The outcome of the FCA business interruption test case appeal will create a series of intended and unintended consequences for insurers and policyholders alike

Blows don’t come much bigger than that meted out to the insurance industry by the Supreme Court in mid-January.

Insurers will be collectively hundreds of millions out of pocket following the keenly awaited verdict on the appeal against the High Court’s ruling last September in favour of the Financial Conduct Authority’s Covid-19 business interruption test case (see Pass Notes).

Not only did the latest decision uphold the High Court’s judgement against the insurers but strengthened it, said Ralph Fearnhead, legal director in the insurance disputes practice at Mishcon de Rey, which represented Hiscox policy holders.

Insurers lost on all grounds, he told Insurance Times: “We have very happy clients who the Supreme Court found unanimously that the insurers were wrong to deny clients for the reasons they did.”

The court said that when government lockdown measures were implemented, it was sufficient for policyholders to show that there was at least one case of Covid-19 within the relevant radius required by their disease cover.

The judges said the ‘but for’ test, which insurers had been relying on to say there was no cover under disease clauses and has been a mainstay of insurers’ defences for over a century, was ‘sometimes inadequate’.

This test has been a useful defence in cases where a loss has multiple causes and the insurer can prove that ‘but for’ a particular one the loss would not have occurred.

Rebecca Carrera, an insurance expert at solicitors Pinsent Masons, told Insurance Times this aspect of the case is “potentially significant” for the wider market.

“It is a basic principle of insurance law that is always part of this test of proximate cause set out in Marine Insurance Act of 1906. It is a very fundamental test in insurance law.”

“The insurers were arguing that there had to be incidence of Covid at the insured premises that could trigger [the policy], but there wasn’t one occurrence of Covid-19 that caused the lockdown it was all the occurrences nationally that caused the government to react.

“This opens the door more widely for exceptions to the [but for] rule.”

Lay of the land 

Rob Allen, chief technical officer at claims consultant Mactavish, agreed.

He told Insurance Times: “It will affect a large number of clams that have nothing to do with Covid or BI. It has changed the lay of the land quite significantly. Over time the impact of that is going to be financially more significant for insurers and policyholders.

Related to this aspect of the case is the Supreme Court’s decision to overturn the earlier Orient Express judgement.

This concerned a New Orleans hotel damaged by Hurricane Katriona in 2005. The High Court accepted the insurer’s case that the BI clause in the hotel’s policy should not be triggered because the surrounding city had been devastated and its custom would have dried up anyway, meaning no compensation was required for interruption to business.

“Even if the hotel hadn’t been damaged, they would still have had no money coming in because whole area was damaged by the hurricane,” said Fernhead, explaining the court’s rationale.

However in a rare example of judicial humility, two of the judges who handed down the original Orient Express High Court ruling were sitting on the Supreme Court and admitted that their previous verdict had been wrong.

This aspect of the judgement has clear implications for how insurers deal with natural catastrophes, like floods, said Fernhead: “This will affect any claims where there are multiple causes of loss.

“It will have wider implications for BI insurance and insurance in general particularly for catastrophic events like hurricanes and floods.”

Insurers don’t always invoke the Orient Express case, said Roger Franklin, head of insurance litigation for Edwin Coe LLP, pointing as an example to the 2009 Cockermouth floods.

Allen told Insurance Times the ruling’s “unintended consequences” may be more significant than the the scale of the payouts themselves as Mactavish estimates that only around a third of the 370,000 individual businesses covered by the Supreme Court judgement will benefit financially due to the way individual policies are worded.

Next logical step 

Alex Balcombe, partner at Harris Balcombe, told Insurance Times the “next logical step” for policyholders still out of pocket will be look at whether their brokers should have provided better advice.

But Carrera said that given that the Supreme Court’s judgement is broadly in favour of policyholders, there is likely to be less scope for broker negligence claims.

SMEs would have little chance winning the argument that their brokers were negligent, said Franklin: “It is very much the benefit of hindsight to say that brokers should have advised on pandemic or notifiable disease cover.

“Most SMEs are trying to reduce the premium as much as possible so it is questionable whether they would have accepted an add on at cost to a risk that would have been perceived as negligible.”

Nevertheless, the industry still has questions to answer about whether the way its products are worded means they are more “impenetrable” than they need to be, said Balcombe.

“These are really complex contractual documents and the way they are sold is not appropriate based on their complexity. The questions for insurers and brokers are about whether they need to be this complex.”

Franklin believes that the Supreme Court verdict might be the final nail in the coffin for open-ended policies which are likely to become “more expensive and more restrictive”.

This includes no more free bolt-ons with underwriters having to consider in much greater detail the cover they provide, said Balcombe.

However, he is worried that the fall out from the case will undermine the take-up of BI insurance by disgruntled SME policyholders.

“The SME market will seriously question the value of BI insurance and that’s a really sad effect of this because it’s an absolutely crucial thing for businesses to have.”