Business needs risk cover for pandemics, but insurers have revealed their fine print exclusions denying most cover. There is 'market failure' for cover at a reasonable cost. Is it the taxpayer who needs to cover these risks?

This article originally appeared in LawNews (ADLS) and is here with permission.

By Diana Clement

Business has had it rough in 2020. Two lockdowns, tourists, students, and foreign workers locked out, skyrocketing unemployment and plummeting growth – and an economic reality New Zealanders couldn’t have comprehended a year ago.

But you would think owners whose businesses were impacted by Covid-19 could claim on their business interruption (BI) policies. Yeah nah, it’s a pandemic, say the insurers.

Business interruption insurance is designed primarily to cover losses in conjunction with a material damage policy. So, if your plant or machinery aren’t damaged by an event such as fire, earthquake or flooding, you don’t have any cover.

Most New Zealand polices are watertight on that front, says AUT law lecturer and former in-house insurance counsel Christopher Whitehead. “The typical product here prevents recovery at two levels. First it covers only business interruption as a result of physical loss or damage to the premises. Even if you get past that threshold, [Covid-19] is a notifiable disease [exclusion].”

Most BI policies sold in New Zealand specifically exclude all losses caused by any animal or human disease notifiable under the Health Act 1956 and the Biosecurity Act 1993, points out Insurance & Financial Services ombudsman Karen Stevens. The exclusions were added after the Sars outbreak in the early 2000s.

“It takes any question away,” she says. “As soon as you see that kind of exclusion in a BI policy, there is not going to be that kind of argument that Covid-19 might be covered under another provision.”

It’s déja vu for New Zealand businesses that have been through earthquakes in recent years. In Christchurch many came a cropper because the cordon, rather than earthquake damage, was deemed by insurers to be the trigger of their losses. That meant no pay-out.

The earthquakes did throw BI cover into sharp focus and some insurers began to add prevention of access and disease extensions to their policies. They’re expensive, and very few businesses have taken them out, says Richard Shehean, head of corporate and sales at insurance broker Marsh.

De facto BI cover

In a sense, the wage subsidy and other government Covid-19 schemes for business have offered de facto BI cover. That has been helpful in terms of managing cashflow, says BusinessNZ’s chief executive Kirk Hope.

In the United Kingdom, Australia and elsewhere, policy wordings are being put under the microscope.

All eyes and ears of insurers and their legal counsel have been on a test case in England where the regulator, the Financial Conduct Authority (FCA) took the landmark case on behalf of policyholders in respect of sample policy wordings from 21 BI policies issued by eight insurers.

The aim was to test three common clauses and clarify key issues of contractual uncertainty. These clauses related to:

• disease;
• prevention of access/public authority; and hybrid disease and prevention.

The English High Court found largely in favour of the FCA and the outcome of the case will affect as many as 370,000 UK businesses. Read more.

A 160-page judgment in mid-September found that most of the disease clauses triggered the cover, as did some of the denial of access clauses.

The judgment was relatively narrow in its focus, says Nick Frith, partner, dispute resolution and litigation, at MinterEllisonRuddWatts. “It wasn’t looking at general pandemic cover. It was looking only at extension cover.”

The UK insurers relied heavily in court on so-called ‘Orient Express’ exclusions. The same case was also used in New Zealand after the Christchurch earthquakes to deny many businesses BI pay-outs.

The argument, says Frith, was that Hurricane Katrina damaged the Orient Express hotel, but also destroyed the city around it. “[The Orient Express’ insurers] said you couldn’t satisfy the ‘but for’ test of causation because regardless of the damage to the hotel, you would have suffered this interruption because of the destruction to the wider area.” As a result, the trends clause in the policy meant the cover was adjusted down to nothing.

The FCA case is relevant to New Zealand for two reasons, Frith says. “The first is that English authority is still persuasive to New Zealand courts in interpreting these kinds of conditions.

“Second, there will be a number of New Zealand policies that include similar prevention-of-access or public authority extensions to those in the FCA test case. To that extent it will be a useful case for insureds and insurers to be across, as it will almost certainly be appealed to the UK Supreme Court.

“The one caveat being, of course, that this is a whopper of a decision relating to thousands of policyholders and the court has already provided a mechanism to the parties to leapfrog to the Supreme Court. So, all the lawyers involved seem to accept this is likely not going to be the end of the story.”

The lucky ones

There have been notable exceptions. Frith points to a policy held by 1500 preschool centres that held cover arranged by broker Crombie Lockwood. Under their Child Proof scheme policies, they were covered for up to 25% of annual turnover, capped at $250,000 per site.

Shehean adds some businesses will have notified their insurers of a business interruption claim but will not yet have been paid because their insurer was awaiting the outcome of the FCA test case.

Events businesses may also have had cover for pandemics, says Frith. At least, until now. “It’s a pretty narrow risk for the insurer. It is a particular event and a number of people attending,” he says.

Catch 22

Specific disease cover is not common in New Zealand, write Bell Gully partner David Friar and senior associate Sam Hiebendaal. They note that with some policies there is an extension providing cover for disease, but a general policy exclusion excluding pandemics. In that instance the two clauses need reconciling.

“In many cases, the policy will expressly provide that the exclusion prevails in the event of a conflict, they say. “In a number of policies we have reviewed, the Health Act exclusion has taken precedence over extensions that would otherwise potentially provide cover.”

