Business Interruption Insurance and Covid-19: FCA’s expectations following Supreme Court’s judgment

The Supreme Court delivered its keenly-anticipated judgment in the FCA’s Test Case on non-damage business interruption (BI) cover for losses arising from the COVID-19 pandemic on 15 January 2021. The judgment is the culmination of expedited proceedings brought by the FCA to clarify cover under a range of sample BI wordings that the Court was asked to consider. While the judgment and (where issues were not appealed) the High Court’s judgment of 15 September 2020 are binding on the Insurers who voluntarily agreed to be parties to the test case litigation, the FCA has made clear its expectation that the Courts’ rulings will be “persuasive guidance” in the interpretation of similar wordings and claims.

On 17th June 2020, the FCA published finalised guidance setting out the regulator’s expectations in respect of their regulatory obligations (under FCA Principles, ICOBS and DISP) for Insurers and insurance intermediaries when handling claims and complaints for BI policies during the test case (the Guidance). The Supreme Court’s judgment marks the ‘final resolution’ of the proceedings and so the final stage in the FCA’s expectations of firms under the Guidance. This triggers three separate processes for Insurers:

1. An update to policyholders with potentially affected claims and/or complaints will need to be circulated confirming that the test case has reached final resolution. This communication should be made as soon as possible and, in any event, by 22nd January 2021;

2. A prompt determination of any outstanding potentially affected claims and/or complaints; and

3. A reassessment of previously rejected claims and complaints will need to be completed and notified to relevant policyholders.

Background

In the early stages of the COVID-19 pandemic it became apparent that the wide number of different wordings in the BI insurance market was creating uncertainty for SMEs facing significant losses and for their Insurers. In response, on 1 May 2020 the FCA announced that it intended to obtain a court declaration to determine the meaning and effect of sample BI wordings. Proceedings were issued under the Financial Market Test Case Scheme and the High Court was asked to consider 21 sample policy wordings. The relevant provisions in the wordings fell into three categories:

1. Disease extensions
2. Prevention of access/public authority extensions
3. Hybrid clauses.

The High Court’s judgment (handed down on 15 September 2020) was supplemented by Declarations made by the Court on 2 October 2020 following a consequentials hearing. The Court (Lord Justice Flaux and Mr Justice Butcher) made detailed findings on the interpretation of the specific wording used in the sample policies. While each policy must be looked at individually, broadly the Court found that extensions for disease and hybrid clauses provided cover but that cover for denial of access extensions was more limited.

Supreme Court Appeal

The FCA, six of the original eight Insurer defendants and the Hiscox Action Group appealed a number of the High Court’s findings. The appeal was “leapfrogged” to the Supreme Court and heard in November 2020. The Supreme Court delivered its wide-ranging 112-page judgment less than two months later.

Disease extensions

The Supreme Court disagreed with the High Court on the construction of the sample disease extensions. The Supreme Court construed the extensions more narrowly, accepting the Insurers’ arguments that:

• each case of illness sustained by an individual is a separate “occurrence”; and
• only BI losses caused by cases of the disease within the relevant vicinity were covered.

However, the Supreme Court still found that cover was available under the disease extensions due to its analysis on causation issues (as explained below) and because it agreed with the High Court that:

• the disease extensions did not confine cover for losses resulting only from cases of a notifiable disease within the relevant vicinity; and
• in interpreting the disease extensions, significance should be attached to the potential for a notifiable disease to affect a wider area and for an occurrence of such a disease within a vicinity to form part of a wider outbreak.

Prevention of access and hybrid extensions

The Supreme Court disagreed with the High Court that “restrictions imposed” by an authority means something which is both expressed in mandatory terms and has force of law. The Supreme Court accepted the FCA’s arguments that this was too narrow and determined that “restrictions imposed” may include instructions given by a public authority provided they carry the imminent threat of legal compulsion or are expressed in mandatory or clear terms. The Court has, however, left over for further argument precisely which of the government instructions in March 2020 fall within this category, noting that an “enforced closure of an Insured Location” would not include “advice or exhortations, or social distancing and stay at home instructions”.

