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Reinsurance Coverage of Covid-19 Business Interruption Losses– The Three Key Issues

  • United Kingdom
  • Insurance and reinsurance
  • Litigation and dispute management

25-03-2021

Payment by insurers of certain Covid-19 business interruption insurance claims is now well under way in many jurisdictions.  As surely as night follows day, reinsurers are now starting to receive corresponding loss presentations under various reinsurance contracts, including on property excess of loss treaties in particular.  In this briefing we explain some coverage issues that could arise in relation to these presentations.

1.    Do the Reinsured Perils include a “pandemic”?

The obvious starting point is the issue of whether pandemics are a reinsured peril under property treaties at all.    Treaties tend to define covered perils by lists, some of which are exhaustive and others which are not.  An exhaustive list will not usually include a pandemic, in which case that will usually be the end of the matter.  A non-exhaustive list is of course more open to interpretation.  The possibility of pandemic being included as a silently covered peril will depend largely on the construction of the individual reinsurance wordings.

English law rules of contractual interpretation are flexible in that they allow a Court to give effect to the literal meaning of the parties’ choice of words at one end of the scale, but equally to the surrounding factual context in which the words are used at the other.  Treaty wordings do not usually list “disease” or “pandemic” as reinsured perils such that there will inevitably be some debate over the impact of the surrounding context on the issue.

This begs the question of what is the relevant context?  If it is the relatively narrow context of the clause itself, reinsurers may seek to argue against coverage on the basis that “pandemics” do not fall within the same general category as the perils specifically listed.   Treaties often list “natural” and “non-natural” perils separately.  Lists of natural perils are usually limited to adverse weather events, in which case it may be argued that there could have been no intention to include cover for the effects of a pandemic.  A cedant would obviously wish to resist that argument, or may alternatively argue that the pandemic was  covered  as a non-natural peril, which often incorporates “catch-all” wording dealing with any other risks not specifically listed. 

Generally speaking, cedants may seek to portray the relevant context as much broader than the clause itself. They may submit that the key background is that the purpose of property treaties is to reinsure losses generally arising from property insurance policies, whether under the main insuring clause or non-damage extensions such as disease clauses and denial of access clauses.  As such the list of named perils should be regarded as purely illustrative of the risks reinsured having regard to the fact that it is not feasible to list each risk reinsured under every extension of the underlying policies and there is no immediately obvious basis for excluding such cover from the reinsurance.

2.    Will it be possible for cedants to aggregate smaller losses for the purposes of exceeding their retention?

Excess of loss treaties by their nature will contain high loss attachment points, whereas individual underlying Covid-19 business interruption losses are comparatively small in amount.  Cedants will therefore usually need to aggregate losses together to recover under their treaties.

The extent to which such aggregation will be possible will of course largely depend on the language of the aggregation provisions.  There are numerous English Court authorities on aggregation wordings which market participants should be acutely aware of when considering their theories of aggregation.  Experience shows that the Courts will not readily depart from the meaning given by previous Courts to similar wordings – attempts to draw fine distinctions with tested wordings often fail as the Courts tend to adopt a conservative approach that provides certainty to others in the market.

The cases generally affirm that wordings that aggregate losses arising out of one “event” constitute the narrowest forms of cover, whereas those which aggregate losses arising out of one “originating cause or source” provide the widest.  The market also uses a range of permutations in between these opposite poles, including clauses that aggregate losses arising out of a series of similar or related events.  It is also relatively common to find provisions aggregating losses arising out of one “catastrophe”, with “catastrophe” left undefined. This is not a term that has been tested by the Courts in this context.

The English Courts have held that an “event” is something that happens in a particular time and place and in a particular way.  It is obviously not a broad enough term to encompass a pandemic, as indeed the High Court held when considering the question of coverage under a denial of access clause in the FCA Covid-19 Business Interruption Insurance Test Case (please see the concluding comments section regarding the applicability of the Test Case to reinsurance disputes).  However, subject to the question of whether or not the treaty requires that the “event” from which the losses arise is an insured or reinsured event, there is certainly a respectable argument that a Government regulation qualifies as an “event”.   This may enable a cedant to recover a sizeable proportion, if not all, of its losses.  For example, it may be that a number of underlying losses paid out by the cedant arose from business interruption caused by the effects of the “Stay at Home” Regulation 6 of the 26 March Coronavirus Regulations in the UK.

