Update on the FCA test case on non-damage business interruption insurance

The insurers represented as defendants in the Financial Conduct Authority (FCA) test case in the English High Court, relating to claims under non-damage business interruption insurance, have recently filed their defences to the claims, and the FCA has filed its reply.

In this update, we report on developments in the FCA test case and summarise some of the key points of dispute.

Recap

The test case is brought by the FCA against eight insurers who agreed to participate. The FCA is advancing arguments on behalf of policyholders, and the case is proceeding under the Financial Markets Test Case Scheme.

The test case concerns a number of insurance policy wordings that provide extensions to standard business interruption insurance cover without requiring the policyholder to establish insured physical damage to insured property. The policy covers under consideration in the test case are, broadly speaking, triggered by a denial of access to, or interference with, insured property, following an order or advice from government, police, local authority and so forth, due to incidents or occurrences, within a particular distance or vicinity, that have prevented or interrupted use of the premises.

Others are triggered by an interruption that arises from an occurrence of a disease within a certain vicinity.

Obviously, exact policy wordings, and the triggers included within them vary, and the policies have been chosen to test a number of formulations.

On 23 June, insurers filed their defences to the claims. On 3 July, the FCA filed its reply.

Key issues

There are, of course, numerous matters included in the particulars and the eight defences, and some differences between insurers’ individual positions. An overview of the positions on a number of key matters are set out below.

Policy triggers

The FCA, in its particulars of claim, characterises the government response, in the form of government advice, instructions and legislation, as a single body of intervention, which it argues prevented and hindered access to premises, caused closure and interrupted activities.

It states that this encompasses businesses that were ordered to partially close or did not close at all, in that the package of measures was sufficient to satisfy policy triggers, and in particular businesses were unable to operate normally.

The insurers’ case is that this characterisation does not pay heed to the words actually used in the policies. (The insurers also argue that the FCA has extracted words from policies, and that they must be considered in the context of the clauses and the policy wordings as a whole.) The insured peril is not the pandemic itself, rather there is cover for specified actions in specified conditions and circumstances. Some particular examples:

• Actions and advice of the government: A number of insurers argue that government advice and announcements not to hold events and gatherings, to socially isolate and so forth, were not compulsory. Therefore they would not trigger cover where words are used in the policy importing the requirement for a mandatory order to close, such as “imposed” or “enforced closure”. The FCA responds that government announcements couched as “advice” were in fact clearly compulsory. In relation to some policies, it is argued that national government is not a relevant authority (for example, it is not a civil or local authority as required by the wordings).
• Incident or occurrence: It is argued by insurers that words such as incident or occurrence refer to local, small-scale identifiable events. Danger requires an acute risk of harm from something specific happening in the immediate locality of the premises. A person with an illness is, it is said, not an incident within the meaning of the policy, nor is the pandemic itself.
• Closure: Some insurers point to the fact that not all businesses were required to close. Words such as interruption require a cessation or stop, and it is not enough that business has become more difficult, or part is closed or certain activities are not carried on. For access to premises to be prevented, it is argued that premises must be physically obstructed, not that access is merely reduced or hindered.

In some cases, it is also argued by insurers that the specific policy wording used means there must be a strong causal link between an incident of COVID-19 in the specified radius and the imposition of restrictions (where wording is along the lines of providing cover for restrictions imposed by an authority due to or following an incident or occurrence). Insurers argue that policyholders cannot demonstrate this causal link as orders and advice by government were given due to the national pandemic and not a specific incident of COVID-19 in the vicinity of the insured.

Proof of COVID-19

The FCA is concerned that insureds will face difficulties in meeting the burden of proof of showing that a case of COVID-19 has occurred within the relevant radius under the policies. As such, it is asking the court to find that a statistical methodology can be used to meet the burden of proof (although not precluding insurers or insureds from proving that the methodology is unreliable in a particular case, or that a weighting other than average is appropriate).

They refer to Equitas v R&Q, in which an actuarial model was used to prove syndicates’ recoverable losses following the LMX spiral. The FCA is arguing that a case should be treated as present in the relevant policy area (among other methods, such as using hospital data) if there have been reported cases within local authority zones or areas, after the number of reported cases have been uplifted by an undercounting ratio (to take account of under-reporting of cases of disease) and then averaged across the zone.

