Business Interruption Insurance Disease Extensions and the CoViD-19 Pandemic Part 3 – Evolution of BI Policy Wordings

Evolution of Business Interruption Policy Wordings

The complexity involved for courts in dealing with how business interruption (BI) insurance should respond to the CoViD-19 pandemic is bewildering. As covered in Context, it is, quite simply, not a contract that lends itself to legal interpretation of either the trigger (causation) or the claim (indemnity).

The BI policy wording follows a set pattern in determining if cover has been engaged (referred to as the 4 tests - Table 1, Background, in Part 1).

This section addresses how the tests should operate, separately and in sequence, in the basic policy coverage flow, moving on to discuss how policy extensions should be worded to ensure test integrity is maintained, and then explaining how the infectious disease, prevention of access and public authority extensions have highlighted how compromised the wording approach has become.

Basic Policy Wording

The standard approach to BI indemnity engagement has been in place in developed insurance markets for 60 – 70 years. It has been tried and tested and, for at least the last 40 years, has provided complex but relatively stable coverage. Despite BI insurance’s inherent flexibility (when it comes to determining what indemnity the policy will provide in each instance of interruption), disputes have been few.[1]

Operative Clause

A typical BI insurance policy operative clause in Australasia is (bold used for emphasis) -

“……

the Company agrees that if during the Period of Insurance or during any subsequent period ……... there occurs Damage to Property used by the Insured at the Premises for the purpose of the Business and the Business carried on by the Insured is in consequence interrupted or interfered with

the Company will, subject to this Operative Clause, and the Limits, Definitions, Indemnity, Exclusions, Conditions and Memoranda of this Policy, pay to the Insured in respect of each Item shown in the Schedule the amount of loss resulting from such interruption or interference.

Provided that the Company will not be liable for any loss under this Policy unless the Property at the Premises is insured for Damage ……… and the Company or insurers of the Insured’s Property have admitted liability for the Damage unless the sole reason that liability has not been admitted is the operation of a proviso excluding liability for losses below a specified amount.”

Readers will note the sequencing of the operative clause and be aware that references to policy sections are usually capitalised, as are defined terms.

For the purpose of this operative clause analysis, the key terms are ‘Occurrence’, [2] ‘Peril (damage caused by), ‘Damage’[3], ‘Property’, ‘Premises’, ‘Locality’, ‘Business’ and ‘Interrupted’.

Occurrence

Firstly, something has to happen (occur) to energise the cover provided by a BI policy wording.

Usually, that is the occurrence of damage (or loss) to ‘property’ caused by an insured ‘peril’.

Occur is an intransitive?verb that requires no further explanation – but care must be taken to keep it separate from the driver (peril) and the consequence (loss or damage), i.e. not make it transitive, in order to avoid unintended consequences, e.g. where the happening of the disease (the illness) becomes the peril, rather than the disease, itself - which has created significant complexity for UK courts in unpicking what their BI insurance disease extensions mean when the term ‘occurrence (or outbreak) of a (human infectious or contagious) disease’ is used, especially when de-linked from the main operative clause of the policy wording (as has occurred with many of the BI insurance disease/prevention of access/public authority extensions in that country, and in Australasia).

Peril

When addressing whether Damage has happened it is also necessary to determine the trigger that caused the Damage –

1.??????With nominated perils policy wordings - an insured Peril has occurred.

2.??????With accidental (or “all risks”) policy wordings – that an excluded ‘peril’ has not occurred.

It is also a requirement that the Property is insured (usually straightforward, especially with business package policies), as hand-in-hand material damage and BI insurance is a pre-requisite to minimise the risk of interruption being extended due to the lack of property insurance. The equation is simple - no material damage insurance, no BI indemnity.

Note: As well as with the BI claim, insurers also have an obligation to move quickly on the concurrent property claim – something that hasn’t always occurred in a timely fashion, especially in catastrophe events (see separate section on New Zealand insurers response to the 2010/11 Canterbury Earthquake Sequence).

