Reinsurance implications of the Supreme Court's judgment in the FCA business interruption Test Case
The original version of this article was published by "The Insurer" and is reproduced with permission from the publisher.
The Supreme Court's judgment in the FCA business interruption Test Case will have a significant impact on the property insurance market. The decision effectively broadened the cover available to policyholders under non-damage business interruption extensions of cover and its analysis of the operation of standard “trends clauses” has essentially removed the ability of insurers to adjust claims downwards in reliance on “wide area damage” type arguments. Exposures and therefore reserves will be revised upwards and insurers/reinsurers will be reassessing the potential impact on their outwards reinsurance and retrocession protections.
So what are the potential implications for the reinsurance market? In this article we examine some of the immediate questions the reinsurance market will be grappling with as a consequence of the Supreme Court's ruling (we should emphasise that our general comments are not to be taken as specific advice).
Aggregation
One of the principal issues that will arise at the reinsurance level is the ability (or otherwise) for a cedant to aggregate its losses and present a single claim. A typical definition of a “Loss Occurrence” in a CAT XOL treaty will provide:
The term “Loss Occurrence” shall mean each and every loss and/or series of losses arising out of and directly occasioned by one [event] / [originating cause] / [catastrophe].
One immediate question that arises therefore is whether a reinsured's COVID-19-related inwards losses (i.e. those sums paid to SME policyholders as a result of the Supreme Court's ruling) can legitimately be presented to reinsurers on the basis that those losses arise out of one "event" or "originating cause" or "catastrophe".
In this context, the Supreme Court's judgment provided some guidance to the market. In particular, the Supreme Court noted that an “event” is synonymous with an "occurrence" and both words have a widely recognised meaning in insurance law, which accords with their ordinary meaning as “something which happens at a particular time, at a particular place, in a particular way” – as originally explained in the well-known case of Axa Reinsurance (UK) plc v Field [1996].
However, of specific relevance to reinsurance market participants are the observations contained in the judgment of the majority of the Supreme Court Justices as to whether the presence of COVID-19 in the UK can be said to satisfy the widely recognised meaning of an "event":
A disease that spreads [such as COVID-19] is not something that occurs at a particular time and place and in a particular way: it occurs at a multiplicity of different times and places and may occur in different ways involving differing symptoms of greater or less severity. Nor for that matter could an “outbreak” of disease be regarded as one occurrence, unless the individual cases of disease described as an “outbreak” have a sufficient degree of unity in relation to time, locality and cause. If several members of a household were all infected with COVID-19 when a carrier of the disease visited their home on a particular day, that might arguably be described as one occurrence. But the same could not be said of the contraction of the disease by different individuals on different days in different towns and from different sources. Still less could it be said that all the cases of COVID-19 in England (or in the United Kingdom or throughout the world) which had arisen by any given date in March 2020 constituted one occurrence. On any reasonable or realistic view, those cases comprised thousands of separate occurrences of COVID-19.
Two of the Justices were less sure that “occurrence” was necessarily an inappropriate word to use about a pandemic disease as a whole, but they accepted that “it may be a pointer of some weight to an individual case analysis”. They were, in any case, in the minority.
The majority view appears to confirm the observations of Flaux LJ and Butcher J in their first instance High Court judgment when considering the meaning of “incident”, which can be considered to be synonymous with “event” and “occurrence” in this context:
… it is a misuse of language … to describe the pandemic as “an incident” let alone “an incident occurring… within a one mile radius of the insured premises”. It may amount to a state of affairs but it is, as Mr Gaisman QC put it, too geographically dispersed, variegated, prolonged and non-specific to amount to an incident
It would therefore appear from the Supreme Court's comments that cedants with "event" aggregation language in their reinsurance contracts will, if those contracts are subject to English law, provide some support for reinsurers’ position that the losses might not be able to aggregate the losses as arising from one event. On the other hand, cedants will argue that the Court’s comments were made in the context of coverage under the direct policies, and not in the context of aggregation under ‘event’ reinsurances where a different test of causation might arguably apply.
Contracts that instead permit aggregation of individual losses by reference to a common "originating cause" may be construed as having a wider basis of aggregation: this is because it is well-established in the English law cases that “originating cause” language opens up the search for an aggregating factor much more widely than “event” wording and can include a continuing state of affairs. It is, however, important in every case to analyse the particular wording in issue very carefully as bespoke aggregation wordings and variants on the typical clause set out above are not uncommon.
What about those treaties that refer to a "catastrophe" - is COVID-19 and/or the public and governmental response to the pandemic - a "catastrophe" for the purposes of aggregation? This question is complicated by the fact that there is no meaningful judicial guidance (in the UK or elsewhere) on the issue and the Supreme Court judgment has not altered this position.
