Covid Business Interruption Disputes: reinsurance contracts

Covid Business Interruption Disputes: Aggregation in Unipolsai Assicuriazioni SPA v Covea Insurance Plc; Markel International Insurance Co Ltd v General Reinsurance AG

Summary

The court agreed with the respective arbitral tribunals’ conclusions that the Covid-19 losses for which indemnity was sought arose out of and were directly occasioned by one catastrophe on the proper construction of the reinsurance contracts.

The court also held that the respective "Hours Clauses" in the contracts, which confined the right to indemnity to "individual losses" within a set period, were concerned with the duration of the catastrophe that causes the individual losses, not the individual losses themselves.

Background

This case concerned two joined appeals from arbitration decisions concerning issues under property catastrophe excess of loss reinsurance. Two principal issues were considered:

1. did the Covid-19 losses for which the cedants in each case sought indemnity arise out of and were directly caused by one “catastrophe”; and

2. did the hours clause, which confines the right to indemnity to “individual losses” within a set period, mean that the reinsurance only covered payments made by the cedant in respect of the closure of the insured’s premises during the stipulated period?

What is a “catastrophe”?

As to the first point, the Court upheld the decisions in the two arbitrations that there had been a “catastrophe” for the purposes of the relevant excess of loss reinsurances. It was not suggested that there was a settled definition of catastrophe in the reinsurance market.

1. There was no need for a catastrophe to cause physical damage for it to be considered a catastrophe. This was not a pre-requisite in the dictionary definitions. Catastrophe was a term that was used in other parts of the reinsurance market (such as in casualty reinsurance policies) where physical damage is not required. And importantly, it was common practice for direct property underwriters to underwrite non-damage business interruption which was intended to fall within the business ceded to their property excess of loss reinsurance programmes. Indeed this idea – essentially that the reinsurance market knows it is reinsuring non-damage as well as damage based property losses – is a theme that runs through the entire judgment.

2. Nor does the term catastrophe require a sudden and violent event or happening. It would, though, probably be necessary to be able to distinguish between the period when the catastrophe is in existence and the period when it is not. Each reinsurance also referred specifically to perils that, whilst capable of being sudden and violent, need not be. This included riots, civil commotion, malicious damage and floods.

3. A catastrophe is not a species of event or occurrence which must satisfy the three unities test taken from Axa Re v Field, at least not in the narrow sense adopted in event and occurrence based aggregation decisions. In that case, the House of Lords concluded that an “event” is something that happens at a particular time, at a particular place and in a particular way. However, the court in the Covea and Markel case noted that ultimately the unities test is “merely” an aid to determining whether a series of losses involve a sufficient degree of unity to permit aggregation under the particular wording, not a definition.

4. The reinsurances did not define catastrophe by reference to either an “event” or an “occurrence” as defined by the courts generally. In other words, a catastrophe was not simply synonymous with an event or occurrence as has been defined in a number of judgments by the courts.

5. Furthermore, a number of factors were identified which pointed “strongly away from anything but the most generous application of two of… [the] three unities”. First, both reinsurances contained a two-risk warranty, which means the catastrophe must comprise losses covered by at least two different policies. Secondly, both reinsurances contemplated losses across a potentially large geographical range and a long duration. For example, flood losses could have a duration of up to 504 hours and still be aggregated as one Loss Occurrence.

The judge was not prepared to define precisely what a catastrophe is. However, in the context of these reinsurances, he did draw out several key features. First, the catastrophe must be capable of causing direct individual losses itself. That would, in most cases, exclude what are better described as “states of affair”. Secondly, the catastrophe must be something which, in the context of the wording, can fairly be regarded as a coherent, particular and readily identifiable happening. Thirdly, it must be broadly possible to identify when the catastrophe comes into existence, even if a precise delineation is open to dispute. Finally, the catastrophe must involve an adverse change on a significant scale from that which preceded it.

How was this applied to Covid-19? In the Covea arbitration decision, the panel concluded that the outbreak of Covid-19 in the UK represented a catastrophe. The judge rejected the appeal from that decision, and appeared to agree with it.

The Markel panel reached their decision through a different route. They concluded that the catastrophe was Government’s order to close schools and nurseries on 18 March, as necessitated by the pandemic. It was argued that the closure order itself could not be a catastrophe. Rather, it was the mitigating measures in response to the catastrophe. The court concluded it was not necessary to determine this point, since the 18 March closure order was inextricably linked to the pandemic. As a whole, it was open to the arbitration panel to conclude that this met the definition of a catastrophe.

