Written by: Fabienne Ruttledge
What is Business Interruption Insurance?
Business interruption insurance is a form of policy intended to protect businesses against financial loss resulting from an unexpected event or disaster. Such policies cover loss of income during periods when business cannot be carried out as usual. Whilst there are various causes of business interruption, the most common are in relation to property damage, e.g., fire and flood. Other less common triggers include state intervention or the outbreak of disease, which have become particularly relevant for many businesses in the past few months.
Losses resulting from COVID-19
The COVID-19 pandemic and national lockdown led to widespread business closures, resulting in significant financial losses. Some businesses sought to claim indemnity for these losses under business interruption insurance policies. Most small and medium-sized enterprises (SMEs) only have basic business interruption cover for property damage. However, some SMEs with non-damage cover attempted to claim in relation to three types of clauses in their business interruption policies:
- disease clauses;
- prevention of access clauses; and
- hybrid clauses that refer to both restrictions.
The Financial Conduct Authority’s Business Interruption Test Case
Many insurers have refused to accept liability and pay out on COVID-19 related claims, insisting that the policy wording under these clauses do not cover pandemic related losses. Insurers also argued that the business interruption was not caused by the pandemic itself, but rather government intervention (the national lockdown), and so the causal test was not satisfied. To summarise, there were two main points of dispute between insurers and policyholders:
- coverage; and
- causation.
Consequently, the Financial Conduct Authority (FCA) brought a test case to urgently clarify key issues of contractual uncertainty for policyholders and insurers. The FCA selected a representative sample of policy wordings issued by eight insurers: Zurich, Hiscox, QBE, RSA, Arch Insurance, Argenta Syndicate Management, Ecclesiastical Insurance and MS Amlin Underwriting. The FCA’s role was to put forward policyholders’ arguments.
The first hearing took place in July and the High Court ruled in favour of policyholders on most of the key issues. The judgment states that most, but not all disease clauses in the sample provide cover, as well as certain denial of access clauses. With regards to causation, the ruling also clarified that the COVID-19 pandemic and national lockdown were a single cause of the covered loss.
The parties were subsequently granted ‘leapfrog’ certificates to appeal to the Supreme Court (bypassing the Court of Appeal). Ecclesiastical Insurance were not party to the appeal, as the FCA chose not to dispute the High Court’s finding that COVID-19 pandemic losses are not covered by its business interruption policies. The other seven insurers remained. The four-day hearing took place from 16 November until 20 November 2020. The president of the UK Supreme Court promised a fast decision but declined to say whether it would be ready before Christmas. We can expect the judgment to be handed down in January 2021.
Impact on Businesses
Although only 21 sample wordings were considered in the test case, it is estimated that the ruling will affect up to 700 types of policies, 60 insurers and 370,000 policyholders. Around 80 per cent of SMEs in the UK have seen a revenue impact from the COVID-19 crisis. If these losses are found not to be covered by their insurance policies, this could result in businesses defaulting on loans, making redundancies, breaching supply chain contracts and in the very worst cases, becoming insolvent.
Impact on the Insurance Sector
The pandemic is set to be one of the most expensive events in the history of the insurance industry, potentially costing insurers over $200bn. If the ruling favours policyholders, then this will have implications for reinsurers (companies which provides financial protection to insurance companies) as insurers seek to be indemnified. However, a report published by Willis Re suggests that such reinsurance claims are likely to be manageable. Similarly, Hiscox executives anticipate that any reinsurance losses resulting from COVID-19 and the FCA test case will be relatively low, as its market share in the UK and Europe is insignificant.
In the long-term, there may be a trend towards businesses purchasing pandemic insurance, akin to that which Wimbledon had for the cancellation of its tennis tournament. Such additional pandemic insurance could become vital for sports and music organisers. This would create new opportunities for growth of premiums, although insurers would face challenges in pricing these premiums due to the novelty and level of risk attached to the product.
However, the insurance industry cannot be expected to take on such large risks alone. Many insurers argue in favour of government involvement or backstops (which already cover things like terrorism and natural catastrophes) being extended to pandemics. In other words, some reinsurers already buy insurance from the government to cover the costs of very expensive disasters and the argument is that this should be available for epidemics like COVID-19.
Impact on the Legal Sector
The test case will have wide implications not only for SMEs seeking to claim under their business interruption policies for the pandemic, but also for principles of causation (including the ‘but-for’ test) and trends clauses in future cases.
Law firms have already seen a significant increase in restructuring and insolvency work resulting from the COVID-19 pandemic. Although this trend is likely to continue for some time, the outcome of the FCA test case may minimise or worsen the impact.
The ruling will undoubtedly have an impact on the way in which business interruption policies are worded in future. The Chairman of the Lloyd’s of London insurance market regarded the pandemic fallout as a “wake-up call for the industry in terms of the wordings in its claims”, which require greater simplification and clarity. Some UK insurers have already begun rewriting their policies to clarify coverage and to mitigate future litigation risks. This will ultimately lead to increased business for law firms which have a strong reputation in advising insurers on commercial and regulatory matters.
Global impact
Of course, the COVID-19 pandemic is a global issue which has triggered business interruption claims worldwide, not just in the UK. There are over 1,200 lawsuits pending across the United States and Europe which seek to recover losses caused by business interruption throughout the pandemic. Multiple landmark decisions have been handed down in the past few weeks, including in Australia and South Africa, which have ruled against insurers. However, not all judgments have been favourable to policyholders. For example, In the US, there have been several judgments in favour of insurers.
The outcome of the FCA’s test case is likely to have substantial impact on the interpretation of similar policies in other common law jurisdictions like Canada. Whilst the decision is only binding on the seven insurer defendants, Canadian courts are often guided by rulings in UK courts interpreting similar wordings. Similarly, the ruling is anticipated to have high persuasive value to Hong Kong Courts. The Supreme Court decision will therefore have wide-reaching implications globally, as many countries whose laws are based on English law are closely watching the FCA test case.
Conclusion
The outcome of business interruption claims arising from the COVID-19 pandemic – particularly the FCA test case – will impact thousands of businesses as well as the insurance sector. The FCA’s test case does not cover all possible disputes and is only intended to ascertain liability, not quantum. This leaves some uncertainty as to how much will actually become payable on business interruption policies if the insurers are held liable. In the long-term, the pandemic raises questions about the future of the insurance industry, as there is simply not enough capital globally to cover the financial fallout from COVID-19. We can expect to see insurers attempting to shift responsibility towards governments whilst advocating for such pandemic risks to be shared.