The Supreme Court also adopted a wider interpretation of “inability to use” than the High Court, holding that this may be satisfied where a policyholder is unable to use a discrete part of its premises or is unable to use its premises for a discrete business activity.

The overall effect of these findings is to broaden the range of government measures which may trigger cover for policyholders.

Causation

In its judgment, the High Court was largely able to circumvent issues of causation by its construction of the wordings. However, the Supreme Court’s interpretation of the disease extensions rendered such issues of crucial importance.

The Supreme Court agreed with the High Court that:

• the government measures were taken in response to information about all COVID-19 cases in the country as a whole; and
• all cases of COVID-19 occurring before the date of any government measure were equally effective proximate causes of that measure.

The Supreme Court concluded that, in order to obtain cover under the disease extensions, it is sufficient for a policyholder to show that at the time of any relevant government measure there was at least one case of COVID-19 in the relevant vicinity. The Supreme Court also indicated that the above analysis was applicable to those hybrid clauses which require as one element an occurrence of a notifiable disease within the vicinity of the insured premises.

In reaching this conclusion, the Supreme Court dismissed Insurers’ arguments that a strict application of the “but for” test was appropriate. The Supreme Court explained that in some instances the test may be inadequate and, such as in this case, it is possible for a series of events to combine to cause a particular result, although none of them are necessary or sufficient to cause that result itself.

Trends clauses and ‘pre-trigger losses’

The Supreme Court dismissed the Insurers’ appeals as regards trends clauses, determining that such clauses only allow adjustment of claims for trends or circumstances which are unconnected with the insured peril. Trends clauses should not therefore permit insurers to adjust claims on the grounds that, had the insured peril not occurred, the business would still have suffered as a result of the COVID-19 pandemic. The Supreme Court’s findings confirm that trends clauses form part of the quantification machinery of the policy only and should not be interpreted so as to take away the cover provided by the insuring clause.

As a natural consequence, the Supreme Court allowed the FCA’s appeal as regards so-called ‘pre-trigger losses’. The Supreme Court determined that the High Court had been wrong to conclude that insurers, subject to qualifications, were permitted to take into account losses due to COVID-19 prior to the insured peril being triggered. This issue was particularly relevant to prevention of access and hybrid extensions as policyholders may have incurred COVID-19 related losses prior to government measures triggering those extensions.

Orient-Express Hotels Ltd v Assicurazioni Generali SPA

Significantly, the Supreme Court held that the 2010 decision in Orient-Express should be overruled. In Orient-Express, the owners of a New Orleans hotel damaged by Hurricane Katrina were unable to recover BI losses because, applying the “but for” test, the losses would still have been suffered as a result of the damage to the wider area. The Insurers had relied upon Orient Express to argue that, “but for” the insured peril, policyholders would still have suffered similar losses due to the national pandemic and the government response in relation thereto.

The relevance of Orient-Express extends beyond BI policies and the Supreme Court’s ruling will have wider implications for the insurance market.

FCA’s expectations

On 17th June 2020, the FCA published finalised guidance setting out the regulators’ expectations in respect of their regulatory obligations (under FCA Principles, ICOBS and DISP) for Insurers and insurance intermediaries when handling claims and complaints for BI policies during the test case (the Guidance). Our previous articles discuss the detail of this Guidance and can be accessed here, here and here. The publication of the Supreme Court judgment marks the ‘final resolution’ of the proceedings and so the final stage in the FCA’s expectations of firms under the Guidance. This triggers three separate processes for Insurers:

1. An update to policyholders with potentially affected claims and/or complaints will need to be circulated confirming that the test case has reached final resolution. This communication should be made as soon as possible and, in any event, by 22nd January 2021;
2. A prompt determination of any outstanding potentially affected claims and/or complaints; and
3. A reassessment of previously rejected claims and complaints will need to be completed and notified to relevant policyholders.

