Law360 (June 30, 2020, 6:14 PM EDT) --
Many claim that they thought their insurance would cover the losses from their doors being closed, but have since been told by their insurers that the lack of physical damage to the premises means that their business interruption policy won't respond. Some may be seen as sympathetic policyholders whose businesses are at risk, but who did as they were told to help protect others from the spread of COVID-19.
U.S. Response to Business Interruption Coverage Denial
At least eight states — Louisiana, Massachusetts, Michigan, New Jersey, New York, Ohio, Pennsylvania, and South Carolina — have introduced legislation that would require business interruption policies purchased by small businesses to provide coverage for COVID-19-related losses where exclusions would otherwise apply.
The likelihood is high that at least one such bill will be passed into law. While such a bill also risks being found unconstitutional, since the U.S. Constitution provides that "[n]o State shall … pass any … Law impairing the Obligations of Contracts," the passage of such a law, even if it is later struck down, may result in some insurers paying claims that they otherwise believe are excluded under the plain language of the policy language.
Policyholders are not waiting for legislators to act and are bringing often high-profile class actions against insurers denying COVID-19 business interruption claims. The attention brought to these lawsuits appears designed to pressure insurers into providing coverage. Depending on the forum and press coverage, some insurers may settle with policyholders, rather than risking a worse outcome, even if the insurer believes that a bad outcome would be contrary to policy language.
U.K. Response to Business Interruption Coverage Denial
Unlike the piecemeal approach in the U.S., in the U.K. the Financial Conduct Authority is bringing a test case on business interruption insurance in an effort to clarify questions surrounding coverage arising out of losses related to COVID-19. An expedited trial is due to take place on July 20 in the High Court before Judge Christopher Butcher and Court of Appeal Lord Justice Julian Flaux and is expected to last eight days.
The FCA consulted with insurers, brokers and policyholders in advance of commencement of proceedings and eight insurers have agreed to defend the action, which seeks a declaration of cover under certain of the most commonly used business interruption wordings in the market that provide cover where there has been no physical damage to property.
In relation to infectious disease clauses, the FCA will likely argue that COVID-19 was prevalent in the U.K. even before the start of the government-mandated lockdown. This is because some policy wordings provide cover only when there is an incidence of an infectious disease within a certain radius of the insured's premises, which then causes a business to have to shut down and suffer business interruption losses. Insurers are looking to put the burden of proof on insureds to prove that COVID-19 was prevalent within that radius.
In relation to denial of access clauses, insurers have indicated that they will argue that insured businesses would have suffered financial loss as a result of the prevalence of COVID-19 in the U.K. regardless of the government-mandated lockdown measures. Insurers are suggesting that the relevant business interruption losses should either not be covered at all or severely reduced in line with the trading position of a comparable business in a country suffering from COVID-19 but without a lockdown.
The test case will not attempt to address all formulations of business insurance policy wording. In terms of causation issues, the test case will consider relevant trends clause or equivalent wording but will not deal with coverage issues relating to clauses that (1) have an exhaustive list of diseases that does not include COVID-19; or (2) require the disease to be present at or on the insured premises. Neither will it address other issues relevant to reinsurers such as aggregation.
There is an obligation on insurers to examine each of their policy wordings to determine whether the outcome of claims under the policy will be affected by the resolution of the test case and to notify the results of their review to the FCA by July 8. The FCA will then publish a list of insurers and policy wordings that will be affected by the outcome of the test case.
The guidance expressly recognizes that claims may be settled between insurers and policyholders while the test case is ongoing. However, when making any offer to settle, insurers should inform the policyholder about the test case and its implications. In particular, they should tell the policyholder whether the final resolution of the test case may affect the insurer's decision about their claim, and the implications of accepting or rejecting an offer made on a full and final settlement basis.
Meanwhile, some policyholders are pressing forward under the terms of their contract where cover has been denied and large groups of policyholders have joined together to take action including by way of expedited arbitration.
What Does This Mean for Reinsurance Cessions?
Reinsurers are typically not required to pay claims that are not actually covered by the insurance policies that are reinsured. Any such claims are considered to be ex gratia and such damages are often explicitly excluded under reinsurance contract wording, or excluded because they fall outside the description of covered business.
This is even typically true where a reinsurance contract includes a follow-the-fortunes or follow-the-settlements provision. In light of efforts made to encourage or require coverage of COVID-19 losses where policies would typically exclude coverage, the question will become whether reinsurers are required to cover these claim payments or whether such payments are ex gratia. Before rejecting a business interruption claim presentation, reinsurers would be wise to look at the circumstances of payment as well as specifics of reinsurance contract language.
