By Peter Richardson and Jacqueline Fenech
In a landmark ruling, the High Court has found in favour of policyholders in the Financial Conduct Authority’s (FCA’s) business interruption (BI) insurance test case.
The FCA's interim chief executive, Christopher Woolard, said: "Today's judgment is a significant step in resolving the [contractual] uncertainty being faced by policyholders [making business interruption claims]."
The regulator also said:
"Although the judgment will bring welcome news for many policyholders, the judgment did not say that the eight defendant insurers are liable across all of the 21 different types of policy wording in the representative sample considered by the court.
"Each policy needs to be considered against the detailed judgement to work out what it means for that policy."
The test case has also clarified that the Covid-19 pandemic and the Government and public response were a single cause of the covered loss, which is a key requirement for claims to be paid even if the policy provides cover.
In a Dear CEO letter by the FCA, Insurers have been urged to communicate directly, quickly and transparently with policyholders who have made claims affected by the judgment to explain next steps, including in cases of appeal and in cases where deductions apply for relevant government support to policyholders. According to the FCA, up to 370,000 UK businesses could benefit from insurers’ payouts, running into more than £1bn, on BI claims.
The coronavirus pandemic continues to cause an unprecedented impact especially on smaller businesses (SMEs). The lockdown imposed by Government, earlier this year, led to many businesses closing their doors. Consequently, insurance companies have been inundated by claims under the terms of business interruption (BI) within insurance policies. However, there is a lack of clarity on which basis insurers are expected to settle these claims. This has created uncertainty for both policyholders and insurers, as they strive to determine whether business interruption, due to Covid-19 lockdown, is covered by the policy. And, therefore, whether a claim is valid or not.
The Financial Conduct Authority (FCA) stepped in to resolve disputes between insurers and policyholders. On 1 May 2020, the FCA released a statement to obtain court declarations aimed at resolving the uncertainty in selected BI insurance policies. It reviewed over 500 relevant policies from 40 insurers. It identified a sample of 21 policy wordings that capture the key issues in dispute. The initial list of insurers and the policy wordings identified by FCA included some of the top UK insurers, most with global operations. The FCA further published draft guidance, inviting all insurers to check their policy wordings against those that the FCA intended to test.
The FCA came up with a test case solution. The objective of the test case was to resolve some fundamental contractual ambiguities to offer clarity for policyholders and insurers. It was not intended to ascertain the amount owed under individual policies; however, it did provide the premise for that action. The result of the test case was to be legally binding on the insurers involved in connection with the representative policy sample being considered.
The FCA had already stated in one of its previous statements its view that most SME insurance policies are focused on property damage and only provide basic cover for BI. In most cases, therefore, insurers are not likely to be obliged to pay out in relation to the coronavirus pandemic. The test case was focused on the remainder of policies that could be argued to include an applicable cover.
The proceedings commenced in the English High court in June and an eight-day trial took place in July. Insurers had countered the FCA’s assertion that the coronavirus epidemic was the proximate cause (i.e. the first event, in a series of events, that cause damage in an insurance claim) of the policyholder’s losses.
Insurers argued in their defence that pandemics and their consequences were not an insured peril and that the business losses were caused by broad economic factors.
Practical Considerations for Insurers
With hindsight, there is now an acceptance that pandemic risk has been a predictable risk all along, even if the impact of Covid-19 was less predictable.
While much attention has been focused on the issues around business interruption insurance (and the damage that can do to the industry's reputation), insurers have maintained payouts through a time of great stress. But this is (in many eyes) a 'systemic' risk, rather than a one-off 'catastrophe' - and that, inevitably, means a bigger role for government. Should there be a Pandemic Re (a government-backed reinsurance pool covering insurers against losses from future pandemics)? But maybe the next crisis will not be another pandemic but a massive cyber-attack or terrorism. Insurers are asking themselves: how do we write policies going forward that are precise enough to satisfy the lawyers but flexible enough to cover risks that are rapidly evolving?
For Insurers, this has far-reaching implications for their risk assessment process. The scope of the risk assessment should be broader to capture early signals of emerging risks. This presumes better 'risk intelligence', more active, and integrated risk-assessment 'collaboration' across all three Lines of Defence. This shifting risk landscape highlights the importance of dynamic risk assessment and dynamic planning. If they are to be managed effectively, key risks need to be taken into consideration outside of the planning cycle. This also helps with providing timely assurance to senior management. Assurance should not be in retrospect. The second and third line should drive action with senior leadership. The outcome from a more 'intelligent' risk-assessment would be to inform financial decisions and operational responses and to help senior leaders build resilience upfront.