The devil is in the detail

When businesses went into lockdown, as part of the measures by governments to contain the spread of Covid-19, the question arose whether earnings or profits lost in the process were recoverable under business interruption insurance. Professor Robert Vivian and Dr Albert Mushai shed some light on this matter.

This question has come before the courts and insurance regulators in many countries, including South Africa. The immediate reaction by insurers was to deny coverage; arguing that for business interruption insurance to cover a loss, physical harm or damage to an asset is a prerequisite.

Covid-19 lockdown losses do not conform to this requirement. They are abstract losses that do not arise from any form of physical incapacitation of a business. In South Africa, the question is still before the courts. In one of the cases, the High Court ruled against the insurers, who immediately indicated that they intend to appeal the decision.

In this article we focus on further developments on both sides of the Atlantic, specifically the UK and the US on the question of Covid-19 losses and business interruption insurance. We reported, in a previous article, that courts in the UK had ruled that business interruption policies in that market covered business interruption due to Covid-19 lockdowns. The case was started as a test case by the Financial Conduct Authority (FCA), a body responsible for regulating market conduct of insurers in the UK.
The matter ended up in the UK Supreme Court. On January 15, 2021, the Supreme Court handed down its judgment, confirming that there was coverage for Covid-19 losses under business interruption insurance policies issued by British insurers.

There are many versions of business interruption wordings that UK insurers used that sought to modify or improve on the traditional position on business interruption insurance. This is normal. In a competitive market, insurers will always try to be creative in order to win more customers.

However, no one ever anticipated a situation like that brought about by the pandemic, where entire economies would come to a standstill not only for months but on a recurrent basis as well.

Therefore, when the various business interruption wordings, which insurers had introduced into the market, came up for interpretation before the courts, problems for UK insurers were easily foreseeable.

In trying to argue that business interruption losses from Covid-19 fall outside the scope of insurance because they do not meet the physical damage pre-condition (which is traditionally the position), insurers forgot that their own wordings had long since departed from the traditional model of arranging business interruption cover and purported to cover situations not normally associated with business interruption insurance at all.

UK insurers re-engineered their business interruption policies at a time when it was impossible to envisage the world coming face to face with a monster like Covid-19. Those who understand how insurance works have a lot of sympathy for UK insurers, though. Insurance seeks to provide protection for events that society anticipates could occur.

More importantly, for insurance to work, the adverse event should not be one affecting all insured people at the same time. Insurance works where some people suffer loss and others do not. If all people who come to insure suffer loss from the same event, and at the same time, insurers will become insolvent – at least in principle.

Let us now cross the Atlantic to the US, where similar issues have also come up for discussion. In the US state insurance commissioners, from various states, came out in March 2020 to issue statements regarding business interruption insurance and Covid-19 losses arising from national lockdowns.

Insurance commissioners of Arkansas, Georgia, Kansas, Maryland, North Carolina and West Virginia, among others, issued statements addressing the issue of whether business interruption insurance will respond to claims arising from Covid-19 national lockdowns.

A number of the statements noted that Covid-19 business interruption losses will, in all probability, not be covered, because business interruption policies issued in some US states contain virus exclusions.

In Arkansas, Georgia and Maryland, the state commissioner’s office of the three states highlighted that business interruption insurance is only triggered when the insured sustains physical damage to insured property that in turn leads to a disruption of the insured’s normal operations.

The bulletins further stated that, ordinarily in Arkansas, Georgia and Maryland, business interruption insurance policies typically exclude virus and disease claims unless there is an endorsement to the policy extending coverage to them. In that regard, the statement issued by the state insurance commissioners of the three states conforms to the traditional conceptualisation of business interruption insurance.

In Kansas, insurance commissioner Vicki Schmidt was more cautious. She said it is her department’s “understanding that it is unlikely” that business interruption insurance policies will cover claims related to the Covid-19 pandemic, as most policies of that type issued in the state have communicable disease exclusions.
The cautionary tone in the commissioner’s statement is understandable; one is never certain of the outcome when courts get involved – especially in the US.

The statement from the North Carolina insurance commissioner’s office was more elaborate. It started by pointing out that standard business interruption policies, by design, do not provide coverage for viruses, diseases or pandemic-type losses because of the potential magnitude of the losses from such occurrences.

This confirms the nature of insurance and how it works. Viruses, communicable diseases and pandemics produce catastrophic losses that defy traditional notions of insurability. Accordingly, the commissioner’s statement further notes that for an event to be insurable its occurrence must depend on chance and the losses resulting therefrom must not be catastrophic.

The statement goes further to say that it is not possible to insure an event that upon its occurrence causes loss to every member in the insurance pool. Essentially this is risk and insurance 101. The commissioner went further to say that recent studies in the US show that business continuity losses from the pandemic, for small businesses (defined to mean those employing 100 people or less), could amount to between US$220 billion and US$383 billion per month against reserves held by US property and motor insurers of US$800 billion.

Reserves are funds held by insurers to pay future losses in case the premium they collect on an annual basis are inadequate to pay claims. One does not need to be a rocket scientist to realise that insurance becomes unsustainable under such conditions.

In West Virginia, the state insurance commissioner’s office also emphasised the point that Covid-19 claims are uninsurable. The commissioner indicated that insuring such claims would threaten the solvency of the insurance industry because the claims do not occur by chance.

Therefore, from what we know so far, it looks like the position in the US on Covid-19 claims, under business interruption insurance, is more certain and clear than that obtaining in the UK.

In the UK, many insurers writing business interruption insurance will pay Covid-19 business interruption claims in one form or another, thanks to their creativity around coverage of diseases.

The 162-page judgement handed down by the Supreme Court last month examines various versions of wordings in use in the UK market and in almost all of them the court found scope for coverage. By contrast, in the US there appears to be little ambiguity in the policies that are in place – they all exclude claims attributable to viruses, diseases and pandemics.

We may want to pose one final question – why did the British insurers find themselves in the mess that they are in with regards to Covid-19 claims under business interruption policies? Well, we leave that discussion for another day.