The Hours Clause

The hours clause is a standard clause in property excess of loss reinsurance contracts to define how aggregation is to operate. Although there were differences in specific drafting, the hours clauses in the two reinsurances were broadly similar.

The reinsurances provided an indemnity per Loss Occurrence (Covea) or Event (Markel) in excess of the cedant’s retention. Loss Occurrence and Event in each reinsurance respectively was defined to mean “all individual losses arising out of and directly occasioned by one catastrophe”. The duration and extent of any Loss Occurrence or Event was limited to a stated number of hours depending on the type of catastrophe. The Covea clause also stated “no individual loss from whatever insured period, which occurs outside these period or areas, shall be included in that ‘Loss Occurrence’”. The Markel equivalent sentence in the hours clause stated "and no individual loss from whatever Insured peril, which occurs outside these periods or areas, shall be included in that 'Event'".

The court here considered broadly three questions.

1. Is there a distinction between the operation of the hours clause where business interruption is caused by physical damage and its operation where business interruption is not caused by physical damage?

The Court was not persuaded that there was a clear difference between the two. It was accepted that the entire business interruption loss where it flows from physical damage to a property is treated for the purposes of temporal limits in the reinsurance as occurring on the day of the property damage (assuming no break in the chain of causation).

The Court considered the position to be the same where the business interruption flowed from non-physical damage. In doing so, the Court re-emphasised the analysis in the FCA Test Case, applied by the Court of Appeal in Various Eateries and Mr Justice Butcher in that case and Stonegate, that the business interruption is the consequence of the insured peril in the direct policies, not part of the insured peril. In the case of prevention of access clauses, this translates as:

(A) an occurrence of a notifiable disease which causes (B) restrictions imposed by a public authority which causes (C) an inability to use the insured premises which causes (D) an interruption to the policyholder’s activities that is the sole and direct cause of financial loss.

2. Is the hours clause, at least in the Markel reinsurance, concerned with the duration of the individual losses or the duration of the catastrophe that caused the individual losses?

This turned on the wording of the Markel hours clause. The clause referred to “no individual loss from whatever peril, which occurs outside these periods or areas, shall be included in that ‘Event’”. It was clear to the arbitrators (and to the Court) that this referred to the date of the individual loss not the date of the insured peril. Covea did not run this argument.

3. When do individual losses occur for the purposes of the hours clause in the reinsurance?

It was common ground that the “individual losses” referred to in each hours clause mean the loss sustained by the original insured. It followed from the analysis in response to the first question above that the business interruption loss “occurs” when the insured peril strikes the premises resulting in a loss of the ability to use those premises. This is, in effect, stage (C) in the sequence below:

(A) an occurrence of a notifiable disease which causes …
(B) restrictions imposed by a public authority which cause ..
(C) an inability to use the insured premises which causes …
(D) an interruption to the policyholder’s activities that is the sole and direct cause of financial loss.

The “individual loss” occurs at the point in time when the insured loses the ability to use the premises based on an insured peril (the occurrence of the notifiable disease which in turn causes restrictions imposed by a relevant public authority in the above example). This is, therefore, the point at which the individual loss is treated as attaching to the relevant period in the hours clause.

Commentary

As noted above, the court was clearly keen to ensure that the construction placed on the excess of loss reinsurance treaties in this case followed the treatment of losses on the direct policies. It is not a surprise that reinsurers should be treated as reinsuring non-damage business interruption when this is so commonly insured as part of direct property accounts.

That said, the reinsurance market has had deal with exposures it had not modelled or predicted, in the same way that the direct market has also been required to.

The discussion of the definition of catastrophe is helpful in clarifying that this means more than a sudden and violent event that causes physical damage. There is also a useful reiteration of the disciplined breakdown between insured peril and loss thereby caused that the Supreme Court set out in the FCA Test case, and which the court in Stonegate and Various Eateries reiterated.

For the purposes of aggregation under the hours clause in an excess of loss treaty, the insured loss is the inability to use the premises as a result of an insured peril. This will not necessarily equate to the full extent of all losses since those will be capped by the maximum indemnity period in the underlying policy. But it is not necessary for the full amount of those losses to occur during the period identified in the hours clause, in the same way as it is not necessary to show that all such losses occur during the policy period in the underlying policy. Again, this aligns the construction of the excess of loss reinsurance with the analysis of the direct policies in Stonegate and Various Eateries.