Bates Research - 04-21-20
Coronavirus and the Approaching Business Interruption Insurance Storm
These are uncertain times for insurers. In a report issued on March 31, 2020, Congressional Research Service (“CRS”) staff noted the likelihood that “loss of income from mandatory or voluntary closures, supply chain disruptions, and reduced demand due to social distancing measures may induce businesses of all sizes to seek compensation from insurers.” That was clearly an understatement. Early estimates from the American Property Casualty Insurance Association (“APCIA”) are that some 30 million small businesses claims may be filed. This would be more than ten times greater than the highest number of claims “ever handled by the industry in one year.” In statement released by the APCIA, David A. Sampson, President and CEO of APCIA, offered preliminary estimates of closure losses for small businesses, which have increased to $255 billion to $431 billion per month. “Continuity losses for small businesses are approximately 43 to 72 times the monthly commercial property insurance premiums,” Mr. Sampson said.
Insurance market participants are sounding alarms about a wave of state and federal legislation that would shift onto insurers a significant portion of the burden to compensate businesses from the massive losses resulting from pandemic-related shutdowns. Bates takes a look at these legislative moves, early legal action taken by policyholders seeking coverage for business interruption losses as a consequence of the coronavirus (COVID-19), and the reaction by the insurance industry.
Types of Business Interruption Insurance Coverage
The CRS report describes various kinds of insurance that cover specific losses due to certain business interruptions. The issues facing insurers are (1) whether the terms of these policies can be potentially stretched to include losses of the kind that may result from government-mandated (“Civil Authority”) pandemic closures, and (2) what might happen if federal or state authorities retroactively require coverage under these policies for COVID-19 claims.
Commercial property insurance has been a target for legislators mainly because most businesses carry it in some form. Generally, these policies require that the insured suffer a loss of income due to direct physical loss or damage to covered property. Assessments of these losses are fact-specific and subject to significant challenge in court. Christine Davis, Bates Managing Director of Forensic Accounting and a commercial damages testifying expert, explains that “to measure business interruption loss requires taking a number of meticulous steps, including understanding the experience of business before the incident, analyzing the business’s financial records and historical performance, estimating the profits lost during the indemnity period, and gathering the proper documentation that supports the loss calculation.”
That said, many of these policies explicitly exclude losses due to viruses and bacteria - modifications to policies made as a result of unexpected losses suffered during the SARs epidemic. According to the CRS, insurance policies of special relevance include: (1) business interruption insurance (which covers business losses directly or indirectly caused by a covered peril or, in some cases, caused by all risks); (2) business income insurance (which covers sustained loss of income due to a suspension of business operations arising out of a covered risk); (3) contingent business interruption insurance (which covers business losses based on destruction of property owned by others); and (4) civil authority coverage (which covers business interruption losses when a civil authority restricts access to a business premises.)
State governments are aware of the limitations included in many of these policies and are responding to constituent concerns with basic FAQs and other general guidance (see, e.g. this dedicated web page by the New York Department of Financial Services (“NYDFS”); and, more broadly, this database resource provided by NAIC offering State Bulletins and Alerts Regarding Coronavirus). The scope of the problem, however, is so great that these early steps may be seen, in hindsight, as mere placeholders before the real battle over coverage began.
Federal and State Legislators Seek Coverage for COVID-19
The real battle includes legislative efforts to compel the industry to cover COVID-19 claims. The first attempt was outlined in a March 18, 2020 letter by a bipartisan group of U.S. House members to four leading insurance trade associations and their response to it. In the letter, the representatives urged the associations “to work with your member companies and brokers to recognize financial loss due to COVID-19 as part of policyholders’ business interruption coverage.” Similar letters have since been sent to insurers from state representatives.