Typically, reinsurance contracts include an arbitration clause that excuses arbitrators from following the strict rule of law in favor of a focus on industry custom and practice. Given that there is a risk that any rejection of coverage might be challenged, parties to a reinsurance contract should consider dispute resolution provisions.
As with any arbitrated dispute, panel composition can impact outcome and panel selection should be undertaken carefully. However, regardless of who serves, the facts underlying the following issues will almost surely impact the outcome of any dispute.
Applicable Laws Requiring Payment of Claims
First and most importantly, a bill or proposal is not a law and pressure from lawmakers does not by itself create a payment obligation. If an insurer is relying on such pressure, but can point to nothing more and no actual legislation is signed into law, that may not be enough to overcome the assumption that such payment is ex gratia and not covered by the reinsurance contract.
If any bills are signed into law, it will be more difficult for reinsurers to claim that payments made to policyholders under the terms of such laws are ex gratia. That said, cedents will be well-advised to keep reinsurers informed of their decision-making surrounding any such payments, particularly where such laws are challenged in court as unconstitutional and payments are made prior to resolution of those proceedings.
For the most part, the decision to settle a lawsuit relating to COVID-19 coverage is no different than an insurer's decision to settle any coverage-related lawsuit and then seek reinsurance coverage. Follow-the-settlements clauses will be examined and, where no such clause exists, cedents and reinsurers will make arguments regarding whether such clause should be implied in a contract.
In the U.K., if there is no express follow clause, the cedent will have to prove that the loss falls within the terms of both the original policy and the reinsurance contract. Even if the reinsurance contract does include a full follow clause, the analysis is often not straightforward. Here there may well be pressure on an insurer to settle as more and more coverage disputes are being framed as class actions. Class actions are both expensive to litigate and a negative outcome could be devastating for an insurer.
Where cedents point to the U.K. test case or the outcomes of similar U.S. cases to justify claim payment, they should be prepared to prove that the case outcomes involve sufficiently similar policy language and factual circumstances to provide a good faith basis for believing the claim is covered under the relevant policy.
As regulators and politicians seek to shift the expense of COVID-19 recovery to insurers, insurers may feel obligated to pay certain claims due solely to public pressure. In these instances, it may be difficult to make an argument that any such payments are anything but ex gratia.
What Should Cedents and Reinsurers Do Now?
Cedents are well advised to consult with their reinsurers early and often relating to circumstances that could impact claim payment, even where cedents have rejected the claim and contend their policy will not respond.
Not only will this notice help ensure both parties are kept informed of developments that potentially impact payment decisions, but certain reinsurers may be seeing trends from numerous cedents and cooperation between a cedent and reinsurer could help ensure the best strategic decisions are made. Moreover, open communication reduces the likelihood of a dispute and the related expenses down the road.
However, even open communications cannot guarantee that cedents and reinsurers can avoid disputes. The earlier outside counsel is involved in decisions made, the better positioned a party will be for any disputes that arise. Specific policy and contract language can be analyzed to help ensure a coverage position is defensible.
And although arbitration clauses are common, they are not universal, and there may be important strategic decisions relating to forum or venue for possible disputes, how to approach a series of similar disputes, and whether it is better to be a plaintiff/claimant or defendant/respondent should be made early on. Experienced counsel can help with all these decisions.
What Might the Future Hold?
It will likely take a few years before the impact of the COVID-19 pandemic on the insurance and reinsurance markets is fully understood and quantified. The U.K. market has recognized that there may be a need for a government supported backstop reinsurance scheme for future pandemics. And there is also appetite for the capital markets and insurance-linked securities to step into the breach.
A backstop for trade credit insurers has already been approved in the U.K. — by way of a guarantee delivered through a temporary reinsurance agreement — the intention being to provide temporary guarantees for transactions currently supported by trade credit insurance and to prevent the widespread withdrawal of cover particularly across sectors such as retail and manufacturing.
In the U.S., Rep. Carolyn Maloney, D-N.Y., has introduced the Pandemic Risk Insurance Act of 2020 which, if passed, would mandate that insurance companies offering business interruption insurance policies cover losses incurred due to pandemics.
It would establish a Pandemic Risk Reinsurance Program within the U.S. Department of the Treasury under which private insurance companies and the federal government would share the responsibility to pay claims for covered losses. The act would be forward looking and would cover pandemics beginning Jan. 1, 2021.
These efforts may create clarity going forward for cedents and reinsurers, but will not, as currently structured, impact losses that policyholders have incurred or are currently incurring relating to COVID-19.
Robin Dusek is a partner at Saul Ewing Arnstein & Lehr LLP and Susie Wakefield is a partner at Shoosmiths LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
 U.S. Const. art 1., § 10.
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