Government rules – Moving the goalposts?
Could legislation re-write business interruption insurance policies to cover COVID-19 losses?
Lawmakers in several states of the USA, beginning with the state of New Jersey, have introduced proposed legislation that would require insurance companies to pay business interruption claims for COVID-19 losses. This legislative response is occurring because insurers are declining COVID-19 related business interruption claims on the basis that they only cover losses arising from physical damage to property.
It is not unusual for legislation to restrict the grounds upon which insurers may reject claims. In New Zealand, for instance, section 11 of the Insurance Law Reform Act 1977 prevents insurers from relying upon clauses that exclude or limit cover upon the occurrence of certain events or circumstances that the insurer apprehended would increase the risk of loss, if the insured can establish that the relevant events or circumstances did not in fact increase the risk of loss.
It is very unusual, however, for legislation to have retroactive effect, so that it would apply to policies entered into or losses suffered before the legislation came into effect. The Insurance Law Reform Act applies only to non-life policies entered into or renewed, and to life policies only to the extent that losses were suffered, after it came into effect.
There are good reasons for this. One reason is that insurers are careful to identify and insure only risks to which their actuaries may assign a probability with a reasonable level of confidence, so that an appropriate premium may be calculated. This enables insurers to earn enough premium income to provide reserves to cover the likely claims, reinsure the remainder and earn a profit. If insurers are compelled to cover claims that they did not anticipate and reserve for, this will affect their ability to set premiums at reasonable levels or even to offer cover at all for types of cover that may become subject to legislative interference. Where there is too much uncertainty about the likelihood or quantum of a loss, insurers may decide that they are unable to accept the risk at all.
A second reason is that insurers may not have sufficient reserves or reinsurance to pay unexpected claims so their viability may be affected. Insurers’ lawyers in the USA have expressed concern that if insurers are obliged to pay COVID-19 related claims that are not covered under the relevant policies, their reserves may be so affected that they are left unable to pay other claims that would ordinarily be insured.
New Jersey’s bill, numbered A-3844, is limited in some respects in an attempt to address these concerns. If passed, it would apply only to insured businesses with fewer than 100 employees. It would also provide for a fund to be set up to reimburse the affected insurers, paid for by levies on insurers more generally.
These provisions, while well-meaning, are unlikely to prevent significant negative effects upon insurers. Many insureds have fewer than 100 employees. In addition, insurers would face a substantial cashflow problem before any reimbursement from the proposed fund could be expected, even if it was adequate to reimburse their additional liabilities.
The limits in business interruption insurance policies exist for good reason. Business interruption policies provide cover for losses that are caused by physical damage to property because such damage is normally localised and the insurer is unlikely to face a large number of claims at once, so its reserves are likely to be sufficient to pay claims. A warehouse may burn, or even a city block, but it is very unusual in modern times for an entire city to burn. Natural disasters such as earthquakes, hurricanes and floods may cause widespread physical loss, but even these losses are normally confined to localised areas such as a single city, so that insurers may anticipate them and purchase global reinsurance accordingly.
In contrast, business interruption losses that result from events that may have widespread effects, such as economic recessions, wars and epidemics, are not generally covered and are often (although not always) expressly excluded from cover. This is necessary because insurers and reinsurers cannot hope to hold sufficient reserves to pay business interruption claims from the majority of their insureds at the same time. The insurance industry is underpinned by the principle of the pooling of risk, such that all insureds pay relatively small premiums into a fund that compensates the relatively few who suffer a loss in each year. Events such as COVID-19, which have widespread or even global effects, result in too many claims for insurers to meet from their reserves.
Insurers’ inability to pay claims that arise from widespread events can result in outcomes that may appear counter-intuitive to insureds. Where, for instance, an insured suffers property damage that would ordinarily qualify it for cover, but there is a widespread supervening event that introduces an additional cause of the loss, the claim may be declined. So, for instance, in Orient Express Hotels v Generali  EWHC 1186 (Comm), where a hotel in New Orleans was damaged by Hurricane Katrina, its business interruption claim was declined because the hurricane also caused widespread flooding to the surrounding area. The Court held that the physical damage to the hotel did not cause its loss because it would have had few customers in any event because of the flooding.
It is perhaps understandable that business owners with business interruption cover are taken by surprise when insurers reject their claims. The reason lies in part in the name – “business interruption” insurance appears intended to cover losses caused by business interruptions generally. While it is normally sold as an adjunct to material damage cover for property, it often appears as a separate item in brokers’ insurance reports. It may be better for business interruption cover to be described as a property damage business interruption extension, to avoid misunderstandings.
The position is complicated further by extensions to business interruption cover that have emerged over time. Most business interruption policies are not limited strictly to loss that arises from property damage but feature extensions such as those for losses caused by acts of public authorities, denial of access to the insured’s property, damage to utilities, customers being prevented from receiving the insured’s goods or services and damage to third parties’ property such as road, rail and air links. These extensions are normally limited to a percentage of the primary cover limit or time period, but they can be significant.
Some extensions may be relevant to Covid-19 claims. Where a business suffers loss as a result of Government directions such as the restrictions upon movement that were introduced in New Zealand in response to Covid-19, it may view this as a claim falling within an “acts of public authorities” extension. Similarly, some policies provide an extension for business interruption loss that is caused by a threat to human life which prevents or hinders use of the insured’s premises, whether the premises are damaged or not. This may apply where a person in the insured’s premises has been infected with Covid-19 and the premises have had to be evacuated for a stand-down period, or where an area is quarantined. In most New Zealand policies, the insurers will be able to rely upon a general exclusion for losses caused directly or indirectly by epidemics or notifiable diseases, although some policies’ wording may be clearer than others.
Some insureds in the USA and England have raised issues with insurers about whether there is physical damage to their premises where the Covid-19 virus has been identified at their premises, such as where a worker has fallen ill, and the business has been closed as a result. More commonly, however, the losses will be caused by the presence of the virus more generally rather than at the business’s own premises and the principle in the Orient Express Hotels case may apply.
It is dangerous for legislators to contemplate passing retrospective laws, as this creates uncertainty. Retrospective laws that would compel insurers to pay claims that are not covered or that are expressly excluded by their policies could have very significant effects upon the continued availability of insurance, even where the effect of those laws is limited. There is a significant risk that this could undermine insurers’ confidence in the predictability of losses and result in substantial increases in premiums or cover being withdrawn altogether. Fortunately, there appears to be no indication at present that the New Zealand Government will consider passing legislation of this nature. It is less clear what the outcome will be in the USA and elsewhere.