The FCA test case – the end, or just the beginning?

The Supreme Court’s recent decision in the business interruption (BI) test case has brought clarity and relief to thousands of policyholders. It has not, however, provided a panacea for all Covid-related insurance claims. A number of BI coverage issues (and other related matters) are outside the scope of the decision or remain otherwise unresolved, so there is plenty still on insurers’ plates to consider. In this article we step back from the decision itself and take a broader look at those outstanding points, and what they could mean going forward.

The FCA has made it clear that it expects insurers to work through Covid BI issues as quickly as is reasonably possible, without placing a financial burden on policyholders. The issues are not, however, all straightforward. From a UK perspective alone they extend from ongoing claim matters (for example, revision of settlements agreed before the Supreme Court judgment) to potential future mis-selling claims and broader issues such as scope for damages for late payment under the Enterprise Act. Perhaps most surprisingly, the FCA has suggested that policyholders’ reasonable legal costs in litigating BI claims should be paid by insurers regardless of the result – a principle which if put into practice would have a profound effect on the insurance market generally.[1]

The Supreme Court decision itself also has important legal implications. Insurers will no longer be able to limit their liability for BI claims in cases of wide area damage. The Court has also developed the law on concurrent causation, with the ‘but-for’ test no longer the decisive test where multiple causes contributed to the loss. The Supreme Court’s judgment will be persuasive authority in other jurisdictions, and in Ireland we have already seen a similar result in favour of policyholders.

Insurers will be aware of the challenging environment for renewing their own PI policies this year, a symptom not only of the general hard market but also concerns around this broad impact of the Covid crisis on insurer portfolios and the potential for claims to arise. Consequently, it is more important than ever to have effective risk mitigation strategies in place and an expert broker to differentiate you from the rest of the market.

Supreme Court Decision - Recap

In overview, while the Supreme Court took a narrower view than the High Court on the correct interpretation of disease clauses, its findings on causation ensured this did not limit cover for those clauses. Moreover, the Court’s interpretation on prevention of access/hybrid wordings materially broadened cover by allowing non-legally enforceable measures to count as restrictions. It also established that a partial inability to use premises could trigger a policy. On trends clauses, the Court sided with policyholders, finding that the clauses should seek to place the insured in the position they would be in if not for the originating cause of the losses (the pandemic).[2]

Broader Considerations - Regulatory Intervention?

The FCA is keen to remove the uncertainty that has afflicted policyholders and insurers alike over BI losses. To that end, it is working with the Supreme Court to assist the Court in issuing a series of declarations to summarise the key findings for the various policy wordings considered.

While the result was undoubtedly good for many policyholders, the FCA accepts that the majority of BI policies will not provide cover for pandemic-related losses.[3] Most BI policies require physical damage to the premises before they trigger, and the absence of physical damage is not currently disputed. However, those policies with extensions for disease and prevention of access wordings, or some hybrid of the two, may provide cover.

In that respect, the expectation is now that insurers can conclude with reasonable certainty the existence and extent of cover for most policyholders. The overarching goal, the FCA reported in a Dear CEO letter,[4] is to avoid creating ‘additional barriers or delays to paying valid claims.’

Where policyholders do commence litigation, the FCA has asked insurers not to seek its costs against policyholders and to pay their reasonable legal costs even if the policyholders are unsuccessful.[5] This might be to incentivise insurers to conduct litigation in the narrowest, cheapest and quickest way possible. However, the mechanisms through which the FCA hopes to enforce this request remain unclear – and if formally instituted, it sets a potentially dangerous precedent for the insurance industry in relation to personal and SME policyholder claims generally. It is certainly something that insurers will need to closely watch.

The FCA released Finalised Guidance following the High Court judgment, outlining insurers’ obligations in reassessing BI loss claims.[6] Claims that were rejected or partially paid out should be reconsidered in light of the judgment and necessary adjustments made to reflect the ruling. Settlements may also need to be revised following the Supreme Court’s decision, including those that were accepted by policyholders. Where a final and binding settlement was offered and accepted, revision will depend on the information that was provided to the policyholder. If the insured was informed about the test case and the possible sum they could have been paid if they had waited for the judgment – and the information was presented in a clear, fair and not misleading way – then the settlement is likely to be binding.  If this was not the case, then the settlement may need to be changed and further payments made to the policyholder. In any event, policyholders should be kept fully apprised of the status of their claim.[7]

A final question in this respect is whether government support offered to businesses can be deducted from claim payments. The FCA has outlined that this should be reviewed on case-by-case basis, taking into regard specific policy wordings. In the Dear CEO letter, the FCA points to correspondence between HM Treasury and the ABI, wherein the former stated their expectation that insurers would not deduct government support from claim payments due.

