Business Interruption Insurance Disease Extensions and the CoViD-19 Pandemic Part 2 – Insurance Response to Increased Exposure

Insurance Response to Increased Exposure

Patchy at Best

Insurance is predicated on the many contributing to the losses of the few. As insurers are the fiduciary caretakers of these pooled funds, society expects them to manage those carefully and act responsibly.

One of the cannons of insurance is that to effectively underwrite a risk you must understand it. The corollary being, if you don’t, then do not offer cover.

Infectious disease extensions for business interruption (BI) insurance was first offered in simpler times[1] when people were less mobile and communities (incl. associated food supply) less concentrated or inter-connected. The expectation was that any contagion would be gradual, readily identifiable, and containable within separately governed regions; so relatively easily managed.

However, competition being what it is, individual insurers, although recognising risk and exposures had increased (especially zoonotic viruses), were loath to be the first mover in restricting infectious disease cover. Competition legislation complicated the response, as did the tin ear of governments.

The compromise that evolved during the 1990s included –

1.????????Applying time deductibles (at the front) and dollar/percentage sub-limits (at the back) of the extension - to reduce exposure,

2.????????Increasing premium rates - to make the risk transfer equation less attractive,

3.????????Specifically excluding the disease of the moment, e.g. HIV/AIDS, highly pathogenic avian influenza (H5N1) or SARS-CoV/MERS-CoV, rather than a range of diseases caused by a particular pathogen,

to make the contraction of cover more palatable, e.g. only effecting an exclusion after the first occurrence of an epidemic/pandemic.

This tinkering did little to abate exposures; while the highly competitive insurance market conspired to render those, and other actions, futile. While the concurrent introduction of formal governance frameworks enforced through prudential re-regulation did improve the ability of insurers to absorb the financial impact of unanticipated outcomes, the focus was primarily on balance sheet strength, not on the up-front management of risk/exposures and balancing stakeholder impacts.

While acknowledging the evolution of portfolio risk management disciplines over the last 20 years, there has been other crimped responses to increased exposures worth mentioning to round out the picture.

For example, the end result of insurers mid to late 1980s action to address flood exposure in Australia was a tortuous water damage wording that engaged cover if water came down, e.g. rain, but not if it came up, e.g. from overflowing waterways. The question at the time, still relevant today, was how is it possible to accurately determine if damage was caused by water ponding or water overflowing (both caused by excessive rain), especially when drains back up or rivers peak? And, if damage was already caused by water falling/ponding, how do you separate damage caused by that overflowing water?

Another example that has both construction and insurance implications is the development of overly complex definitions of a building defect (whether defects are structural or non-structural, cosmetic or non-cosmetic) in order to allocate responsibility (to building owner, builder or insurer) when the real issue remained unaddressed, i.e. an appropriate level of quality and construction discipline.

Conversely, the improved cyclone resilience of buildings in Northern Australia, especially in the Northern Territory post Cyclone Tracey (1974), has been a model response.

If you treat the cause (respond to the risk) rather than the symptoms (react through cover price and scope adjustments) a better result can almost always be achieved. The challenge is in creating the space and corralling the resources to do so – including bringing along all stakeholders in tandem.

And, as insurers have rushed to find any way to reduce the impact of CoViD-19 claims, we now have the unseemly maul of court actions across the insurance markets of Europe, North America and Australasia - including those initiated by regulators (on behalf of the general public) seeking clarity around how BI disease, prevention of access and public authority extensions should respond – which exposes the lack of market discipline and effective co-ordination; reflecting poorly on all.

A response that just deals with the interpretation of policy wordings will not address the root cause(s) of this predicament. However, an attempt to embrace all the moving parts necessary to construct a comprehensive fix risks getting bogged in the detail. To avoid this, the author will, after a higher-level exploration of policy wording construction, take a more detailed look at how the BI policy wording and the relevant extensions have evolved, while leaving the reader to form their own opinions about the way forward – a more detailed look at the core issues left for later in this analysis.

