COVID-19 BI judgment: not quite the worst-case scenario

“The decision is quasi-political in its effect as the impact on the insurance industry is likely to be seismic.” Clive Zietman, head of commercial litigation at Stewarts.

· The test case judgment is “not a panacea for thousands of prospective disputes”
· Some claims decisions to be delayed to November or later as COVID-19-related complexity affects BI
· Court’s dismissal of ‘Orient Express’ defence will “raise eyebrows” and is likely to drive appeals
· Insurers and FCA keep options open with “leapfrog” application to appeal to the Supreme Court

It may not be the outcome insurers wanted but, according to insurers and industry experts, the UK High Court ruling is not a worst-case scenario either, and the opportunity to appeal remains open for some.

When the much anticipated verdict in the Financial Conduct Authority’s (FCA) test case for COVID-19 business interruption (BI) claims was revealed, it wasn’t quite what insurers had been hoping for. With so much at stake, insurers had hoped for vindication in the UK High Court that their policies were watertight and that potentially costly claims could be rejected.

But on September 15, 2020, the ruling, for the most part, found in favour of the FCA and policyholders.

Insurers “will not be happy”, Clive Zietman, head of commercial litigation at Stewarts, said at the time, adding that he expected the matter to go to the Supreme Court on appeal.

The judgment, described as “complex” by more than one commentator, ruled on 21 sample wordings from eight insurers (see note below for full list of insurers) that were deemed representative of disputed policies across the industry.

During the case, the FCA argued that the “disease” and/or “denial of access” clauses in the sample policy wordings did provide cover in the circumstances of the COVID-19 pandemic.

The judgment agreed that most, but not all, of the disease clauses in the sample provide cover. Certain denial of access clauses were also judged to provide cover, but the ruling said this depends on the detailed wording of the clause and how the business was affected by the government response to the pandemic, for example, whether the business was subject to a mandatory closure order or ordered to close completely.

The FCA said that the ruling had “clarified that the COVID-19 pandemic and the government and public response were a single cause of the covered loss, which is a key requirement for claims to be paid even if the policy provides cover”.

Aaron Le Marquer, partner at UK firm Fenchurch Law, says the judgment “is undeniably a good outcome for those policyholders with infectious disease coverage”.

“According to the court, not only are their claims covered, but the value of their claims will not be reduced by the application of trends clauses,” Le Marquer says.

“However, those pursuing claims under prevention of access covers will be very disappointed at the court’s finding that coverage will be engaged only under very narrow circumstances, and not in response to the national lockdown.

“A striking aspect of the judgment is the way the court neatly despatches with the complicated causation arguments raised by insurers, by making it a part of their very clear finding on the construction of the coverage clause.

“This is because, the court says, the insured peril is the composite peril of interruption or interference with the business caused by the national occurrence of COVID-19, the causation arguments ‘answer themselves’. For the same reasons, trends clauses are largely irrelevant and the principle in Orient Express has no application,” he adds.

It will have been a disappointment to defendants, and the wider industry, that the ruling effectively ignores the Orient Express case, going so far as to suggest it was “wrongly decided and that they would not have followed it even had they not found it to be distinguishable”, according to Le Marquer.

The Orient Express Hotels (OEH) v Assicurazioni Generali t/a Generali Global Risk case in 2010 centred on a dispute over OEH’s BI policy after the hotel suffered significant hurricane damage in August and September 2005 and had to close for two months.

The court ruled in favour of the insurer, saying that as New Orleans, where the hotel was located, was closed for several weeks due to widespread flooding from the same hurricanes no-one would have been able to use the hotel even if it had not been damaged.

Therefore, OEH could not claim under the primary insuring provisions for BI loss suffered during this period.

Le Marquer adds that the decision in the COVID-19 BI test case to disregard the earlier Orient Express judgment will “certainly raise eyebrows” and “will surely lead to an appeal from insurers on this issue at least”.

Commenting on the broader COVID-19 BI ruling, Zietman says: “The case will give rise to litigation on specific policies and no doubt insurers may, in individual cases, rely on other defences such as failure to make full disclosure at the time the policy was taken out or failure to notify in good time.

“Other cases may well settle but this judgment is not a panacea for thousands of prospective disputes.”

But he adds: “The consequences that flow from this judgment are huge—with possibly 370,000 policyholders affected. The decision is quasi-political in its effect as the impact on the insurance industry is likely to be seismic.”

Zietman also references the 2010 Orient Express defence, saying insures “were plainly hoping to thwart the tide and relied heavily on the Orient Express case to get them home”. But the court didn’t favour this approach.