Late Payment Claims Appear Unlikely to Succeed

Policyholder action groups have repeatedly raised the prospect of making claims for late payment of damages under the Enterprise Act 2016, which would be the first testing ground for those provisions since they entered into force.[8] However, at least at this stage, it appears most may be disappointed. Insurers have been widely praised for their cooperation in the test case, including by the FCA, as having helped to prevent prolonged litigation. Moreover, insurers’ reliance on Orient Express Hotels was based on the law in force at the time, which was not overturned until the Supreme Court delivered its judgment. It appears difficult in these current circumstances to argue that insurers have unreasonably delayed payment, assuming of course that outstanding claims are now handled efficiently and correctly. If not then grounds for the Enterprise Act to be tested may arise.

Even so, anxious comparisons to bad faith allegations in the USA have been made, though perhaps not entirely fairly – certainly jury awards of punitive or multiple damages are not in question. Rather, damages are available only to the extent an insured can prove they suffered loss as a result of the late payment. In most cases, this will limit damages to compound interest to reflect the cost of borrowing.

Nonetheless, the Hiscox Action Group has expressed interest in filing late payment litigation, and if the claims are deemed to have merit then litigation funding resource is likely to be available.[9] In any event considerable defence costs may need to be incurred, but costs in relation to such claims should be covered under insurers’ own professional indemnity policies.

Potential for Mis-selling?

As noted, many policyholders with purely property-damage triggered BI cover will not benefit from the Supreme Court’s decision. If insureds were under the impression that they had coverage for either infectious diseases or public authority orders to close – because of representations made by insurers – then there is a possibility of mis-selling claims being made.[10]

In May 2020, the FCA published a statement that covered the issue of mis-selling in the context of BI cover. Customers who did not receive the cover they requested, or where the cover was different from what they were advised, were told to complain to the insurer. If they remained unsatisfied the FCA advised them to complain to the Financial Ombudsman Service (FOS).[11]

Some claimant litigation firms are already advertising their services to disgruntled customers, though the merits of any claims are unclear. Again, however, the involvement of claims management firms coupled with economic needs of many SMEs may drive the process. Costs and associated damages of such litigation would then form another basis for erosion of insurers’ own professional indemnity policies.

Finally, the FCA suggested the test case may provide guidance on the proper interpretation of policies similar to the non-damage BI policies at issue.[12] Particularly, comparable clauses in wedding and landlord insurance might be resolved in a similar fashion.

Broader Considerations - Legal Implications?

The broader implications of the test case are chiefly in the area of causation. The Court relied on existing authority regarding concurrent causation, but extended the law substantially in cases where there are multiple causes of a loss. In arriving at this conclusion, the judgment clarified that the ‘but-for’ test (i.e. that the property would not have been damaged but-for the insured peril), is not always the decisive factor in establishing proximate causation between the insured peril and loss. In addition, the overturning of the Orient Express Hotels decision is likely to increase insurer exposures in cases of wide area damage following natural disasters. We discuss each further below.

Orient Express Hotels

It is well established that where there are two proximate causes of a loss, and one is an insured peril and one is not, then as long as the non-insured peril is not expressly excluded, the insurance policy will provide cover. This is despite the fact that neither cause on their own would have been sufficient to bring about the loss.

The Supreme Court relied on this in finding that Orient Express Hotels had been wrongly decided. The case concerned a hotel that had suffered substantial BI loss following hurricanes Katrina and Rita in New Orleans. Insurers successfully argued that on a ‘but-for’ basis the BI loss would have occurred regardless of the physical damage to the hotel because of the destruction to the surrounding area. As the policy covered BI loss following physical damage only to the premises and not the wider area, there was minimal cover.

The Supreme Court disagreed with this analysis. They found that the BI loss had two proximate causes – the physical damage to the hotel (the insured peril) and the damage to the wider area. As both arose from the same underlying fortuity (the hurricanes), the loss arising from both concurrent causes was covered by the policy.

While this certainly expands cover for policyholders, one potential response from insurers in physical damage BI policies may be to expressly exclude loss resulting from damage to the vicinity. If so, the ultimate outcome may simply be to oblige policyholders to pay a substantial additional premium to benefit from any broader coverage.

Multiple Causes

The Court extrapolated from authority on concurrent causation to find that where an insured cause acts in combination with other similar uninsured causes to bring about a loss, causation can still be established. In the test case, each Covid case could be regarded as a separate and distinct cause. In combination, these cases caused the BI losses. Importantly, while each case was not a ‘but-for’ cause of the government restrictions, they were still regarded as proximate causes that together resulted in the losses.