Degradation in Policy Wording Design

Insurance market changes over the last 30 – 40 years have seen a gradual but inexorable degradation in policy wording (and related document) integrity. Despite impressive technological developments with document management, content control and grammatical oversight, almost every document the author has touched reveals issues with construction, terminology and integration.

The following are fundamental to the design of a policy wording –

1.???Framework – a fit with the product category, product suite and market segment; properly integrated into distribution and administration processes.

2.???Architecture - order and consistency in the look and feel, logic and flow, options and variables.

3.???Definitions – where the use of word(s) is to be modified/clarified a clear, concise and fair process that does not mask the intention and accords with accepted norms.

4.???Readability – plain language, uncomplicated structure, contemporary usage, absent jargon, and pitched at target market levels.

5.???Transparency – unusual features highlighted, what is and isn’t covered placed together,[2] and links (and related limitations) between occurrence and indemnity trigger(s) clearly explained.

6.???Interoperability – sections within a policy wording interconnect properly while separate policy wordings dovetail effectively when customised or bundled with no gaps/overlaps.

7.???Variations – application and claim procedures, optional cover selection, policy schedules & endorsements, and changes to wordings should all follow a standard approach and be aligned to the policy wording, with timing and effect clearly communicated.

Touching first on how these rules got relegated to the back seat, the author moves quickly on to how this translated into the BI policy wording and the extensions of the CoViD-19 moment and what the latest regulatory expectations are, before moving on to a more detailed analysis of the evolution of policy wordings since de-regulation using business interruption (BI) insurance policy wordings as a representative example of the current malaise.

The end of the insurance tariff system in Australasia during the 1970s resulted in the demise of industry standard wordings. This specialist function, previously centralised in insurance bodies, saw maintenance abandoned and the few drafting resources distributed out to a few individual insurers.

With no industry standards, limited product governance arrangements and insufficient expertise, competition saw insurance policy wordings deviate to such an extent that there is now no clear reference point from which to compare them – with the amalgam of styles making it difficult to even compare one insurers product with another and rendering price comparisons, moot.

It has also seen insurers emphasising the positives of their wordings while down-playing limitations, and while the increasing use of incorporation by reference may have improved readability, it has heightened complexity and the potential for disconnection between documents.

Although Australia legislated for product disclosure statement (PDS) use, it has not had the desired effect. Insurers simply took the shortcut of calling the policy wording a PDS rather than investing in the skills and resources necessary to do the job as originally envisaged (the legislation as ultimately passed being sufficiently flexible[3] to allow this approach to occur). Expansion of the corporate counsel function during this period also had limited success in addressing wordings and often led to a narrow and more legalistic approach to both drafting and in the response to subsequent issues.

Although the 2020 amendment to the Corporations Act and ASIC’s RG274 Guide have expanded the product disclosure regime to include product design and distribution - originally recommended from the 2014 Financial System Inquiry (Murray Inquiry) but only belatedly implemented post The?Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Hayne Inquiry) – it only comes into effect in October 2021 and will take time to be fully implemented. What it should ultimately do, however, is re-embed product development and distribution back into insurers’ operational environment by removing the tendency to hand-off due diligence and outcome responsibility to legal and compliance (returning them to the advisory role they are more suited to).

It should be standard practice for drafting notes to accompany any contract wording (including insurance) explaining the author’s intention in using words and clauses, how they interact with other parts of the contract, and to aid interpretation consistency.

That regulators have felt the need to set out in detail what is required of the manufacturers and distributors of financial products shows just how far the sector has fallen behind in good governance and acceptable practice, not just in personal advice but in the design and delivery of the products, themselves; and how far consumers have slipped in stakeholder ranking.

Products must be ‘fit-for-purpose’, i.e. their scope must cover all the most likely occurrences/losses of that class while explaining how cover tails off or transfers between sections or to other products.

