UK BI test case ruling could have far-reaching ramifications for insurers, warns Fitch

Ratings agency  Fitch has determined that the ratings of UK non-life insurers are likely to be unaffected by  the Supreme Court ruling on the validity of business interruption (BI) claims related to COVID-19 pandemic, but warned of "far-reaching ramifications" for insurers who have relied on the 2010 ruling for the past ten years.

The January 15 ruling largely went in favour of policyholders, upholding a judgement made by the UK High Court in September 2020 in a test case to clarify the validity of claims.

The final judgment means that several UK insurers will be forced to pay out billions in business interruption claims triggered by the pandemic.

The updated claims estimates of affected insurers have so far suggested "modest increases" to their previous estimates. Fitch expects their ultimate claims costs to still remain within its rating sensitivities, and thereby not affect their overall ratings.

For example, Fitch explained, Hiscox will add $48 million of reserves (net of reinsurance) to the $130 million it had in place at end-3Q20 for BI claims. Its total BI reserves, net of reinsurance, will now equate to 7 percent of its total end-1H20 equity of $2.4 billion.

The ratings agency, however, warned that the ruling "could have far-reaching ramifications" for insurers as the Supreme Court judgment overturned a 2010 ruling that insurers had relied on in the test case to reduce payouts for BI claims.

The 2010 ruling was on a dispute between insurer Generali and Orient-Express Hotels, and related to a BI claim for damage to a hotel in New Orleans caused by Hurricanes Katrina and Rita. The court ruled that Orient-Express Hotels should only be compensated for lost business up to the amount of business it could have expected with lower post-storm visitor levels, rather than up to the amount it would expect with normal visitor levels.

Insurers have relied on this decision for the past ten years to reduce payouts for BI claims. In the FCA test case, insurers argued that businesses forced to close during the pandemic would have suffered reduced earnings even had they been allowed to stay open, due to other restrictions and changing public behaviour. They believed that compensation should be reduced to reflect the lower trading activity rather than being based on pre-pandemic business levels.

"UK non-life insurers could face a substantial increase in BI claims costs - and not just those related to the pandemic - following the Court's decision to overturn the 2010 ruling, unless their contract wording specifically defines the reference point against which to assess losses," said Fitch.

Fitch noted that the ruling had other bad news for insurers - "under the original judgement, cover for BI losses due to business closures during lockdown would have been based on a strict definition of lockdown, when closures were mandatory. The Court decided that this interpretation was too narrow and that cover should include closure instructions from a public authority, even if not backed by the force of law."

Similarly, under the 2012 judgement, businesses that continued to operate with reduced services, such as restaurants switching to a takeaway service, would generally not have been eligible for BI claims.

"However, the Supreme Court opined that the policy wording provided for cover where the policyholder is unable to use the premises for a discrete business activity or is unable to use a discrete part of the premises for its business activities. On that basis, a restaurant having to limit itself to takeaway service should still be able to claim for the lost restaurant earnings," the agency explained.

According to Fitch, BI claims are likely to be one of the main costs from the pandemic for the UK non-life sector, along with claims for event cancellation.

"Since the onset of the pandemic, insurers have amended policy wordings to exclude pandemic cover. Exposure is therefore gradually running off as annual policies are renewed, and insurers have much lower BI and event cancellation exposure to the current UK lockdown than to the first one in spring 2020," it concluded.