Damage

Damage is defined as –

1.??????Nominated perils policy wordings – “loss, destruction or damage caused by the Perils.”

2.??????Accidental (or “all risks”) policy wordings – “Accidental physical loss destruction or damage.”, with Accidental defined as “neither expected nor intended nor desired by the Insured.”

These definitions use common words and rely on their ordinary meaning. For example, Damage (which is almost always defined as loss, destruction or damage) also includes being physically altered or affected, and loss includes the inability to use as well as complete destruction.

Note 1: The deliberate use of the word ‘physical’ to qualify the word ‘accidental’ removes the potential for unexplained loss or disappearance of property becoming a claim, e.g. discovered during a stocktake (not an issue with nominated perils cover).

Note 2: the use of the words loss, destruction or damage together strongly suggests that each word has a different meaning so each should be addressed separately in determining indemnifiable ‘damage’. Courts continue the layman bias in their approach – with ‘loss’ including property which is simply no longer there (or still there but cannot be used), ‘destruction’ meaning completely destroyed (with the indemnity focussed on replacement), and ‘damage’ including partial destruction (with the likely indemnity being the cost of repair).

That property must be damaged to sustain a BI claim harks back to the defined perils origins of property insurance. Those perils, e.g. fire, lightning, explosion, etc., invariably caused physical damage so no need for further qualification arose. However, the shift to accidental damage policy wordings coincided with increasing business sophistication and technological advances that showed not all property is tangible and not all loss or damage is physical in nature or physically evident, e.g. computer software and data. And property could be rendered unusable through exposure to pollutants, gases and radiation; or unsaleable/undeliverable because it no longer meets specifications or is otherwise contaminated.

Similarly, the actions of others (especially, but not exclusively, governments and other public authorities) in response to events like natural disasters and disease outbreaks can have extensive direct and indirect consequences on a business that don’t involve actual damage to their property.

These incidents can be as devastating for business as property damage so there was a growing demand for broader risk transfer options. Two questions arose for insurers –

(a)?????How to express cover to include circumstances where property had not been damaged or destroyed but the insured had been deprived of its use?

(b)?????How to provide insurance that includes interruption/interference caused by these non-damage events?

The answer was – expand the definition of damage in property insurance (from that caused by nominated perils, to any damage unless excluded) and extend the BI cover, accordingly. There is absolutely no doubt about insurers’ intention here. It was clear and unequivocal. However, like many things in life, all good in theory but the devil was in the detail.

Property

Property can be tangible (buildings, plant and stock) or intangible (data, digital processes and proprietary rights).

A common definition in property and BI policy wordings is “any building or other property or any part of any building or other property”, which broadly captures what is ‘property’ in a relatively simple though tautologous fashion – backed up by a supporting cast of property type exclusions that remove cover for assets not insurable or not contemplated for cover through the standard property insurance product, e.g. money, vehicles, data (and systems), crops and livestock.

The reason for defining Property and qualifying its ownership is two-fold –

1.????????ensuring the material damage and BI policies are linked, and

2.????????that BI cover applies only where the property is used by the Insured (at the Premises for the purpose of the Business).

What happens, however, when property is not directly damaged or, while damaged, is not owned or used (but relied upon) by the insured? This arose originally from recognition that damage to supplier and customer premises, and public utility networks, could have similar impact on business continuity as damage to an insured’s own property. The demand for cover (which arose almost contiguously with BI insurance, generally) was resolved by extensions that simply deemed these additional locations to contain ‘property used by the insured at the premises’.

Premises

At the premises, within the vicinity, in the neighbourhood and adjacent to the situation are all terms that invoke limitations on where the peril operates and damage to property occurs in order to be indemnifiable. Insurers needed this basic restriction to the damage footprint in order to calculate exposures and match it with their underwriting capacity.

In simpler days premises were readily identifiable and exposures manageable, but with greater manufacturing sophistication and componentisation, the evolution of the services sector, and increasingly complex supply chains, the number of ‘premises’ upon which a single business relied expanded exponentially.