Today, many of them do not pass that fundamental test, none more so (by both omission and commission) than BI insurance where, in the outcome of the UK Financial Conduct Authority CoViD-19 case on behalf of insureds, the High Court judges commented -

“In our view, the consequence which flows from the Orient Express (Hotels) decision, that the worse the fortuity that befalls the insured and the (closer the) vicinity of insured’s premises (to that fortuity), the less the insurance responds, cannot have been intended.”[4]

Courts are increasingly delivering judgements that support the ‘fit-for-purpose’ test and the expectations of consumers. In Australia, when looking through the artefacts being thrown up by insurers, the QC for the insured, in a test case appeal to the High Court, said –

“You have underwritten these policies on the basis of the Quarantine Act and its listed diseases and set the premium accordingly.?If the government were to wholly repeal the Quarantine Act and replace it with a new scheme of regulation, touching on the same matters but using different mechanisms, would you prefer for the term of this policy to have your exclusion clause operate by reference to whatever the government’s new dispensation was, or rather by reference to the Quarantine Act list of quarantinable diseases on the basis of which you did your underwriting?”[5]

Along with the contra proferentem rule, this is a key point. How could any insurer say an insured was an equal party in drafting policy wordings (other than bespoke examples) and how could any insurer say they were underwriting/pricing for a disease they did not know about because it had not happened? If they wanted to exclude future diseases of a particular type, e.g. coronavirus, they would logically have been less specific in their terminology or, if still insisting on reference to a regulatory list, combine both general and specific references in the exclusion, making sure that the act of parliament involved was clearly stated and the exclusion embraced any amending or replacement act.[6]

Disingenuity is evident in the way the original disease extension was modified during the 1990s to reflect the lack of insurer appetite for epidemics/pandemics. While previously declared diseases were self-evidently excluded, any future declaration of a notifiable disease retroactively cuts out an indemnity for that new disease once it is ‘listed’. Putting aside for the moment the inexorable erosion of cover this entails, if retroactive exclusion of new diseases was insurers’ intention, then no cover is provided for declared diseases at all - past, present or future.

There is a fundamental unfairness associated with this. It renders any infectious disease extension nugatory, i.e. “we won’t cover you for already declared infectious diseases and any that might subsequently be declared”.

With no cover on foot (other than for less dramatic, endemic nasties that are part of normal life and have limited impact on a business) what is now the point of the disease extension at all? If there is a PDS that draws customers’ attention to this, it has yet to be identified!

The scrambled response to CoViD-19 shows just how far insurers have become bound by legal machinations rather than consumer expectations. Insurers are now backed into a corner; not through mistake, but through structural degradation in product development disciplines and policy drafting skills due in large part to a manufactured disconnect between corporate operational and functional roles in increasingly matrixed environments that has diffused ownership to the point where no one has direct responsibility for, or authority over, the end product.

Australia’s BI insurance disease extension Quarantine Act exclusion test case (referred to, above) has had an entirely predictable outcome and poses the question for more than a few insurers – has abrogation of responsibility by those who should be in control gone too far and where are the cohort of professionals that should be responsible for product design and delivery now to be found?

What has happened with the BI insurance disease and public authority extensions is symptomatic of an underlying lack of wording quality/integrity across insurance. Unless urgent action is taken to beef up technical resources in, and shift authority to, this area, it is only a matter of time before insurers are hit with the next unexpected, but entirely predictable, consequence of the skill erosion that has occurred.

With ASIC having now laid out in full product development requirements, APRA applying the blowtorch on insurers to show they know what they are doing, and the robes of the court threadbare, there is no place left to hide.

Packaged & Bespoke Wordings

Differentiation vs Discipline

Had document drafting and product enhancement remained disciplined and retained an appropriate degree of standardisation, the insurance industry might not have found itself in a CoViD-19 bind.

Not that this observation suggests competition should have been moderated. Far from it. A healthy level of competitive tension is vital for markets to evolve and remain relevant.

Over the last 40 years insurance markets have become less disciplined and seen professionalism eroded. While re-regulation has addressed some aspects, e.g. strengthened balance sheets and increased the focus on liability valuations and pricing, a more subtle degradation in front-end activities like product development and policy wording construction has quietly bubbled away beneath the surface; only now becoming more apparent.

