FCA Update and Guidance following judgment in the Business Interruption Insurance Test Case

The much-awaited decision in the FCA’s High Court test case in relation to non-damage business interruption (BI) insurance policies and their response to the COVID-19 pandemic was published yesterday (15th September 2020) (the Judgment).

The 162 page decision is indicative of the degree of complexity that the Judges found in analysing the BI wordings they were asked to consider – complexity which itself may be seen by many – including the FCA – as a systemic issue for the market.

Many of the Court’s findings are specific to particular wordings, but a number of broad themes can be derived from the Judgment.

• Generally speaking, extensions providing cover for disease have been held to apply (with limited exceptions where the cover is specifically limited to local ‘events’ or ‘incidents’).
• Cover for denial of access extensions will depend on the specific wording, but generally cover will only apply for more limited local shutdowns – interestingly, this may result in cover potentially being available for ‘second wave’ local lockdowns even if not available for the nationwide ‘first wave’;
• Where trends clauses apply, the appropriate course is usually to compare the reduced turnover during the period of interruption against the turnover prior to the peril occurring – usually pre-COVID-19 but in some limited cases after COVID-19 had started to spread but prior to lockdown.
• Although found not to be applicable, the Court dismissed the Orient Express line of authority on causation – if upheld, that will mean that Insurers and Reinsurers will no longer be able to argue that localised damage is not the cause of loss, because of wider area impact – potentially material to (re)insurers’ exposure to BI losses following major CAT events.

Given the mixed findings, it remains to be seen whether the FCA or Insurers will seek to appeal some or all of the Judgment. If upheld, the Judgment is likely to result in claims against Insurers crystallising, albeit that those claims may now be limited to cover under specific extensions.

In the meantime, the FCA expects that:

• All policyholders with potentially affected claims or potentially affected complaints will be updated that the Judgment has been published;
• Any potentially affected claims and complaints which turn on questions that have now reached final resolution (i.e. will not be appealed) will be determined promptly; and
• Potentially affected claims and complaints which have previously been rejected or reduced, but which involved questions that have now reached final resolution will be reassessed.

The manner in which Insurers have responded to this crisis is likely to come under regulatory scrutiny once the dust has settled. They should therefore ensure that they have robust governance processes in place in order to evidence their compliance with the FCA guidance and relevant regulatory obligations and in particular ensuring policyholders are treated fairly and communicated with clearly. As part of this, we would remind relevant senior managers to remain fully engaged and provide the appropriate level of oversight and challenge.

Background

SME Business Interruption insurance and COVID-19

As the scale and impact of the COVID-19 pandemic became clear earlier this year, the FCA quickly focused on the handling of claims by SMEs under BI insurance policies. Given that so many SMEs were forced to cease operations overnight, the impact on SMEs and the potential for claims to be brought under BI insurance policies is huge.

The FCA’s early assessment, communicated in its Dear CEO letter of 15th April 2020, was that most BI policies have basic cover, do not cover pandemics and therefore would have no obligation to pay out in relation to the COVID-19 pandemic. It therefore did not propose any active intervention.

However, it quickly emerged that there is a significant range of policy wordings and types of coverage available in the BI insurance market. The FCA therefore significantly stepped up its response and on 1st May 2020 announced that it intended to obtain a court declaration to resolve uncertainty over whether certain BI policies cover interruption as a result of pandemics.

The test case

On 1st June, the FCA announced that it had identified a representative sample of (originally) 17 policy wordings which were representative of the key arguable issues and asked eight insurers who underwrote policies in the sample to participate in the test case. That trial was heard over 8 days commencing on 20th July 2020 (the trial was conducted entirely over Skype for Business).

The Court for this trial was made up of Lord Justice Flaux and Mr Justice Butcher (both eminent insurance lawyers), hence it is unsurprising that the Judgment adopts a fairly legalistic approach to the actual words used in each policy, rather than seeking to discern some higher purpose. The inclusion of a Lord Justice of Appeal on the bench for this first instance trial is intended to add weight to the findings but also to increase the likelihood that the parties will be permitted (if they elect to appeal) to bypass the Court of Appeal and ‘leapfrog’ to the UK Supreme Court. Should permission for such an appeal be granted, it would be likely to be held towards the end of 2020.

The Judgment issued by Lord Justice Flaux and Mr Justice Butcher was published yesterday. At 162 pages, the Judgment merits careful analysis rather than knee-jerk reaction.

Disease extensions

Overall, the Court has been favourable to policyholders whose policies include specific extensions for disease.

• This depends on the definitions being broad enough to encompass COVID-19 – for example, clauses with ‘closed lists’ of named diseases (not including COVID-19) would not provide cover.
• Generally speaking, the Court has not distinguished between different disease extensions.
• No material distinctions are drawn between different public authorities acting in response to COVID-19, and in such cases the cause of loss is a ‘composite cause’ – which enables the Court to circumvent fine distinctions on causation by focusing on the insured peril – accordingly, there is no material difference between varying “connector” words, although “following” was held to denote a looser causal connection than ‘proximate cause’.
• In the case of disease extensions, the Court has generally found that coverage within a specific radius (e.g. 25 miles) applies essentially nationwide, and the broader pandemic does not negate the cover within that radius.
• There are a limited number of extensions where cover is limited to localised ‘events’ or ‘incidents’.
• On the whole, ‘trends’ clauses should not negate the cover by limiting the quantum that can be claimed to post-COVID-19 turnover – on the contrary, the correct ‘counter-factual’ is in most cases the pre-COVID-19 turnover.

Denial of access

In contrast, the Court has construed cover under denial of access extensions much more narrowly, and limited cover to specific circumstances under specific clauses.