In response, phrases like “anywhere in [insert country] where the Insured has Property or operates the Business” became a default premises descriptor – with insurers relying on (sometimes non-contractual) location schedules, along with single loss limits, to manage exposures. Again, this was unequivocally intentional.

For this analysis it is not particularly relevant how premises are defined (they’re expressed specific to each insured in the policy schedule). However, as premises definitions expanded (initially for supplier, customer and public utilities, and subsequently, prevention of access, public authority and infectious disease extensions), determining exposures from the various expressions became increasingly difficult.

With the initial set of extensions (supplier, customer and public utilities), as with Property, the other locations were deemed to be part of the Premises – “Damage to Property occurring at [Customers’ or Suppliers’ Premises (insert address(es)] [any power station or substation in (insert region)] is considered to be damage to Property used by the Insured at the Premises.”

Locality

Articulating neighbourhood boundaries or radii for the subsequent set of extensions (prevention of access, acts of public authorities, infectious disease) was not as simple as Premises, and it is evident from what has recently transpired that insurers have not been particularly successful in defining local area footprints, especially where (hybrid) extension wordings were completely de-linked from the policy wording’s main operative clause and/or departed from a sequential approach to confirming indemnity.

And further afield, the inconsistent way perils operated/damage occurred meant restricting wide-area damage through spatial boundaries proved challenging – with natural catastrophe damage usually being corralled through temporal limits, e.g. 72 hours.

Business

Like Premises, the definition of the Business was left for freeform description in the policy schedule.

And, like Property and Premises, so long as the insured’s key activities could be adequately identified (for risk underwriting and rating purposes), Business descriptors evolved to become more general as business activity became more expansive and complex. Yet again, this was unequivocally intentional.

So long as the calculation of the various sums insured encompassed all the business activity, and the activities (or property/premises used) were not specifically excluded, then there was no real issue.[4]

Interruption

Interrupt - to cause or make a break in the continuity or uniformity of (a course, process, condition, etc.): to break off or cause to cease, as in the middle of something.

Interfere - to come into opposition, as one thing with another, especially with the effect of hampering action or procedure (often followed by?the word, with).

The requirement that the Business be interrupted or interfered with is not expressed in defined terms, so the ordinary meaning of these verbs applies.

Interruption or interference can be either total or partial, in time or to process. It connotes something direct and physical, not simply a distraction, deflection, annoyance, or the ebb & flow of business. It, of course, must have a monetary impact (see Indemnity).

The two words embrace the essence of the BI insurance compact. As long as the business remains disrupted the indemnity continues (subject only to the claim minimisation condition and any specific limits). This fundamental obligation is central to insurers BI promise and must not be crimped by any countervailing argument that applies the ‘but for the damage’ trends test to the peril and resultant damage (see Turnover below).

Indemnity

The BI indemnity is designed to replace the business’ margin on lost revenue or reimburse additional cost as the result of the damage caused by the insured peril.

It does this by a before and after calculation of revenue and costs –

·??????????Revenue - estimating the insured[5] profit margin and the revenue that would have been derived if the damage had not occurred, subtracting the margin/revenue actually achieved,

and/or ??

·??????????Costs – identifying any additional expenditure incurred after the damage in order to avoid a reduction in revenue (but not exceeding the insured profit on the revenue reduction avoided),

across the period of interruption (Indemnity Period).

Turnover (Revenue)

Both turnover (revenue) and rate of ‘insured’ profit are subject to a ‘trends’ assessment which, with actual revenue and margin prior to the damage as a guide, adjusts revenue and profit margin to reflect the market environment and business exigencies that were in train prior to, or would have occurred irrespective of, the damage and its event trigger, i.e. the ‘peril’.

Note: This is an important point (which will be expanded on under ‘Trends’), especially now that the UK Supreme Court has determined the Orient Express Hotels case (which said that the wider effects of an insured peril such as a cyclone should be considered when determining how the business would have performed) was wrongly decided and overruled it.