Often, in the interest of doing the deal or getting to market, the first thing to go was a full product risk assessment and a comprehensive test of the wording’s integrity and practical application.

This section of the analysis traces how policy wording drafting became compromised - as it has, generally, across all classes of insurance but, more so, where policy wordings were packaged for market segments, designed for classes requiring specialist skills (which includes BI insurance), or created bespoke for distributors or clients.

The hybrid disease/public authority clauses applicable to BI insurance represent, in microcosm, how drafting has gone so fundamentally awry.

Nominated Perils vs All Risks

While not falling neatly under this section’s heading, the generational shift in the way events covered by property insurance (and attendant BI insurance) were framed, set in train during the 1970s (as the tariff system dissolved), was heralded by a reallocation of document drafting resources from industry bodies to individual insurers - a one-to-many demand on resources that just weren’t there.

Along with the relaxation of price controls, insurers could now compete on many more levels – one of which was to broaden cover by offering accidental loss or damage (unless otherwise excluded) for buildings and contents.[7] This shift from ‘fire & perils’ to ‘all risks’ happened in a rush, spearheaded by independent insurance intermediaries (brokers) whose day had finally arrived; their value proposition now freed of insurance tariff shackles. The broker who could clearly identify gaps in business’ risk transfer programs, articulate how those holes could be closed, tap markets that were willing to provide such protection, and negotiate attractive terms, could steal a march on the competition (which, intriguingly, also included many of the same insurers those brokers would be relying on to underwrite the offering and who held current direct or tied agency relationships with those same clients).

The drive to obtain (brokers) and retain (insurers) customers in the tension of this post-tariff environment was exceptionally strong and heralded the start of the first, full-blown insurance cycle.[8]

Articulating the shift from nominated perils to accidental damage covers became the province of policy wordings labelled industrial all risk, special risks or material damage. It involved a fundamental reversal in the order of expression; where the trigger became, not the operation of an insured peril (that the insured had to demonstrate occurred – along with the resulting damage), but that loss or damage had occurred to insured property (the insurer having to prove that it was caused by an excluded peril if they wished to avoid the claim).

This inversion was neatly achieved by a new version of the Damage definition, shifting from –

·??????????Nominated Perils – “Damage means loss destruction or damage caused by the Perils”[9]

to

·??????????Accidental Damage – “Damage means Accidental physical loss destruction or damage”[10]

That the word ‘accidental’ is central to the wider version of cover is quite deliberate – it is used in the expectation that any loss or damage will not have resulted from deliberate action (or inaction) by the insured, and implies that the insurer understands what they are offering is broader protection for any unexpected, unintended or undesired event, i.e. if anything goes wrong it will be insured unless the event, damage or type of property involved is specifically excluded.

Colloquially referred to as “all risks”, it was a more customer-centric cover where the exceptions, rather than the rules, were listed – making for a user-friendly checklist that did not leave the insured guessing at what was not covered. This shift by insurers was unequivocally intentional.

With the tariff regime of UK-centric insurance markets no longer providing standard policy wordings (unlike the USA who retained their Insurance Services Office and, with their business interruption equivalents, a much more damage-centric indemnity trigger), guidance on how to express both perils and damage coverage (and the linkages) was lost. While competition legislation in many developed markets prevented the use of compulsory frameworks, standards at least had the benefit of flagging when individual insurer policy wordings were departing from tried and tested construction, placing drafters on notice.[11] But, in the heady years that followed de-regulation, even those were cast aside.

Note: The impact of the transformation in expressing ‘perils’ coverage and what constitutes ‘damage’ is further developed as this analysis explores packaged, bespoke and add-on extension wordings.

Packaged

Bringing together in one document various standalone policy wordings in order to provide a total package of covers specific to a particular industry segment also gained marketing traction in the mid to late 1970s. This involved taking policy wordings common to that segment and presenting them as a checklist, and doing the same with extensions - wrapping them up in the wording (automatic) or presenting them for selection (optional).

This package approach usually involved staying tightly aligned to the insurer’s stand-alone policy wordings. But, as competition increased, so did the pressure to differentiate offerings; particularly via insurance brokers who saw own brand policy wordings as a competitive advantage.