The undercounting ratio, it is said, can reasonably be inferred from reports by Cambridge University and Imperial College, London. This issue has been the subject of debate between the parties at the two recent case management conferences before the court. Insurers point to the fact that the FCA needs recourse to elaborate methods of proof to show an incident of COVID-19 as an indication that the policies cannot have been intended to respond to such COVID-19 exposures.

The court has ordered that the trial will determine, as a matter of principle, the type of proof that would be sufficient to discharge the burden of proof. If, on the assumption that the data on which the FCA relies is the best evidence available (as per Equitas), this would be sufficient to discharge the burden of proof, then it may be necessary to hold a further hearing in September on the application of the methodology. (To date insurers have been unable to obtain expert evidence on the issue of prevalence of the disease and there is no time to deal with expert evidence at trial.)

Causation and loss

The insurers’ position is that in each case the insured peril (for example the particular local incident or particular restriction) is not the proximate cause of the loss. There is no “but for” causation. There are a number of independent causes, such as the pandemic itself, its impact on public confidence and economic activity and the measures imposed by the government at national level to protect life and the National Health Service, which are the cause of most or even all of the loss. Where there is more than one independent cause of loss, only one of which is an insured peril, then the loss is not covered, as it cannot be proven the loss would not have occurred but for the peril. (This, it is said, is in contrast to a situation where there are interdependent causes, where the general law provides that if one cause is insured and the other is not insured (rather than excluded) then there is cover.)

Insurers argue that the law provides that the correct counterfactual in relation to the “but for” test is one where the insured peril (as defined by the policy language, so for example the particular restriction, or case of COVID-19 locally) is absent but that all else remains the same. So that the existence of COVID-19, the government measures and economic impacts remain the same.

The FCA argues that there is only one proximate cause of the loss: the nationwide disease including its local presence or manifestation and the restrictions due to the disease. The FCA says that the epidemic itself and its consequences in terms of lockdown and the social distancing restrictions are inextricably linked so as to amount to a single cause or single set of concurrent interdependent causes, and this is the case where one of the things – COVID-19 in the UK – is the underlying cause of the other. Its case is that the correct counterfactual is a situation where there is no COVID-19 and no government measures, and that any other approach is unrealistic.

In response to this, insurers point to the fact that their counterfactual scenario actually existed in previous pandemics where government restrictions of the kind we have seen were not imposed, and in Sweden where there has been no lockdown in the context of COVID-19.

Trends clause

The FCA argues that the trends clauses in the policies do not apply to non-property damage in many of them, and that where or if they do apply their purpose is not to exclude the natural and probable result of the peril that has resulted in the loss to the insured, but have in contemplation only ordinary vicissitudes of commercial life, such as economic trends or regulatory actions independent of COVID-19.

Insurers dispute that the trends clauses do not apply, argue that “but for” causation would apply even without the trends clauses, and the express purpose of the trends clauses is to ensure that the amount paid reflects the result that would have been achieved if the insured peril had not occurred. At least one insurer makes reference to the controversial case of Orient Express Hotels, which concerned business interruption losses following Hurricane Katrina, although the FCA in reply disputes the correctness of this first instance decision.

Exclusions

The FCA argues that there are no express or implied exclusions for pandemics in relation to the coverage clauses relied on by the FCA, although there are such exclusions in some of the wordings in relation to other coverage clauses. Insurers contend in response that the lack of an exclusion for a pandemic cannot be used to infer that a policy does provide cover, and such exclusions are not necessary.

In addition, the FCA argues that a general exclusion in respect of disease cannot prevail over a specific extension of cover for the same peril, with the result that the extension has no application at all.

Developments and next steps

At the recent case management conference the court allowed intervening claims by certain other policyholder representatives (the Hiscox Action Group and the Hospitality Insurance Group) so that they may be heard at trial on the issues that relate to their policy wordings. The trial of the claim will take place across eight days from 20 July, and will be heard by Lord Justice Flaux and Mr Justice Butcher.

The judgment will be awaited with interest, given its importance not just to BI insurance, but to some general matters of insurance law and causation.

In the meantime, the FCA has also issued finalised guidance for the steps that the FCA requires all insurers who may have issued relevant non-damage business interruption policies to take during the lifetime of the test case, in terms of reporting to the FCA communications with affected policyholders, and a requirement to review affected claims and complaints in light of the final outcome of the test case.