The flexibility inherent in BI insurance is no better demonstrated than in the transparency and co-operation necessary for this adjustment to produce an acceptable outcome for both parties. It is central ?to the core BI indemnity promise – that flexibility having been regularly reinforced by cover modifications, e.g. the department clause, turnover alternatives, e.g. output, and additional increased cost of working.

Expenditure (Cost)

Another fundamental insurance principle is that an insured must do whatever they can to minimise loss. BI insurance (and the required property insurance) provides the financial wherewithal to do this, and the indemnity provided is, in turn, subject to the same principle, i.e. any additional cost (in responding to the interruption) must have a margin-equivalent effect on revenue.

Of course, in the aftermath of an event it is not always possible to determine in advance the efficacy of?expenditure with the policy-required degree of accuracy. As with other extensions, BI insurance evolved (with an Additional Increased Cost of Working extension) to cover costs, reasonably incurred at the time, but don’t meet the test. For example, the cost of alternative premises is unlikely to be fully offset by a reduction in the cost of renting (or depreciation & maintenance of) the damaged premises but may be the only viable option and come with a minimum lease period longer than the indemnity period.

Other Insured Items

Just for completeness, and to continue the flexibility theme, BI insurance has evolved to cover other expenditure that doesn’t meet the equivalency test, such as salaries/wages (so that employees can be kept on and remain available for the recovery phase), claims preparation costs (presenting a business interruption claim to an insurer can be time-consuming and diverts resources required for business recovery), and fines or damages (from failure to meet contractual obligations).

?Equity

As the reader will appreciate, no one knows a business quite like the owners or their executive. Similarly, at claim time, insurers have the upper hand on what, if anything, will be paid.

To round out the discussion on BI insurance indemnity, in determining the reasonableness of each party’s actions –

·??????????an insured’s decision-making post loss is tested against what they would do if they were uninsured while,

·??????????the insurer is expected to partner as a trusted adviser during the business’ recovery rather than focussing on finding ways to avoid or limit the claim.

In no other insurance is this responsibility more central to a balanced outcome, and the overarching principle of utmost good faith more relevant, than in BI insurance.

Whether damage from the peril is just to the insured premises, in the locality or more widespread, an insured can be vulnerable and in need of their insurer’s support (insurance is a mechanism to reduce such vulnerability). Unfortunately, for a variety of reasons, this support has not always been forthcoming, particularly in catastrophe events of recent decades.

Indemnity Period

But, before moving on to the overall policy wording context, the author would like to make a brief point about the Indemnity Period limit.

Just like the sum insured places a dollar limit on what the insurer will pay, the indemnity period in BI insurance adds a time limit on the indemnifiable interruption. Depending on the size of the business, these usually range from 12 to 36 months.

Selecting the indemnity period is somewhat of a cost:benefit balancing act and, once selected, it acts as a lever to encourage appropriate action by both insured and insurer. Or it should do - but in recent catastrophes, e.g. the Canterbury Earthquake Sequence and CoViD-19, the lack of timely responses by insurers has further undermined the value of the BI compact.

An Event and its Wide Area Implications

An event (or occurrence or incident) is the happening of –

·??????????a peril (that causes damage), or

·??????????damage (caused by a non-excluded peril)

depending on the type of cover, i.e. nominated perils or all risks.

The event can either be wholly or in part insured or excluded, e.g. fire but not fire caused by earthquake, water or rain but not flood, or infectious disease but not ‘notified’ diseases.

More often than not the event happens to just one property or premises owned by a single insured and determining the application of policy cover in these instances is usually straight-forward.

