more than a century ago bridged the oceans with the Panama Canal and more than half a century ago put a man on the moon failed so badly in protecting its citizenry from an invisible enemy?

The reasons are an absence of long-term thinking and systematic mispricing of risk. Let's not point fingers solely at government because these faults are equally evident in the private sector. We need a change in mindset on systemic risk. And when thinking about risk, there is a lot to learn from the insurance industry.

Perhaps the $42 billion budget of the National Institutes of Health seemed like a lot earlier this year (the proposed budget would actually have reduced that allocation). Yet, in retrospect this sum is puny relative to the loss of life, societal disruption and economic destruction wrought by the pandemic. Not to mention the tens of trillions of dollars of wealth that have been eviscerated in the past few weeks and the trillions more the government will have spent to save the economy. Investment in permanently higher budgets for medical research and other precautionary measures (reserves of emergency medical equipment and personal protective equipment alongside upgraded testing and contact-tracking tools) represent an insurance premium. And everything we're going through right now is the catastrophic loss from uninsured risk.

Human nature leans toward fighting the last battle. The next time we are tested may not be due to a virus — it could be a severe shock to power generation and distribution grids, communications networks, water supply, or flooding of coastal communities. It is encouraging that Congress and the administration are reportedly thinking about ways to finance infrastructure and extend its definition to include catastrophe response platforms. Resilience needs to be central to this. It will be expensive. But so is a strong military. These are essential public goods whose cost is an insurance premium properly borne by everyone.

What about the private sector? Responsive to stiff market forces and a quest for maximum efficiency, American business has achieved tremendous gains for shareholders and persistently high levels of employment. This shows up in labor markets, supply chains, investments in technology and innovation, and in the capital structure of corporate balance sheets. Management and boards have been held to increasingly tough standards by institutional fund managers, by activist investors, and by credit analysts on behalf of lenders. The whole process is under tension as tight as a drum. There is little slack in the system.

But there's a trade-off between efficiency and resilience in the private sector. The current crisis has surfaced risk to all sorts of companies from sudden systemic shocks — whether the choke point is access to capital, raw materials and intermediates, physical facilities, power or other inputs.

This ongoing shock should serve as a wake-up call for companies and shareholders. It is time to consider whether — in optimizing efficiency — the business sector has effectively underinsured against systemic risk. Operations chiefs will have to rethink production locations, supply chains, inventory levels and continuity planning. Treasurers will have to rethink liquidity needs. Senior management will have to think far into the future to anticipate the unknown unknowns because next time it will not be a virus.

All of this investment in greater robustness or "antifragility" will no doubt impact returns on capital and profitability, so investors will need to rethink their risk models. Companies that take resilience or enterprise robustness seriously must ensure that this is effectively communicated to investors and lenders. Sure, costs will have increased and some revenue opportunities will have been lost, but these can be more than offset by reduced enterprise risk. Capital markets must reward companies that invest in resilience with lower discount rates instead of penalizing them for the foregone short-term gains.

What is needed is for governments and companies, investors, and lenders to adopt a long-term risk-sensitive mindset using the same thinking that insurers use every day. Robustness has value, and needs to take its rightful place at both the systemic and enterprise level.

Ingo Walter is a professor emeritus of finance at NYU Stern School of Business. Clive Lipshitz is managing partner of Tradewind Interstate Advisors, New York. This content represents the views of the authors. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.