In the early 1980s, and as governments upgraded consumer protection (e.g. Insurance Contracts Act), plain language policy wordings also came to the fore. This required a new set of skills around word usage, readability and layout – and the need to ensure that the end result for insureds (i.e. the scope of cover) translated seamlessly along the insurance chain (incl. into insurers reinsurance arrangements).

While underwriting manuals and rating schedules had been, and continued to be, features of each insurance portfolio, to that point there was little, if any, guidance documents explaining how policy wordings were constructed, the coverage intention, and how the new varied from the old (or standard). ?

Until the advent of product disclosure legislation in the early 2000s it was up to each insurer how far they took this.[12] And, to the extent that competitive pressure ‘allowed’, how far they extended this discipline into negotiation of underwriting rights for broker own brand and bespoke client wordings.

Packaging suggests the product suite is tailored to that customer segment, is fit for that purpose and, unlike bespoke wordings, implies the insurer has taken responsibility for ensuring cover adequacy.

Bespoke

Industrial all risk, special risks or material damage insurance policies covering property and other assets were at the forefront of bespoke policy development and applied mostly to corporates involved in large scale extraction, manufacturing, transportation and construction activity, and with multiple businesses and regional/global spread.

Apart from insurers needing specialised underwriting skills, these corporations had complex risk transfer requirements involving umbrella and cross-border arrangements, embedded risk management and self-insured layers/captives, making constructing an appropriate wording the domain of only the most competent drafters.

Among the eclectic collection of wordings that evolved for bespoke use could be found wordings with the widest coverage and simplest forms – where, at the cutting edge, a relationship between insurer, broker and insured existed that was fundamentally reliant on complete openness and trust and where, if the policy wording had to be referred to, at all, that was the first indicator of failure.

Sometimes it mattered little how well the policy was worded; other times it was absolutely essential each i was dotted and t crossed (especially for excluded risks, e.g. war and nuclear)!

While brokers and underwriters competed with each other to wrap up as much coverage as they could into the one continuous policy wording, there remained some covers that could only be granted as extensions, and then only within tight parameters (i.e. extension-specific deductibles and limits).

Extensions

Fundamentally, if you are going to add to a policy cover it needs to be done in a way that links the extension correctly into the coverage framework, especially the policy wording’s operative clause. After-all, that’s what the word ‘extension’ means, i.e. it is not a separate cover.

Historically, extensions always referenced the section in the policy wording that was being ‘extended’, e.g. the perils/property types covered or exclusion(s) modified/waived. If the type of damage/cost covered or approach to calculating the indemnity was being modified, then the extension referred to the ‘Damage’ definition or indemnity clause and explained how it was being modified.

Invariably, the extension did not contain its own operative clause.

As extensions evolved this discipline was maintained?by using commencing phrases such as –

·??????????“Cover under Section [insert name] of the Policy is extended to include …..”

·??????????“The definition of Property Insured is extended to include ….”

·??????????“Damage to Property in the vicinity of the Premises which prevents or hinders the use of or access to the Premises is considered to be Damage to Property used by the Insured at the Premises.”[13]

To continue the BI prevention of access theme, the following murder, suicide and defective sanitation extension in a more recent broker wording[14] is a good example encapsulating how expansive drafters believe they needed to be to capture intent -

“CLOSURE DUE TO INJURY

If there is, in the vicinity of the Situation during the Period of Cover:

(a)?????Danger to human life; or

(b)?????Injury to, murder or suicide of, any person; or

(c)??????The premises or part thereof are closed by any authority due to defects in the drains and other sanitary arrangements or the escape of fumes or any hazardous material;

or the threat or fear of any of them, and this prevents or hinders access or egress or the use of the premises (whether the Insured’s property or the premises suffer damage or not), there is deemed to be Loss or Damage. If this Loss or Damage results in interruption to or interference with the Insured’s Business carried on at the Situation, the Insurer will cover the Insured as set out in each item stated in the {Schedule}.”