Policyholder updates

Where Insurers have determined that the outcome of certain policyholders’ claims/complaints will depend on the outcome of the test case, Insurers will now need to update the relevant policyholders individually on the final resolution setting out the next steps and likely timings.

In order to treat customers fairly, customer communications will need to be clear and balanced in keeping with the Insurers’ regulatory obligations under both Principles 6 and 7. This will need careful thought as the Supreme Court judgment presents complex issues and, although the matters under consideration by the Supreme Court have now been settled, there remain ongoing significant uncertainties which may be a challenge to communicate to customers clearly, especially if it involves updating previous communications.

Determining potentially affected claims/complaints

Insurers have been permitted to wait until final resolution of the test case before reaching a decision on potentially affected claims or potentially affected complaints. These decisions must now be taken and should be taken ‘promptly’ with ‘swift’ settlement. Each policy under which such claim or complaint arises will need to be considered against the detailed Supreme Court judgment and should be handled and assessed in line with ICOBS 8 and DISP 1 respectively. Particular attention should be paid to seeking to ensure fair customer outcomes and compliance with TCF obligations. This should include prioritising vulnerable customers where possible and making interim payments as appropriate.

When looking to determine a claim under a policy which requires proof of the presence of COVID-19, Insurers will need to consider the FCA’s expectations as to the manner in which Insurers require policyholders to prove the presence of COVID-19. This guidance is currently in draft form (the “Draft Proof Guidance”) and seeks to provide clarity and additional simplicity for policyholders in proving the existence of the virus within the ‘relevant policy area’ (“RPA”). In particular, Insurers are encouraged to adopt a streamlined approach which seeks to expedite claims handling, for example by:

1. Proposing to policyholders a date by which COVID-19 will be deemed to have been established in any given RPA (provided policyholders are given the opportunity to prove an earlier case where appropriate); or
2. Publishing records of the RPAs in which cases of COVID-19 have already been proved by policyholders in order to assist other policyholders with their claims.

The FCA has also stressed that Insurers should not require policyholders to prove that COVID-19 was ‘sustained’, ‘occurred’ or ‘manifested’ in a given location where this has already been proved by another policyholder. Rather, the evidence accepted in respect of one policyholder should be considered sufficient for others and policyholders should be informed of this.

The Draft Proof Guidance is under consultation until 22 January 2021, after which the final guidance will be published as soon as possible. Insurers should consider this guidance carefully in order to develop and implement a fair and consistent approach to the proof of the existence of COVID-19 which meets the FCA’s expectations. This approach should be scrutinised by relevant senior management, documented and communicated to any relevant third-party claims handlers. Relevant processes will need to be implemented without delay in order to ensure that outstanding claims decisions can be made in the prompt manner expected by the FCA.

The FCA has also noted that it intends to assist with this process by publishing a set of Q&A’s to assist with understanding the test case and will publish a list of BI policy types that potentially respond to the coronavirus pandemic based on information to be obtained from insurers.

Review of rejected/reduced potentially affected claims/complaints

Insurers must now also conduct a reassessment of all claims and complaints that they have previously rejected that would, if still open, be impacted by the outcome of the test case applying the judgment(s) in the test case.

Insurers are not expected to reassess any (i) claims or complaints that have been settled on a full and final settlement basis, or (ii) complaints that have been accepted for consideration by the Financial Ombudsman Service. However, Insurers may want to seek advice on practical issues such as proactively contacting the FOS prior to any FOS determination.

Insurers must promptly inform relevant policyholders that this reassessment has taken place and its outcome and for rejected complaints provide a revised final response under DISP 1.6.2R.