However, certain perils also cause damage beyond these confines. A range of natural and man-made catastrophes have spatial, temporal and intensity dimensions that magnify their impact. Storms, floods, earthquakes and volcanic eruption have demonstrated the potential to inflict damage to multiple properties and infrastructure assets and constrain business activity well beyond the immediate environs. Weather can exacerbate flooding or drought across regions; earthquakes can generate tsunami across oceans; volcanic eruption can send ash around the globe. And weather patterns are now far less predictable; the return cycle and reach of damage events expanding beyond past boundaries, e.g. cyclones extending out of tropical latitudes.[6]

One event can also have many instances. A thunderstorm can spark multiple fires from lightning strikes, a storm front spawn a number of tornadoes, and an earthquake generate aftershocks and chain reactions along seismic faults and plate boundaries.

Localised events can have regional or global consequences, especially if they occur in areas of concentrated industrial, commercial or agricultural activity, or at utility or supply chain pinch points; while the response to local and wide-area events can have both near vicinity and broader network impacts depending on how componentised a business is and how its products are distributed.

As previously mentioned, as the world developed, product, service, technology and communication options have expanded exponentially and become more complex, adding to exposures.

Businesses don’t purchase insurance for incidents (e.g. fire, explosion, impact damage, etc.) likely to just affect their property but for events that often have more far-reaching consequences. The original narrow view of the insurance purchase decision has long since given way to those broader drivers. Nowhere is this more evident than with BI insurance and, within BI insurance, the expansion of cover to a range of contingent risks (triggers) and eventualities (outcomes), both direct and indirect - including events that affect how people interact with a business, confound the causation trail, and complicate the?‘but for the damage’ indemnity test. Insurers recognised this need and actively accommodated it.

Insurers and insureds alike appreciate how cover has expanded and, equally, appreciate the cover limitations imposed by general exclusions, e.g. war, nuclear contamination and terrorism. However, where cover is expressly offered, whether that be for riot, civil commotion, windstorm, earthquake or infectious disease, it is reasonable to assume that –

·????????insurers know that they are offering (intent), and

·????????insureds understand they are getting (expectation),

cover for both local and wide-area impacts of those perils. And, in the case of diseases (where many are caused by viruses that have epidemic/pandemic potential), it is disingenuous to provide cover on one hand and then rely on general or retroactive exclusions for viruses, or causation arguments, to limit or avoid indemnification.

Reliance is placed on insurers getting the equation right (and having the financial wherewithal to absorb it – even if they get it wrong). It matters not whether they have got pricing right or even fully understood the risk. As part of their capital management, insurers arrange reinsurance for both single loss (vertical) and multiple loss (horizontal) event exposures that reflect the advanced mapping and analysis techniques at their disposal. This has, increasingly, been an important consideration for insureds in what insurance product to buy and from whom – as have the existence of government arranged or underwritten backstop arrangements where those horizontal exposures have exceeded commercial insurance market capacity or risk tolerance.

The insurance industry, long aware of the impact of non-damage contingencies (e.g. disease and prevention of access) and wide-area events (e.g. supply chain disruption and quarantine actions) on individual insureds, expanded the BI insurance offering to include cover - albeit with sub-limits in some cases. It has also long been aware that the business interruption loss can be disproportionately greater than the related material damage.

So, while it is generally accepted that interruption caused by individual decisions to prepare for a catastrophe event that didn’t eventuate (e.g. boarding up in advance of a cyclone - especially in regions where such events are seasonal) or reduce the number of employees or customers on the premises for workplace health & safety reasons (e.g. to prevent the introduction or spread of disease) is not covered - and may be part of normal/seasonal trading, anyway - insurers cannot expect that this ‘reasonable insured’ activity would still mean no cover even though those actions prevented damage to or illness at the insured’s premises but neighbouring property was so damaged or movement in the neighbourhood so restricted that it interrupted the insured’s business, anyway.

Similarly, how to rationalise the absence of cover for the insured who prevented any damage to their property, but minor damage to a neighbouring property from the same event, e.g. a broken window, was enough to engage the neighbour’s BI insurance policy?