• In this case the Court has tended to focus on the localised nature of the grounds for denial of access – a bomb scare causing a police cordon to be erected being the example relied upon.
• The Court has construed ‘vicinity’ in such cases relatively narrowly.
• For the most part, only full closure (and not reduced trading) would be sufficient to trigger these clauses.
• Even then, the effect of the trends clause may be to make the pre-closure reduced trading the applicable counter-factual instead of pre-COVID-19 completely.
• Although found not to be applicable, the Court dismissed the Orient Express line of authority on causation – if upheld, that will mean that Insurers and Reinsurers will no longer be able to argue that localised damage is not the cause of loss, because of wider area impact – potentially material to (re)insurers’ exposure to BI losses following major CAT events.

Orient Express

Although the Court’s focus on insured perils renders causation analysis largely irrelevant, the Judges nevertheless take the opportunity to critique the Orient Express decision. The effect of Orient Express is that loss which is caused by wider area damage cannot be recovered even if an insured peril causes damage to the insured premises – on the facts in issue in Orient Express that meant that the owners of a New Orleans hotel were unable to recover for losses following Hurricane Rita on the basis that the immediate cause of loss was the shutdown of New Orleans generally following the hurricane as opposed to the specific damage to the hotel itself.

The Court’s findings on this issue – albeit obiter – are fairly dismissive of the reasoning in Orient Express – arguing that the effect of that construction is to render the cover illusory.

If the test case is appealed, it seems highly likely that this issue will be part of the appeal – that will enable the Supreme Court to express a definitive view on the Orient Express reasoning, which has previously been criticised by commentators. An interesting sub-plot is that the Supreme Court bench hearing such an appeal might include either Lord Leggatt (who sat in the original Orient Express arbitration) and / or Lord Hamblen (who heard the Commercial Court appeal from that award).

FCA Expectations Following the Judgment

On 17th June, the FCA published finalised guidance setting out the regulators’ expectations in respect of their regulatory obligations (under FCA Principles, ICOBS and DISP) for Insurers and insurance intermediaries when handling claims and complaints for BI policies during the test case (the Guidance). Our previous articles discuss the detail of this Guidance and can be accessed here and here. The publication of the Judgment marks a new stage in the FCA’s expectations of firms under the Guidance.

Policyholder updates

Where Insurers have determined that the outcome of certain policyholders’ claims/complaints will depend on the outcome of the test case, Insurers should update the relevant policyholders individually on the status of the test case and its implications for their claim or complaint at certain key points throughout the process. One key point identified in the Guidance as triggering such an update is the handing down of a judgment at first instance. Such individual communication concerning the Judgment (which, at this early stage, is unlikely to have to explain the impact of the Judgment on individual claims/complaints) should be made as soon as possible or at the latest by 22nd September and should set out the next steps and likely timings.

Insurers should continue to keep up to date with proceedings following the Judgment because further individual communications are expected to be made at the following times:

• when all judgments at appeals on substantive issues in the test case are given;
• when the test case reaches final resolution; and
• at any other significant development in the test case that may be relevant to the policyholder’s claim or complaint.

Above all, in order to treat customers fairly, customer communications will need to be clear and balanced in keeping with the Insurers’ regulatory obligations under both Principles 6 and 7. This will need careful thought as the test case presents complex issues and involves significant uncertainty which may be a challenge to communicate to customers clearly, especially if it involves updating previous communications.

Determining potentially affected claims/complaints

Pursuant to the Guidance, Insurers are permitted to wait until final resolution of the test case before reaching a decision on potentially affected claims or potentially affected complaints. The concept of ‘final resolution’ is tied to the Court’s determination of the agreed issues in the test case after all rights of appeal have been concluded. However, this does not mean that any appeal of the Judgment enables Insurers to delay decisions on potentially affected claims/complaints. Rather, the issues in the test case should be considered separately, such that issues addressed in the Judgment and not appealed will be considered by the FCA to have reached ‘final determination’. Care must be taken in undertaking this analysis as the Judgment does not specifically address the answer to each of the agreed issues. Rather, it provides a substantive analysis of the coverage position in respect of each individual policy.

Determinations on potentially affected claims/complaints should to be taken ‘promptly’ on final resolution, and should be handled and assessed in line with ICOBS 8 and DISP 1. Particular attention should be paid to seeking to ensure fair customer outcomes and compliance with TCF obligations. This should include prioritising vulnerable customers where possible and making interim payments as appropriate.

In order to ensure that decisions on outstanding potentially affected claims/complaints can be made in a sufficiently timely manner, Insurers should consider commencing a triage exercise of their policy wordings in order to assess how the Judgment impacts the claims/complaints received in relation to each. This will enable Insurers to react quickly once it is clear which aspects of the test case will not be appealed and have therefore reached final determination.

Review of rejected/reduced potentially affected claims/complaints

Upon final resolution Insurers should reassess all claims and complaints that they have previously rejected that would, if still open, be impacted by the outcome of the test case. When reassessing rejected claims and complaints, Insurers have to apply the judgment(s) in the test case.

Insurers are required to promptly inform relevant policyholders that this reassessment has taken place and its outcome. In respect of rejected complaints a revised final response under DISP 1.6.2R should be provided.

Governance

In accordance with Insurers’ regulatory obligations, which are likely to be a matter of future regulatory scrutiny, it is essential that Insurers ensure that have a strong governance framework around their continuing compliance with the Guidance with appropriate senior management engagement and oversight. In particular, they should ensure that:

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

Further reading: The Financial Conduct Authority v Arch Insurance (UK) Ltd and Others [2020] EWHC 2448 (Comm).