The implicit threat behind these inquiries is that either the federal government or the states will force insurers to cover COVID-19 related claims. The intention is clear and the concerns are real, warned Sheila Murphy, an insurance consultant and expert with Bates Group: “the government is seeking to expand or shift this risk, but insurers have not priced it into their premiums.” In various forms, state legislative bills have now been introduced in New Jersey, Ohio, Massachusetts, New York, Louisiana, Pennsylvania, and South Carolina. Though there are differences among the bills, in general they require insurers to retroactively include the coronavirus as a “covered peril” under business interruption policies. In the interim, various state agencies have adopted emergency regulations requiring that property and casualty insurers provide relief to consumers and small businesses with extensions for the payment of premiums and fees under these policies, (see, e.g. NYDFS Emergency Action).
The U.S. House Financial Services Committee, meanwhile, is considering a draft Pandemic Risk Insurance Act (“PRIA”) patterned after the Terrorism Risk Insurance Act (TRIA). According to Maxine Waters, U.S. House Financial Services Committee Chair, PRIA would “create a reinsurance program similar to [TRIA] for pandemics, by capping the total insurance losses that insurance companies would face.” Recent reports suggest that PRIA “would be triggered when industry losses exceed the $250 million threshold and aggregate losses would be capped at $500 billion in a calendar year for both insurers and the government.” Further, the bill reportedly states that participating insurers will be charged an annual premium for reinsurance coverage, “based on the actuarial cost of providing such reinsurance coverage, including costs of administering the program.” Insurers, in turn, would agree to provide coverage for insured losses that does not “differ materially from the terms, amounts and other coverage limitations applicable to losses arising from events other than public health emergencies.”
Other legislative proposals include establishing a compensation fund – currently referred to as the “Federal Business Interruption and Workers' Protection Recovery Fund." Lilian A. Morvay, Bates Insurance expert and consultant , describes such a solution as similar to the 9-11 Victims Compensation Fund or the National Flood Insurance Program. Shestates: “clearly, the pandemic and the losses it is leaving in its wake are unprecedented. In the interest of supporting businesses without bankrupting the insurance industry, this solution would backstop insurers that provide monetary relief to businesses that suffered economic losses.” Under the proposal, insiders say, businesses would “submit claims to their insurers as if business interruption resulting from coronavirus were covered. Insurers would then adjust those claims as normal and determine the appropriate claims payment, which would be funded by the government.”
The industry response to the bipartisan letter and state and federal actions has been forceful. Collectively, the insurers are leaving no doubt that they will fight attempts by state and federal legislators (and in court) to force payment for income losses from COVID-19 that their policies were never designed to cover.
In their letter in responding to House members, the associations asserted that “the proposed retroactive application legislation would fundamentally change the agreed-upon transfer of prospective risk-of-loss exposure to coverage for a known and presently occurring loss, something the parties did not agree to, the insurer did not rate for, and the policyholder did not pay for.” Following up, the association leadership said that while insurers stand ready to help, “if policymakers force insurers to pay for losses that are not covered under existing insurance policies, the stability of the sector could be impacted.” Siding with the trade associations, the National Association of Insurance Commissioners (“NAIC”) issued their own statement asserting: “while the U.S. insurance sector remains strong, if insurance companies are required to cover such claims, such an action would create substantial solvency risks for the sector, significantly undermine the ability of insurers to pay other types of claims, and potentially exacerbate the negative financial and economic impacts the country is currently experiencing.”
In the days to come, there will be a fair amount of reporting on state lawsuits filed by policyholders attempting to challenge existing terms of business interruption policies (see, e.g. here, here and here). For now, these coverage claims may be raised against insurers, agents, and brokers, and are handled on a normal case-by-case basis.
Insurers must brace themselves for these cases. That said, the real concern for insurance industry leadership is the momentum building for state and federal intervention in the sector to address this extraordinary challenge. Only some agreement on a collaborative framework between the industry and the government to respond to the national need could possibly result in a way forward. Absent that, the legal battle will be epic. Bates will keep you apprised.
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