So, in the context of CoViD-19, it is trite for insurers to suggest that they didn’t know they were exposed to such happenings and contrived of them to attempt to shift the ‘problem’ back to the policyholder as though they were an equal partner in the design of the insurance contract and that they could not have expected to receive “windfall” indemnity outcomes. If the insurers used an extension wording, then it is their responsibility, including when relying on legislation to define?cover, to ensure the act and the policy wording are properly aligned. Suggesting otherwise just doesn’t ring true and places insurers in poor light and, just as applying to courts to interpret what they meant with their policy wording, it raises questions about their competence and their capacity/willingness, especially with wide-area events, to respond to their commitment when the unfortunate ‘few’ become the calamitous ‘many’.

While individuals’ insurance purchase decisions may be more tactical in nature, businesses, especially as they get larger, make strategic risk transfer arrangements that are designed to remain intact and work as expected over the longer term. As financial pressure has mounted on insurers from the gradual but inexorable increase in frequency and cost of catastrophe events, their reaction has undermined the value of their service to such an extent that it has now become a major societal issue – with a resulting increase in judicial and regulatory attention.

Not implying for a moment that the UK Supreme Court Justices in the CoViD-19 test case FCA v Arch Insurance (UK) Ltd and others https://www.supremecourt.uk/cases/uksc-2020-0177.html intended to send such a signal, but that is the effect of their decision - especially in overturning the Orient Express Hotels precedent.

And it is not coincidental that the messages emanating from other courts in the English common law system and related country legislators/regulators are similar. They are reflecting how community expectations have shifted and their responsibility as caretakers of a system designed to provide citizens with a fair and equitable legal framework.

What is unmistakably clear, however, is the strong message sent by the full bench of NSW’s Court of Appeal in a 5-0 ruling denying insurers attempt to transpose the notifiable disease list of Australia’s Biosecurity Act onto the repealed Quarantine Act list. The subsequent 1 minute decision by Australia’s High Court not to entertain any further appeal by insurers gave that decision crystal clarity. Although this test case applies to something that is peculiarly Australian - not touching directly on other cover matters considered by the UK courts – it leaves little doubt in the minds of plaintiff lawyers and their litigation funders that other Australian cases involving the same issues as the UK will likely have the same result!

The definition of Event (and the addled use of both peril and damage in that context) is just one of many examples associated with the way policy wordings have degraded.

The time has arrived. Insurers and governments need to work together to standardise the approach to insurance contracts, re-establish the industry’s professional estate and, especially for catastrophe events, create more even and accessible offerings. If this requires modification to competition laws, it would be a small concession to make in the interest of long-term sustainability.

Having as a guide industry standard wordings, with insurer PDS’ explaining where their individual wordings differ, would go a long way to correcting this imbalance – and would also help reduce the difficulty customers have in value comparison of their insurance purchases.

Unless this happens, it won’t be long before a court rewrites the insurance contract - and it will probably be a business interruption policy of an insured who has suffered CoViD-19 related losses.

In Part 4 the author will focus on causation and trends, being the two factors that have caused (excuse the pun) so much angst, especially around catastrophe events.

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[1] This says a lot for way adjusters and claims handlers have approached indemnity calculations – but the underpinning professionalism necessary for this to work has, to a large extent, been lost.

[2] It should be noted that words like ‘event’ and ‘incident’ are also used to express the operation of physical (and, sometimes, non-physical) forces representing a policy coverage trigger. This range of expressions (incl. the use of the word ‘outbreak’) has contributed to the complexity of the BI insurance CoViD-19 environment.

[3] Wordings often express the coverage tests of (determining) damage and (the operation of an) insured peril interchangeably. The author has used perils first - as this suits best when determining disease extensions.

[4] The author notes that larger corporations with multiple subsidiaries can be impacted both positively and negatively by the same damage event. Trend clauses require that these are offset in arriving at the post-event standard turnover for BI insurance loss adjustments – the only variation being in the rate of insured profit provided by the Departments extension.

[5] The rate of Insured Profit usually lies somewhere between the business’ gross and net profit rates, depending on the make-up of fixed/variable costs and which of them are not insured (usually because they are 100% variable).

[6] A recent example was Cyclone Seroja 11/12 April 2021 Western Australia.