Not the worst-case scenario

The consequences of this judgment are huge, with the FCA estimating that, in addition to the particular policies chosen for the test case, around 700 types of policies across more than 60 different insurers and 370,000 policyholders could potentially be affected.

However, while insurers may have been hoping for a ruling more in their favour, the outcome did not fit the definition of a worst-case scenario.

For example, prior to the judgment, insurer Hiscox had estimated additional COVID-19 BI claims could be anywhere between £10 million and £250 million. Once the court confirmed that fewer than a third of the insurer’s 34,000 UK BI policies “may respond” to these claims, Hiscox revised its estimate to less than £100 million, considerably lower than the top end of the company’s risk estimate.

Hiscox said that coverage under these policies is “essentially limited to those customers who were mandatorily closed by government orders, and then only in certain circumstances”.

Analysts at equity research firm Jefferies added that although much of the market’s attention is on claims, the management at Hiscox “took the opportunity to highlight growth in gross written premiums thus far in the third quarter of 2020 of +19 percent, as the group writes more volume, at higher prices”, suggesting the insurer is in good shape to deal with additional costs from BI.

RSA, which acted as defendant in relation to five of the policy wordings in the test case, said “Our interpretations of some provisions impacting RSA were upheld by the court and some were not.”

But emphasising its ability to manage the fallout from the ruling, the insurer pointed to its half-year 2020 interim results saying it had “paid or reserved for circa £57 million in claims in relation to COVID-19 losses”.

RSA estimates that the additional financial impact of the judgment is about £104 million on a gross basis across its portfolio of relevant BI policies. However, the insurer says this figure drops to £85 million “after the application of our catastrophe reinsurance protection”. In fact, the firm expects the figure “to reduce further through qualifying as a loss covered by the group-wide aggregate reinsurance programme”.

“The court’s decision will not change our assessment of RSA’s capital position,” said S&P Global Ratings, even with the additional costs of BI claims. Commenting on the insurer’s estimated costs of £104 million on a gross basis, expected to fall to less than £85 million, the ratings agency said: “We expect that the group will contain these costs comfortably within its earnings in 2020.

“RSA’s half-year 2020 results were more robust than those of some of its peers, such as Lloyd’s and Hiscox, which recorded losses due to the COVID-19 pandemic.”

Clarity and appeals

With such a complex judgment there was always going to be uncertainty around exactly how much the final BI costs would be and the eventual impact on the re/insurance industry.

James Rayner, global relationship leader at claims management firm Crawford & Company, says that COVID-19 has caused a great deal of complexity in the BI claims environment.

“Existing claims caused by insured perils such as fire and flood are being affected as the impact of lockdown on businesses’ ability to trade has to be taken into account when calculating losses, resulting in some difficult conversations with policyholders.

“For those insurers that are providing BI cover directly related to COVID-19 the claims still require insurers to have some challenging discussions with policyholders over the correct counterfactual positions to be adopted as well as the impact of income grants and furlough payments on their claims,” he explains.

In addition to this complex environment around BI claims, Rayner says that even after the verdict on September 15, appeals are likely to delay a final resolution until November this year or later.

“This may be too late for some businesses and a raft of Enterprise Act claims may arise in 2021.”

He warns: “We are finding that many insureds are significantly underinsured as their sums insured have not changed for years while their insurable amounts have risen significantly.

“This could lead to professional indemnity claims against brokers or other advisors.”

On the subject of appeals, Le Marquer says: “In deciding whether to appeal on the policy trigger issues, insurers will have to weigh up the potential further reputational damage they may suffer from being seen to resist the court’s very clear findings.”

This hasn’t yet deterred Hiscox or the FCA, which both filed a “leapfrog” application to the Supreme Court to appeal the High Court’s ruling on September 29, as Intelligent Insurer Review went to press. Of course, filing the application does not mean an appeal is definitely on the cards, but it does keep options open, as the deadline to make such an application loomed.

The FCA says it is working with the insurers on a range of issues to negate the need for appeals. But the regulator adds that the “leapfrog” application has been filed on a “precautionary basis” in the event that this agreement is not reached before the Consequential Hearing on October 2, 2020.

At this hearing the High Court will listen to further arguments intended to clarify the issues of the case. The judge will then decide how the conclusions set out in the judgment should be applied to the claims and circumstances of individual policyholders.

Before the ruling on September 15 one senior industry veteran told Intelligent Insurer that the case could go either way, adding that “there are strong arguments on both sides”. With the opportunity to appeal the court’s decision still in play, everyone in the industry will be watching the ongoing development of this case for some time yet.

Insurers who agreed to take part in the COVID-19 BI test case

Hiscox, Arch, Argenta Syndicate Management, Ecclesiastical Insurance Office, MS Amlin, QBE UK, RSA, Zurich