The Supreme Court was clear that this should not be viewed as the end of the ‘but-for’ test and that in the vast majority of cases it remains the proper test for causation. Rather, it would be a matter of contractual interpretation as to whether multiple causes could constitute a proximate cause.

Further Litigation?

The wordings considered by the Supreme Court were limited so as to assist with the timely resolution of the test case. Those not considered include BI clauses that required damage, those that contained an exhaustive list of diseases but did not include coronaviruses, and those that required the infectious disease to be at the premises.

Insurers may well have stronger arguments in respect of such cases. However, policyholders may be emboldened by the test case outcome, and we may see continuing litigation particularly if, as noted, insurers are obliged to pay the reasonable costs of policyholders. At the very least, insurers may find themselves incurring significant defence costs. Similarly, the treatment of the test case as matters proceed up towers of reinsurance may well result in further litigation focused on aggregation matters in particular (as distinct from the individual Covid loss scenarios considered in applying the test case at a policyholder level).

International Perspectives

The Supreme Court’s judgment is likely to be persuasive authority in other jurisdictions, particularly those with similar common law systems. Cases are progressing in a number of jurisdictions globally, and so insurers’ aggregate exposure is likely to remain in flux for some time.

In Ireland, a similar result was very recently reached by the High Court, which found that outbreaks inside and outside the specified vicinity were equal and joint causes of the BI losses in dispute.[13] In reaching this conclusion, the Court modified the ‘but-for’ test in a similar fashion to the UK Supreme Court, and rejected the key argument from insurers that the losses were not primarily caused by the insured peril. While this was not a formal test case, the result is highly indicative of the likely outcome of similar Irish litigation – and notably the main insurer in the case, FBD, has accepted the result.

The Central Bank of Ireland has also established a similar position to the FCA on costs in further litigation – asking insurers not to recover their costs against policyholders in BI litigation. Moreover, in any case that could be viewed as an effective test case, the Central Bank expects insurers to pay the reasonable legal costs of policyholders.[14]

In the United States, the majority of current cases are focused on the interpretation of physical damages clauses (rendering the Supreme Court judgment of less relevance). Prevention of access wordings there are generally contingent on physical damage having led to the public authority restrictions which created the losses (e.g. mandatory closure following a natural disaster) – a category of wordings that the FCA excluded from the test case.

Nonetheless, a number of coverage cases are active in the US, albeit in their early stages. Around 1500 Covid-19 lawsuits have been filed in state and federal courts, mostly concerning BI cover. More than 200 of those cases include bad faith allegations, and a similar number have sought class action status. So far, the majority of issued rulings concerning BI have been in favour of insurers.[15]

In Australia, the High Court is expected to soon hear an appeal from insurers following a decision in favour of policyholders in the New South Wales Court of Appeal.[16] The Insurance Council of Australia (ICA), who filed for appeal on behalf of insurers, noted that the wordings of UK policies considered in the test case ‘differed in significant ways’ from many of the policy wordings in Australia.

In South Africa, a Cape Town court ordered a major insurance company, Santam Ltd., to pay out BI claims to two hotels.[17] The judge broadly agreed with the FCA’s approach that Covid cases were an insured peril that caused the BI losses. While claims advocacy groups have asserted that this should be viewed as a test case, a number of insurers maintain that a global pandemic is not an insurable event. Guardrisk, another major insurer, is currently appealing a separate ruling in a similar case.[18]

In Canada, the majority of BI policies require physical damage to trigger, including the prevention of access wordings which require public authority restrictions to be a consequence of damage. However, there is a reported class action law suit for denial of BI claims against insurers including Lloyds, Aviva and RSA.[19]

Finally in Hong Kong, while some non-damage BI policies may provide cover, once again the majority likely will not trigger. Insurers paid out US$ 42 million following the SARS outbreak in 2003, and have subsequently been keen to exclude any pandemic-related cover in BI policies.

As will be clear from the above, while the Supreme Court’s decision brought clarity on a number of key points (under English law at least), it will be some time before all issues have been considered and insurers’ overall exposures become clear.

Differentiation in the Market

The substantial volume of litigation against insurers proceeding through the courts creates a difficult environment for renewal of insurers’ professional indemnity policies. Many of the themes are not themselves new – whilst numerous bad faith claims have been made, that is hardly a novel risk for insurers doing business in the US. However it is key to consider the Covid impact specifically, against insurers’ particular lines of business and internal controls and processes. Working with your broker to assess your particular exposures and to differentiate your risk from those of the market generally will be key to obtaining a positive outcome.