Note 1: This wording (in how it clarifies the intention of the cover) also touches on a number of aspect of BI insurance disease covers currently being litigated, especially pre-event action.

Note 2: Readers will recognise this extension as one that deems these events to be ‘damage’, thus linking it to the base policy wording structure. The section of the policy wording that contains it also has an inclusory statement that prioritises the extension if there is any construction conflict. ?

It is hard to put a finger on just when extensions started to incorporate operative clauses, but it may coincide (at least in BI insurance) with attempts to constrict disease extensions and seems to have been particularly prevalent in the UK.

Stay tuned for Part 3 where the author drops down a level, translating this into the evolution of the business interruption policy, starting with the standard framework and then tracking how, as cover within that framework has been extended, the approach and words used have compromised the integrity of the proffered indemnity – with particular emphasis on what constitutes an event (occurrence).

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[1] The author notes this extension starting to be used more widely in Australasia during the late 1970s.

[2]?Especially when exclusions carve out a component usually associated with a peril, e.g. smoke or heat damage without flames (fire) or infectious disease but not contagious disease; a property type, e.g. stock-in-trade but not vehicles; or class of interest, e.g. owner-occupied not tenanted.

[3] With its focus on financial security/probity rather than the consumer's ability to understand the scope and limitations of what they are buying, i.e. make an informed decision, the Corporations Act falls well short of its intended objective. ASIC’s PDS Guide RG 168 also overtly allows PDS elements to remain within the policy wording (see paragraphs 120 & 121), whereas, for example, a properly constituted PDS would have outlined what infectious diseases a BI insurance disease extension was designed to cover. Note: Combining the wording and disclosure into 1 document is logical to ensure both get delivered to the customer, but illogical where a PDS also relies on the fine print of a policy wording.

[4] Flaux LJ & Butcher J UK High Court Judgement 15 September 2020 - The Financial Conduct Authority v Arch Insurance (UK) Ltd and others (para. 528). Note: This paragraph in the judgement explores the impact of the Orient Express Hotels case and ruminates on academic reaction questioning its soundness, noting – “Riley on Business Interruption Insurance (10th ed) states that “there must be doubt over whether it is actually a satisfactory outcome for either insurers or policyholders”.”

[5] Sheahan QC for the Respondents (Insureds) - HDI Global Specialty SE & Anor v Wonkana No 3 Pty Limited Trading as Austin Tourist Park & Ors [2021] HCATrans 117 (25 June 2021) (lines 488 – 495)

[6] A classic example of this combined general/specific exclusion style is found in motor insurance where claims arising from the driver being under the influence of alcohol and/or with an alcohol level in excess of the limit stated “in the Transport Act or any Act or Acts in substitution therefor” is found.

[7] The approach was not new - already in use with marine, motor, construction, and insurance for specific property, e.g. jewellery.

[8] As an insurance sales representative, underwriter, product developer and portfolio manager during this period, the author was front and centre; riding the rising wave of the 1970s and surfing along the mid-80s crest.

[9] Perils were separately defined as fire or lightning, explosion, windstorm, etc.

[10] Accidental being separately defined as “neither expected nor intended nor desired by the Insured.”

[11] The author notes that the US ISO standard policy wordings can be complex and is not necessarily recommending what has evolved in practice in the USA. Rather, that standards exist for many commercial endeavours and product manufacturing, and that industry guidance has its place, incl. adopting best practice language and layout.???

[12] Product disclosure legislation/regulation has gone through various iterations over the last 20 years. With the 2019 report of the Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (also known as the Hayne Inquiry after the Commissioner heading it up) again highlighting significant inadequacies (the author is contemplating a separate exploration of how product disclosure statements should be constructed to achieve the desired state, along with product design and distribution disciplines, as a separate article).

[13] Prevention of Access Extension - New Zealand Insurance Commercial Special Profits Insurance Policy 7310 0886 WORDING CSP 1185

[14] BrokerNet NZ Material Damage and Business Interruption Policy Wording NZI MDBI Wdg 1 12 10 V6 (underwritten by IAG)