Business Interruption Insurance Disease Extensions and the CoViD-19 Pandemic Part 4 – Causation & Trends

Causation & Trends

“The causes of causes are infinite.”[1]

Causation is the link or trail connecting the damage to the cause of the damage (or loss).

The proximate cause of a loss need not be the event, incident or occurrence closest in time to the damage. It can also be the most efficient contributor to the damage. But, for practical and societal reasons, it cannot be a remote contributor. The central test is one of foreseeability/continuity.[2] The contractual obligation is founded in reasonable expectations (of both insured and insurer).

Causation relates to the insurance cover engagement.

Trends, on the other hand, relates to the indemnity provided by the insurance policy once cover is engaged and is specific to business interruption (BI) insurance. It is a separate consideration.

To determine the BI insurance indemnity it is necessary to consider the totality of the Insured’s business environment when determining what would have been that business’ performance. Known as the ‘but for the damage’ test, once the actual post-event performance of the business is known, it needs to be measured against the likely performance had the damage not occurred, reflecting any factors emerging prior to the event or after the event that would have influenced the business’ performance irrespective of the peril and the damage.

This ‘look forward’ indemnity adjustment has both positive (a future ‘locked-in’ opportunity now missed) and negative (the already flagged loss of a major customer to a competitor) connotations for the insured. Matters considered can be both factual and hypothetical.

But the trends adjustment must ignore post-event factors directly related to the event, itself, otherwise the very foundation of the indemnity is undermined. For example, the widespread damage and disruption caused by catastrophe events inevitably slows recovery beyond that of the direct damage to the insured’s premises and, conversely, windfall gains for a business arising from the event, e.g. the removal of a competitor, creates an ‘artificial’ turnover boost - the impacts of both not to be included in establishing the Standard Turnover as they would not have occurred ‘but for the damage’.

Due to the widespread and multiplex nature of the pandemic, both the causation and trends principles have created considerable angst in the BI insurance CoViD-19 context for insurers and insureds, alike.

Causation

The Damage

The BI insurance policy cover is engaged if there occurs Accidental (neither expected nor intended nor desired by the Insured) Damage (physical loss, destruction or damage) to the Property (any building or other property or any part of any building or other property) used by the Insured at the Premises for the purpose of the Business. This is the cover trigger.

Separately, the indemnity (see next section) is provided if the Business is interrupted or interfered with as a consequence (provided the accident or damage is not excluded).

The BI policy, like all other insurance, is subject to a cross-check to confirm that the proximate cause of the damage is an insured or a not excluded peril. Once this is established, and the damage is confirmed, the claim is accepted. There is no further need to explore the impact of that peril.

However, insurers have effectively doubled-down on the Serbonian Bog that is insurance causation by writing operative clauses that mix up cause and effect; compounding it further at BI insurance claim time by engineering spill-over into the ‘trends’ adjustment – creating a sweeping interpretive quandary, and remediation complexity of similar proportions.

The Indemnity

So, once the damage causes interruption/interference, the insurer then has to move on to calculating the indemnity.

This calculation is controlled by separate sections of the BI policy, the main one being the Insured Profit. It should not be confused or conflated with the cover trigger.

Insured Profit sets out a formula for calculating the indemnity, starting with determining –

1.????????the Rate of Insured Profit and

2.????????the Standard Turnover,

both of which require assumptions to be made on what the performance of the Business would have been ‘but for the damage’. Usually, but not exclusively, this involves taking past performance as the base and adjusting it for factors, both positive and negative, that would have affected the Business irrespective of the damage.

The important point here is, as mentioned, there is no requirement to revisit the impact of the peril or the damage it caused. Nor is there any requirement to address how the peril and its damage has more broadly affected the business environment. Once the Standard Turnover is set, the Rate of Insured Profit is applied to the entirety of the difference between Standard Turnover and the post-damage turnover, irrespective of what caused the turnover reduction - subject only to the reasonable insured condition and the indemnity period limit.

The formula draws no distinction between turnover lost due to the damaged Premises or the surrounding damage; nor does it distinguish between custom that has not returned due to either.

How the insurance industry came to ignore this fundamental is somewhat of a mystery. When it happened is less so – the arbitration appeal decision in the UK case of Orient?Express Hotels Ltd v Assicurazioni Generali?SpA [2010] EWHC 1186 (involving Hurricane Katrina and the Windsor Court Hotel in New Orleans) being the catalyst.

To that point the author had never experienced the inclusion of event wide-area impacts in the establishment of Standard Turnover.

It is, of course, highly probable that the increasing frequency and cost of natural catastrophe events created the impetus for this re-interpretation of the ‘but for the damage’ approach by conflating both direct and indirect turnover reduction drivers into what has now become known as the ‘trends’ clause.

Trends

As mentioned, central to the adjustment of any BI insurance indemnity is establishing the trajectory of the business and what the performance would have been but for the occurrence of the damage.

It applies to the assumption of both the Rate of Insured Profit and the Standard Turnover. It does not apply to the actual post-damage turnover – the other component in calculating Reduction in Turnover.

Previously known as the adjustments clause, the ‘but for the damage’ test requires the adjuster to assist insurer and insured to reach a consensus on what the revenue/costs would have been so that the adjusted turnover figure “…represents as nearly as may be reasonably practical the results which, but for the damage, would have been obtained during the relative period after the damage.”