A cedant that benefits from a provision allowing for aggregation of losses arising from a “series of related events” may even be able to argue that the Coronavirus Regulations as a whole constitute such a series, in which case it will be able to aggregate a much greater proportion of its losses.  It may be possible to argue that regulations across different jurisdictions constitute a related series.  Alternatively, the cedant may raise arguments by way of analogy with the Supreme Court’s causation analysis applied to disease clauses in the FCA Test Case (see our briefing here – https://www.eversheds-sutherland.com/global/en/what/articles/index.page?ArticleID=en/Insurance_and_reinsurance/Supreme_Court_Judgment).

The meaning of “catastrophe” wordings in an aggregation context is not clear, though some legal textbooks suggest that a catastrophe is a “sudden violent event” such as a storm, rather than a “state of affairs” such as a cold winter.  A cedant with this wording might therefore argue by analogy that it is able to aggregate losses arising out of a particularly intense outbreak of Covid-19 (say that in March 2020), although it may concede that it is not possible to aggregate all of its losses arising out of the pandemic.

At the other end of the spectrum the English Courts have determined that an “originating cause or source” is very wide wording that could include a state of affairs.  Aggregation wording that includes such a cause or source as the “unifying factor” would certainly, on the face of it, allow a reinsured to argue that all its losses arising from the Covid-19 pandemic fall to be aggregated under the treaty.  Again, the Supreme Court Judgment in the FCA Test Case contains some potentially helpful dicta that would assist a cedant seeking to construct such an argument.  

Having analysed the relevant aggregation provisions outlined above, and should the possibility of aggregation of losses remain open, one needs to consider whether any further provisions define the scope of aggregation.  Typical provisions of this nature include hours clauses and territory clauses.

One sometimes encounters “hours clauses” in reinsurance treaties, whereby all losses occurring with a certain period of hours (e.g. 168 hours) are to be treated as a single loss occurrence.  The meaning of these clauses may be uncertain when the clause also includes an additional unifying factor, such as an originating cause.  In that case the logical conclusion may be that the hours provision serves as a cap on the losses arising from that cause, although it could be argued that the hours and cause elements are internally inconsistent and priority should therefore be given to one over the other.

The scope for aggregation can also differ by territory, with parameters and limits for the aggregation of certain forms of losses being set for particular territories.  Again, this will depend on the particular treaty wording, but one can often find a difference in treatment of North American losses and losses outside that region.

3.    Loss settlements

A number of circumstances surrounding the adjustment of Covid-19 Business Interruption claims that might potentially cause a reinsurer to question underlying settlements, subject of course to whether the treaty allows it the standard of review to do so – a “Follow the Fortunes” provision, for example, would only allow very limited opportunity for it to investigate underlying claims.

Questions raised by reinsurers might concern the following topics:

-    were settlements made within (or arguably within) the terms of the underlying policies, or were they primarily driven by reputational issues or a desire to preserve commercial relationships?

-    what is the legal status of agreements between industry associations and state/regulatory authorities through which insurers agreed to pay certain claims on which coverage issues were not certain?

-    where there were no such agreements, were any of the underlying settlements the result of regulatory pressure following statements by regulators such as the FCA Dear CEO letter of 18 January 2020 (see our briefing here – https://www.eversheds-sutherland.com/global/en/what/articles/index.page?ArticleID=en/Insurance_and_reinsurance/fca_dear_ceo_interruption_insurance_litigation)?

-    were there errors and omissions in the handling of certain claims as a result of the sheer case load dealt with by insurers’ claims-handlers under severe time pressure?

-    to what extent, if at all, are foreign law settlements based on the FCA Test Case within the coverage provided by the treaty?

Concluding comments

The answers to the issues raised above will depend on the individual wordings involved and will be subject to significant debate, largely because of the unprecedented situation created by the Covid-19 pandemic.  There is also a distinct lack of legal precedent reflecting the fact that reinsurance disputes tend to be subject to confidential arbitration rather than public court litigation.  As a result we would expect that it will take some time yet before the market has fully worked its way through the loss presentations that have recently started to emerge.  It would not be surprising if there were further changes in the legal landscape between now and that point that will impact on the issues. 

Finally, it has been observed by some commentators in the market that the FCA Test Case findings are not relevant to aggregation, at least not in the reinsurance context.  We would caution against accepting this as a matter of fact on the basis that (i) the Supreme Court reached key parts of its decision by giving the same exact meaning to certain terms as was given to them in cases about aggregation in a reinsurance context, (ii) in arriving at its causation analysis the Supreme Court imported terms often used in aggregation language, such as a “series of events” and “originating cause” and (iii) generally speaking, proximate causation and causation in an aggregation context involve the same fundamental analysis, save that the Courts have recognised that the latter does not require as strong a link as the former.