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The United Kingdom’s regulator for insurance and financial services — the Financial Conduct Authority — last year brought a test case on behalf of commercial policyholders against various insurers regarding COVID-19 claims under property damage business interruption policies. The FCA case, which found mainly for the policyholders, has implications and consequences for the global insurance industry.
The FCA case, which went straight to the U.K.’s highest court, provides some clarity concerning coverage, and this clarity will be reflected in insurance policies in the future. This will help policyholders to make informed decisions about coverage for infectious disease risks; although it now appears that decision may actually be out of their hands.
Many insurance leaders have argued that systemic risks, such as global pandemics, may be more appropriate for governments to take rather than insurers. If such coverage were to be provided by the insurance industry, pricing would become an issue. Insurers are being honest about decisions to exclude pandemic coverage from future policies, for many, that was always the intention anyway. Even specialist non-damage business interruption policies exclude pandemic.
The U.K. FCA case was groundbreaking — some say radical — but it could not cover all bases. According to the FCA, there were more than 60 insurers involved, with 700 different types of policies, and over 370,000 policyholders were affected. It has, therefore, been of incredible significance. There were 21 policies chosen to be representative for the actual case. The process was expedited and significant savings in time and money were achieved.
The main coverage extension clauses reviewed by the court were:
There were some key findings that have far-reaching implications for future insurance cover and claims around the world, including:
Extension vs. exclusion
Extensions expressly provided now take precedence over general exclusions. In the future, insurers will need to make intention absolutely clear and link those exclusions directly to specific extension clauses.
Orient-Express Hotels case and the complexity of the trends clause
The decision in the FCA case overruled a precedent set by the 2010 Orient-Express Hotels Limited v. Assicurazioni Generali Spa case, despite some of the judges being common to both cases. In Orient-Express, there was damage to a hotel in New Orleans following hurricanes Rita and Katrina in 2005. The disputed business interruption loss is calculated by comparing expected revenue with actual revenue. Expected revenue should reflect trends in the business in a ‘but for’ scenario — the FCA case referred to this as the “counterfactual.”
The Orient-Express decision stated that expected revenue should be ‘but for the damage’ using a strict interpretation of the wording (instead of ‘but for’ the hurricane). With minimal damage, this left the claim much lower. It assumed that the hotel and its expected revenue would have been impacted by the hurricane in any event, whether the hotel was damaged or not. The trend therefore reflected the devastation already created by the hurricane, and expected revenue was much lower as a result.
The FCA case found that expected revenue should, in fact, be “but for” the insured peril (not the damage). Orient-Express losses should have been much higher; expected revenue should have been ‘but for’ the hurricane. In the FCA case, it was “but for” the disease, therefore stripping out the impact of the pandemic and the lockdowns from expected revenue. This massively increases the calculation of loss. A decision that now provides clarity for all involved.
If the impact of the insured peril is apparent in the performance of the business before the policy is triggered, that trend should not be included in the calculation of expected revenue in the counterfactual. A logical decision, as the aim of the insurance is to put the insured back in the position they would have been before the loss.
Some insurers were found to have robust exclusions, so no coverage was granted. Pure denial of access with no mention of disease, might be covered depending on the category of business, but even if covered, the losses would be minimal. The case referred to “what was covered but not causative vs. what was causative but not covered.” In essence, the insured peril — denial of access to premises — was not the cause of the loss. Any calculation of expected revenue in the counterfactual would be “but for” the insured peril; all the other issues would have impacted the business in any event. Expected revenue would, therefore, be the same as actual revenue; in other words, there would be no loss.
For many businesses, their policies didn’t have an exclusion for pandemic risks, in which case insurers would be liable, even if the intention was only to cover business interruption losses that related to physical damage. Clarity of cover was achieved for those with infectious disease extension clauses, or hybrid extensions. For those that don’t have policies matching the test case disputes continue. The FCA continues to apply pressure on insurers; it continues to publish data on the number of claims that remain unresolved for each insurer.
It is worth also noting that this is just the beginning of the claims process. We are now in the “quantification machinery” phase where it is the forensic accountants who step in to establish the expected revenue for these businesses, and quantify the losses.
In the United states, policies may include a communicable disease endorsement that carries a sublimit significantly less than the actual loss sustained. By and large, U.S. litigation has been on a case-by-case basis, with most courts ruling in favor of insurers. Some plaintiffs have sought to centralize the resolution of business interruption cases in multi-district litigation procedures; however, the MDL panels have largely rejected plaintiffs’ attempts to consolidate such cases, finding that there was no commonality between the various defendants and that the cases involved different insurance policies with varying coverage provisions and exclusions.
Even though the FCA case concerns U.K. law, the world has taken note and similar principles are being considered elsewhere, including the U.S. The Orient-Express case involved a U.K. company and U.K. law but a U.S. site, so it has always been of interest, and its dismissal is important for insurers globally.
Other issues continue to arise. For example, we have seen examples where there is a lack of consistency in wording between insurers on the same risk, which resulted in only a portion of the claim being paid, as some insurers had an exclusion in place and some did not. A situation which may seem bizarre to anyone outside of the industry. Also, we have seen disputes related to inconsistencies between wordings for reinsurance purposes, as there can be different wordings and different exclusions.
Many questions remain, the big one being: “Does the impact of coronavirus constitute physical damage?” The answer, so far, is “no” in most places around the world, where courts accept that property damage policies remain ring fenced for property damage and tangible perils. Some U.S. courts have ruled that coverage might be available, but the cases are complex. Business interruption is never simple.
Caroline Woolley, is a director and practice leader, investigative accounting group, at forensic accountants Meaden & Moore in London. Meaden & Moore work on behalf of insurers in the quantification of claims, but also work as a single expert. She can be reached at firstname.lastname@example.org. Michael Vannucci is a partner, investigative accounting group, in the firm’s Los Angeles office. He can be reached at email@example.com.