While most current BI policy wordings have moved on from the old retrospective view to a more prospective calculation of what the business’ turnover would have been, the adjustment still naturally requires a comparison of the business budget to actual performance up to the point of damage. If not a baseline, it still functions as a benchmark – which supplements business plan and market tests (see ready reckoner later on in this analysis) in the ‘but for the damage’ approach to determine, as near as possible, the financial performance of the business if it had not been interrupted.

As the adjuster is dealing with probabilities/possibilities rather than certainties, all involved need to retain a degree of flexibility in order to reach a reasonable outcome.

While techniques to estimate the direct impact of business, market and economic conditions, pre- and post-damage, are relatively well developed, the more indirect impact of environmental, societal and geo-political happenings are not so readily calculable. Similarly, the effect of social and geophysical changes in the neighbourhood of a business are more easily discernible than those occurring elsewhere in that city, state or country.

And, to top all this off, if another event has occurred (either pre- or post-damage) unrelated to that which caused the damage in the first place, its near-area impact is more readily discernible than its wide-area implications.

All in, the BI indemnity adjustment considerations are a grab-bag of trends, variations and special circumstances, not all of which will apply to an individual business; while one or more may be unique just to that business. And the CoViD-19 pandemic has served to multiply the variations on those themes.

Some ‘trends’ are baked into business budgets, e.g. holiday seasons (higher revenue) or weather seasons (lower revenue/protection costs) – with the impact of the latter already priced in.

Similarly, the cost of preparing for a natural catastrophe event that may or may not happen, e.g. initiating property protection through boarding up and personal protection through not accepting customers due to an approaching cyclone, is not recoverable if the event does not occur and, even if it does, may only be partially recoverable.

If the event does happen, the trick then lies in differentiating between the average expectations built into budgets and the actual impact of that event/damage.

Determining which aspects to factor in, leave out or trade-off, is the domain of experienced loss adjusters who have gained the confidence of insurer and insured.

Wide-area damage is also known to affect prices, e.g. creating the opportunity to sell into a rising market or causing a drop in demand and lower prices, while high demand/limited resources may extend the cost and time it takes to manufacture product or provide services.

And the event can affect business performance long after the damage has been repaired and the insured has re-opened for business. Once custom has been lost it takes time to restore, especially if customers have had to look elsewhere or the product/service is now less attractive due to the event.

But, nowhere in the BI insurance policy does it say that the wider-area impacts of an insured peril that has operated on the premises to cause damage (and thus trigger the cover) must be considered in determining the Standard Turnover. If it did, it would be akin to an unwritten second level deductible or exclusion.

Courts use the counterfactual approach to assist them with causation determination but this has its limitations when it comes to BI insurance indemnity calculations, especially with trends. As the judges in FCA v Arch Insurance & Ors [2020] EWHC 2448 (Comm) stated, when referring to the Oriental Express Hotels decision of 10 years prior, “In our view, the consequence which flows from the Orient Express decision, that the worse the fortuity which befalls the insured and the vicinity of the insured’s premises, the less the insurance responds, cannot have been intended.” [3]

Infected by the reasoning on causation, the Orient Express Hotels case construed the trends clause without regard to its original intention. If taken to its extreme, conflating causation and trends could have included the very existence on planet Earth itself - where weather happens (incl. cyclones) or plates shift (incl. earthquakes and tsunamis) – so a business is always subject to those risks and, therefore, the standard turnover adjustment must take this into account. Patently absurd and fortunately, triggered by other like arguments around CoViD-19, UK courts saw reason.

On FCA v Arch Insurance & Ors appeal, the UK Supreme Court reversed the Orient Express Hotels decision.[4] ?So, it is only the business trajectory of the Insured, without reference to either the direct cause/effect of the peril/damage, nor the wider cause(s) or damage, that should be considered in the ‘but for’ test when determining the business’ trends.

The clause cannot be used as an additional policy exclusion[5] - nor, for that matter, can broad general exclusions (designed to limit basic policy cover) be reworked to render specific extensions, impotent, e.g. disease extension made subject to the general exclusion for micro-organisms and biological processes, pollution or contamination.

In Part 5 the author will review insurers response to New Zealand’s 2010/11 Canterbury Earthquake Sequence; an estimated 1:8000 year event (for the 22 February 2011 earthquake locality)[6] that occurred at a time when insurance returns were under considerable pressure and engendered a reactive chain of decision-making, the results of which remain in play 10 years on and will, likely, go through another review round, this time for BI insurance claims, due to reversal of the Orient Express Hotels decision.

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[1] Professor Fleming James Jnr.

[2] See Australia’s Wagon Mound case.

[3] Para 528

[4] See Wendy Pugh’s Insurance News Magazine article Derailing the Orient Express - A UK court?has overturned a decision that’s been influential in assessing business interruption claims after catastrophes Feb/Mar 2021 ?https://issuu.com/insurancenewsmagazine/docs/magazine_1944f37520a4a4?fr=sZTkxNDM4Nzk3NzA for a easily readable summary of the reversal and implications.

[5] An 8 April 2021 article for the ANZIIF by respected insurance lawyer, Crossley Gates, is an excellent summary of the causation vs trends issue - https://anziif.com/members-centre/articles/2021/04/how-the-english-supreme-courts-bi-decision-affects-new-zealand?p=1&mbs=how%20the%20english%20supreme%20court&cat=articles

[6] See GNS Science report to the CES Royal Commission.