Governance

It is essential that Insurers ensure that they have a strong governance framework around their continuing compliance with the Guidance, with appropriate senior management engagement and oversight. In particular, they should ensure that:

• There are clear processes in place concerning the (i) determination of potentially affected claims/complaints, including the manner in which the presence of COVID-19 is proved, and (ii) reassessment of rejected or reduced potentially affected claims/complaints, and that these are documented, with the rationale for conclusions clearly recorded;
• Relevant senior managers, which will include the senior managers responsible for claims and complaints handling as well as the senior manager allocated the responsibility for oversight of Guidance expectations on the insurer (if different), should be fully engaged so that they can exercise the appropriate oversight and challenge and clear escalation processes should be implemented to ensure that key decisions and issues are being resolved at an appropriate level of seniority. This should include obtaining management information concerning the timeliness of decisions (in respect of coverage, quantum and settlement) following final resolution; and
• Claims and complaints handlers should receive training on how the test case and associated Guidance impacts ongoing and new claims and complaints and the processes that should be followed in respect of these.

Insurers are likely to face scrutiny from the FCA on their compliance with the Guidance, and the finalised version of the Draft Proof Guidance, either on a sector or firm-level basis. It is worth noting that the FCA commenced a thematic review of insurers’ compliance with the FCA guidance on Product Value and Coronavirus within weeks of the deadline for such compliance passing, highlighting the regulator’s concern to understand the manner in which Insurers have responded to COVID-19 and the FCA’s guidance. FCA could take a similarly proactive approach in relation to the Guidance given the FCA’s obvious interest in ensuring policyholders have been treated fairly, but also in ascertaining the effectiveness of its use of the court declaration process.

Comment

In certain respects, the judgment of the Supreme Court reflects a shift towards policy construction in favour of policyholders. This is perhaps most manifest in limiting Insurers’ ability to rely on general exclusions, causation defences or limitations in the scope of cover (such as trends clauses) to narrow coverage that has been expressly provided for in the form of policy extensions.

It may be relatively easy for Insurers to seek to ameliorate the immediate effects of the judgment by narrowing cover in certain respects – for example, by removing or re-wording disease extensions and imposing specific exclusions for COVID-19 or pandemics generally going forward – and by increasing premiums for businesses to seek to replenish their balance sheets. More difficult to overcome in the longer terms may be the effects of the Supreme Court’s determination not to allow Insurers to rely on ancillary clauses to narrow the scope of cover provided by policy extensions.

At the same time, it is important to recognise that the Supreme Court’s judgment applies only to certain wordings. For example, the FCA did not challenge the inapplicability of “damage” extensions, and indeed first instance findings in favour of Insurers on certain “non-damage” extensions were not subject to appeal by the FCA.

In light of the Supreme Court’s findings, attention is now likely to turn to the presentation and adjustment of detailed loss calculations for businesses benefitting from disease extensions or prevention of access clauses. Insurers will be under severe pressure from the FCA to process and adjust claims and – at a minimum – to make interim payments to policyholders as soon as possible. However, the application of the judgment to different types of business, which have been subject to the government’s myriad different “rules”, will require careful analysis on a case-by-case basis.

The judgment provided guidance for the treatment of partial closures – the relevant part of the business being a discrete operation that was forced to close - and the relevant counter-factual for the purposes of the trends clause – namely the relevant business’ pre-COVID turnover.

The judgment is very much focused on the “first wave” of COVID-19 business interruption. Other difficult issues on the adjustment of loss that have developed with time as the pandemic has gone on are not addressed by the Supreme Court and give rise to significant further challenges. These include:

• The period of indemnity
• Coverage for local lockdowns and the government’s Tier system
• Ongoing cover for second and third lockdowns
• Reinstatement of sub-limits
• Treatment of government support for businesses

At a wider level, one of the key lessons of the case for both insureds (and their brokers) and Insurers is that the multiplicity of different wordings in the market can lead to confusion and ambiguity. This poses a challenge for both the insurance market and its regulators. Is it possible to achieve increased consistency in wordings whilst maintaining competition on the breadth of cover as well as price?

The authors wish to acknowledge the assistance of Andrew Starling, Associate in CMS’ Insurance and Reinsurance team, in preparing this article.

Further reading: The Financial Conduct Authority v Arch Insurance (UK) Ltd and Others [2021] UKCS 1