Friar and Hiebendaal say the English court held that this general exclusion for epidemics and disease could not reasonably be interpreted to cut down more specific cover for disease that had been provided by an extension; the policy could not give with one hand and take away with the other.

Frith says there have been some “interesting arguments” about BI cover discussed in legal circles here in New Zealand.

“One I read being touted was that if you had, say, a hotel and somebody with Covid had stayed there and left a residue of the virus on elements of the hotel, that might constitute [material] damage because it was a physical change to the hotel.

“It was a potential way to shoehorn a Covid claim into a physical loss. But I think it was a bit of a stretch. Also, I would have thought you would be in the waiting period anyway.”

Business protection

Business needs insurance at an affordable price, says Hope. “Our default position [is] you would hope the market would be able to provide that to New Zealand businesses at an affordable price. The last thing you want is for businesses not to be able to protect themselves against a wide range of risks.

“I am not bagging the insurance providers because generally they continue to provide product into New Zealand. The question has to be if risks like this aren’t going to be covered and we are going to see more of them, we will need options for businesses to protect themselves.”

Nothing is stopping insurers covering the next pandemic, says Stevens.

“I did read there was cover for BI for pandemic. It was an extension. At the end of the day, nobody wanted it because it was too expensive. That’s what happens. If businesses don’t buy the cover, it gets taken away.”

Caps and excesses

Whitehead argues that excesses and annual caps can help insurers manage tricky situations such as the Twin Towers attacks, Christchurch earthquakes and Covid-19.

“I tell my students [to] put a cap on how much you will pay for a calendar year. Don’t rely on wording that requires interpretation to limit your losses. You are better off sticking with figures. Say ‘right we will pay ... a maximum of $1 million per year’.

“Covid-19 has been a moment of reckoning for insurance companies’ PR machines. Taking such an approach would help the reputation of insurance companies,” he says.

Standardisation and excesses

Whitehead argues in favour of standardised policies with insurers competing on service and other aspects.

Too often insurers don’t know what’s in their policies and need to do a stocktake when an event such as Covid-19 comes along, he says.

The actuaries and the lawyers don’t work closely enough together when policies are drafted. Their diseases clauses had not been tested, as the FCA case showed, he says.

“Insurance companies have so many different policies that something like this happens and they have to do a survey of their policies. That’s the problem with insurance. When things get tough, you have to go back and see what you have actually written. Nasty surprises come up.

“If everyone is selling the same policy, it’s not a question of what’s in the policy. We just have to go onto our website to find out.”

Whose job?

If insurers can’t offer the cover at an affordable price, then we have a market failure, says Hope.

So, there may be a case for intervention from government if future pandemics and other events such as climate change are uninsurable.

Stevens says most New Zealanders would expect it’s the government’s role to ensure New Zealand has a sustainable future.

Examples exist here with EQC, and abroad. After 9/11, the UK and Australian governments drew that logical conclusion and stepped in to reinsure terrorism risks through Pool Re and the Australian Reinsurance Pool Corporation, Frith says.

“That is a viable option [for future pandemic cover] because it’s like a proxy for the wage subsidy, but more expansive in the sense the government is acknowledging that it’s putting these restrictions in place.

“The risk is going to be the frequency or the likely frequency if that can be quantified from an actuarial perspective. Major events don’t usually affect whole regions for long periods of time like these lockdowns can. These are issues to be worked through.”

Shehean says it would need to be a Treasury-level reinsurance-type approach. “That is just drawing a logical conclusion.” A Treasury spokesman told LawNews it was not something the department was looking into currently.

Cover tightening

Frith says the London market has added very broad communicable disease exclusions to BI policies. “Some are so broadly drawn that they exclude liability for loss arising concurrently or in sequence with the threat or fear of a communicable disease. That could be similar to the Orient Express example where you have unconnected but concurrent loss but this time it’s under an express clause.

“Some of these new clauses are designed to exclude loss that arises during a pandemic or when there is fear of a pandemic, even if the loss in question has nothing to do with the disease. It will be interesting to see if insureds look to s 11 of the Insurance Law Reform Act 1977 to resist the application of such clauses in New Zealand,” Frith says.

“For example, in Auckland we certainly had a resurgence [of Covid-19]. In the rest of the country there was no evidence of cases but restrictions were imposed to a greater or lesser degree. So, [there was] fear of the transmission of the virus. The London market has sought to exclude that risk on the rationale that pandemic loss is so huge and effectively unquantifiable.”

The clauses in question were produced by the London Market Association but some have been adopted by other underwriters including Delta Property Insurance in New Zealand and extend to “perhaps unexpected” types of cover, such as property damage and cyber policies.

Contractual interpretations

It’s hard trying to sell the interest factor to noninsurance lawyers, Frith says. But the FCA case considers contractual interpretation points of interest to a wider legal audience.

“So, to the extent that we get some jurisprudence around the interpretation of these [policies], that ought to be generally interesting.”

He says the Canterbury earthquakes thrust New Zealand to the forefront of insurance jurisprudence.

“I suspect the pandemic, and in particular the FCA case, are likely to result in more interesting jurisprudence from an insurance interpretation perspective.

“My understanding from the commentaries is that a couple of class actions have at least been commenced or about to be commenced in Australia so it will be interesting to see how the litigation market responds to the FCA decision and whatever follows.”

Diana Clement is a freelance journalist. This article originally appeared in LawNews (ADLS) and is here with permission.