Reinsurance: COVID-19 – the second wave

United Kingdom

Earlier in the pandemic, we examined emerging issues likely to be of interest to reinsureds and reinsurers (see our Law-Now). With the spread of the disease apparently easing in some jurisdictions but unabated in others, we address ongoing developments and implications for the reinsurance industry.

Classes of business

In our earlier law-now, we focused on a number of classes likely to be hit by concentrations of COVID-19 related claims. Each of those classes has seen developments as the impact of COVID-19 has continued to spread:

  1. Property / business interruption, including loss of rent – payments under a large percentage of BI policies in the UK have been on hold pending the FCA’s test case. Elsewhere in the world there appear to be particular concentrations of exposure but the majority of BI policies are subject to physical damage provisos which have limited pay-outs – political threats to override those provisos have so far proved unfounded;
  2. Contingency policies (such as event cancellation) – the ongoing spread of the pandemic is leading to a further wave of event cancellation claims;
  3. General liability including employers’ liability, general casualty, professional negligence and D&O – an area that is exposed to claims arising from lockdown – if infection occurs on premises that are supposedly “COVID-secure”;
  4. Trade credit insurance – now heavily supported by European governments; and
  5. Political risk – a potential exposure as COVID-19 continues to spread in South America and elsewhere.

Second wave or second spike?

In the UK and Europe, there is a great deal of discussion about the potential implications of a “second spike” in COVID-19. This tends to assume that the disease will spread homogenously with second spikes nationally following a similar pattern to the first wave in March / April 2020. However, we are already seeing more localised outbreaks leading to re-imposition of lock-down (for example in Catalonia and in Leicester) or outbreaks spiking in particular industries (meat processing or the clothing industry).

Meanwhile, new waves of COVID-19 are impacting US States not so severely impacted earlier in the spread, in particular Florida, Arizona and parts of California. Scientific evidence is somewhat divided whether this already amounts to a second wave or the continuing spread of the first wave to States not so heavily impacted earlier in the pandemic.

Elsewhere in the world, it is clear that the first wave of COVID-19 is still very much ongoing, with other South American countries starting to replicate the high death toll in Brazil. The financial impact is being felt not just in specific sectors but across whole economies. There are, however, clear “second spike” events starting to impact in jurisdictions that had previously seen an easing of lockdown, for example the latest outbreak in Melbourne, which has led to a re-imposition of restrictions.

Scientific evidence around the anticipated spread of the disease – the so-called Imperial Analysis and Cambridge Analysis are already part of the FCA’s test case on the applicability of non-damage extensions in direct policies. As the evolution of COVID-19 progresses, the scope of scientific experts facing one another across court rooms or arbitration hearings seems likely to increase.

Causation

Particularly in the English Courts, issues of causation are critical to the determination of the FCA test case. In the majority of cases, the Court is seeking to determine the proximate cause (which does not necessarily mean the immediate or direct cause). Where policies respond to disease, claims are being disputed on the basis that the proximate cause was government action, and on policies responding to the orders of public authority, insurers are arguing that the loss would have been suffered in any event due to the impact of the disease.

The determination of whether a direct policy responds is not necessarily the same exercise as determining the relevant cause for the purposes of aggregation under excess of loss reinsurances.

The market is also grappling with the implications of the Orient-Express case and the operation of Trends clauses – market-wide issues which cause difficulty after every catastrophe (see our commentary after Hurricane Harvey in 2017).

When it comes to a second wave, the position will become even more complex, because the impact of the downturn will still be ongoing. Some businesses will have exhausted their BI cover but others which survived the first wave (particularly with government bail-outs) may need to look to insurance cover to respond. Success for the pioneer claimants in the FCA test case may lead to a second wave of claimants seeking to maximise their recoveries across 2020 (provided they still have cover as blanket exclusions are progressively introduced on renewals).

The proximate cause of losses in a second wave may be rather different from the first wave (and not necessarily insured under the same non-damage extension). In the second wave, there is far more potential for harm to a business because of deliberate actions by government to stimulate economic growth by releasing lockdown, which may be more difficult to characterise as a preventable fortuity. Such steps may be more difficult to characterise as a “disaster” or “catastrophe”, especially if natural perils are required as a proximate cause. And as noted above, further lockdowns are much more likely to be localised, leading to re-examination of “in the vicinity”-based clauses.

Aggregation

On the one hand, the ongoing spread of the disease – particularly where, from a scientific point of view, the spread is clearly an ongoing evolution of the first wave – could be said to increase reinsurers’ catastrophe exposure to COVID-19 as a whole.

Some reinsureds have to date presented all COVID-19 losses on the basis that they are aggregable as a single catastrophe or event. However, ongoing geographical spread and prolongation of the scientific first wave may make it increasingly difficult to argue that there is a single global catastrophe or occurrence that is still ongoing (particularly when many treaties contain hours clauses that have long since been exhausted).

The likelihood of more localised lockdowns and sporadic outbreaks in different geographical areas may arguably tend to point to those future outbreaks being treated as much more conventional events, satisfying the Kuwait Airways “unities” tests.

Just as national or regionalised outbreaks as part of the first wave may arguably be treated as single catastrophes, occurrences or events if there are widespread national or regionalised second waves then it is also arguable that they may be aggregable as fresh catastrophes, occurrences or events (but separate from first wave aggregation of losses).

Settlements

Whilst a number of insurers / reinsureds have taken a fairly robust line in resisting payment of claims pending resolution of the FCA test case, others have been keen to be seen to “do the right thing” and to confirm cover – subject to adjustment – particularly for classes of insureds that might be viewed favourably by the Financial Ombudsman’s Service or equivalent.

The extent to which reinsurers have any right to intervene in claims settlement varies considerably from treaty to treaty. Some proportional treaties include claims co-operation or control clauses (in the more extreme cases expressed as conditions precedent to liability).

In excess of loss treaties, we are seeing a mix of loss settlements clauses, some of which contain only the Hill v M&G second proviso, that the claims must fall within the terms and conditions of the reinsurance, but others which contain both limbs of the “double proviso”, that claims must fall within the terms and conditions of the original policies, as well as the reinsurance. The latter allows reinsurers considerable latitude to challenge reinsureds’ settlements that are driven by the desire to avoid court findings or FOS adjudications.

This difficulty for some reinsureds is likely to increase further as 2020 progresses. Depending on the outcome, the FCA test case could place many insurers / reinsureds under pressure to settle quickly (and that might be the case even if an appeal is pending), a scenario that could unfold at the same time as new “second wave” claims are being notified.

Next steps

We commented in April that the pace and financial pressure arising out of COVID-19 claims will only continue to increase and will put existing claims handling procedures (for both reinsureds and reinsurers) under strain. That has certainly proved to be the case for direct insurers involved in the FCA test case (whether directly or indirectly). The resolution of that case will shift more of the burden to reinsurers.

At the same time, reinsureds may seek to notify claims arising from the second wave (which they may or may not seek to present as a continuation of a single COVID-19 catastrophe or event). The potential for a different cause adds to the complication of already difficult issues.

To date, we have seen reinsureds reluctant to nail their colours to the mast in terms of causation and aggregation, and to avoid settlement of all but the most obvious exposures. Upcoming months will thus see difficult choices for reinsureds and test out reinsurers’ willingness to challenge their reinsureds.

Further reading: Orient-Express Hotels Ltd v Assicurazioni Generali SpA [2010] EWHC 1186 (Comm).

Kuwait Airways Corporation v Kuwait Insurance Co SAK [1996] 1 Lloyd’s Rep 664.

Hill v Mercantile & General Reinsurance Co Plc [1996] 2 All ER 865.