As the Supreme Court's judgment in the FCA Test Case emphasises, the test is what a reasonable person, with all the background knowledge which would reasonably have been available to the parties when they entered into the contract, would have understood the wording of the contract to mean. Evidence of what one or other of the parties subjectively thinks about how the contract should work is irrelevant to the exercise of interpretation.
We therefore envisage that aggregation is an issue that may require judicial interpretation. However, that in itself is complicated by the general inclusion of confidential arbitration clauses in reinsurance treaties, and with limited rights to appeal. This was a factor which the Supreme Court relied upon in the FCA Test Case when over-ruling the ten year old decision in the Orient Express Hotels case, which was itself an appeal from an arbitration award.
If aggregation of individual losses is permitted in principle, reinsurers will then be looking to see whether and how cedants propose to apply hours clauses, which again are typical features of “Loss Occurrence” definition clauses. These typically permit aggregation of covered losses occurring within a specified period (e.g. 72 or 168 hours). Many such clauses permit the reinsured to choose when the relevant period of consecutive hours starts. They also often allow reinsureds to, in effect, reinstate cover by presenting aggregated losses on the basis of multiple separate periods of hours where losses arise across a longer period of time than the specified period of hours. However, each separate period will attract fresh deductibles and limits.
Accordingly, whether this is possible, will depend upon a range of factors, many of which will be fact sensitive, including the inwards loss profile over time, the levels at which deductibles and limits have been agreed, and the proper basis upon which the losses are aggregated (if they can be aggregated at all).
One thing is clear: the ability or otherwise of cedants to aggregate COVID-19-related losses will be a key battleground.
Allocation & adjustment
Another issue that will require careful consideration by the market is the allocation of COVID-19-related underlying losses to the appropriate policy year and the proper adjustment of those losses.
The Supreme Court's judgment focuses on the UK's first government-mandated 'lockdown' dating back to March 2020. The Supreme Court also made clear, in the context of “disease” clauses which cover the occurrence of disease within a specified radius or vicinity of the insured premises, that the insured peril which triggers cover is not COVID-19 itself but each case of illness sustained by a person within the specified radius (although, depending upon the wording of the insurance contract, such illness does not need to have been diagnosed or even manifested in symptoms).
In the case of “prevention of access” and “hybrid” clauses, the Supreme Court gave quite nuanced guidance about the types of interruption loss that would and would not fall within the scope of the clauses: for example, loss sustained by a travel agency which lost walk-in business when its shop closed as a result of lockdown would be covered, but online sales which suffered a downturn because of the general effects of the pandemic would not. It is also necessary to read the Supreme Court judgment together with the High Court decision in respect of these clauses, as much of the High Court’s reasoning was not appealed and remains binding.
Of course, since the first national lockdown, England has seen two further 'lockdowns' – the second in late 2020 and the third, which commenced in January 2021, is ongoing at the date of publication of this article. The devolved nations have, of course, also been subject to restrictions, although of varying nature and at different times.
Reinsurance contracts that renewed at 1 January 2021 typically include exclusions in relation to COVID-19-relates losses, meaning that those losses arising from the January 2021 lockdown may be unreinsured. However, extended expiration clauses in 2020 treaties may assist cedants who wish to allocate COVID-19-related losses from the January 2021 lockdown to the 2020 year. Extended expiration clauses typically provide that, where the contract expires while a covered loss occurrence is in progress, reinsurers are obliged to indemnify the cedant as if the entire loss had occurred during the term of the expiring contract. This raises further questions as to whether separate lockdowns can be aggregated together for the purpose of triggering the extended expiration clauses so as to attach ongoing COVID-19-related losses flowing from the January 2021 lockdown (and beyond) to a 2020 treaty. These questions may, again, be influenced by the approach taken to aggregation generally (discussed above).
The reinsurance market should not be surprised to see new litigation spring up under direct policies in respect of issues that were either not dealt with in the FCA Test Case or were expressly left open. Whilst the Supreme Court’s judgment provides general guidance and will no doubt permit insurers to determine very many outstanding claims, it still needs to be applied to the facts of individual cases, and these could throw up their own specific issues.
Follow obligations
Reinsurance contracts typically include a "Loss Settlements" clause that provides for either a "qualified follow" or "full follow" obligation. A wide variety of these types clauses used in the market and each must be considered on its own merits, some of which may exclude ex gratia payments. However, whatever type of follow obligation is included, the claim presented must fall within the terms of the reinsurance contract. In this context, exclusions in the reinsurance contract, for example in relation to contingent business interruption losses, may be relevant.
Conclusion
The Supreme Court's judgment in the FCA Test Case brings to a conclusion some of the more complex issues that arise at direct insurance level. However, the judgment only serves to pull the trigger on the starting pistol for debates that will now take place at the reinsurance level. With market participants' exposures moving upwards, disputes as to the correct interpretation of various contractual issues appear inevitable.
