In a year where so many assumptions, plans and received wisdoms have been torn up and thrown like confetti into a gale, the UK regulator’s decision to sue the insurance companies that it regulates is just one of the many remarkable events that define the new “normal”.

Open for business night

But putting to one side the jarring concept of the FCA accusing Hiscox and seven other insurers of acting unlawfully and in breach of their obligations, the current Test Case is likely to have significant implications for (re)insurers who operate under English Law.

This is because it is addressing the issue of the “but for” doctrine that – in a seminal case Orient Express Hotels vs Generali – was assessed in favour of insurers.

But as we hear in this article, the FCA is pressing hard for this decision to be overruled (the Court hearing continues today). The consequences – if the regulator succeeds – could be profound and may even lead to insurer insolvencies and much heavier reinsurance losses.

To make sense of the issues, we speak to one of the lawyers who – after Hurricane Katrina – advised Generali on the dispute that led to this ruling: Damian Cleary.

We begin by asking Damian whether he thinks it’s appropriate that the FCA stepped in with litigation, before examining why the decision is so important in the context of UK insurers’ potential BI liabilities and losses emerging from the Covid-19 lock down measures…

Q: Has any aspect of the FCA or insurers’ approaches been surprising?

My own view is that I don’t think it is appropriate for the FCA, as the insurers’ regulator, to have instigated the test case as claimant.

It is a natural result of an adversarial process that the FCA will be seen to be adopting a biased position in favour of policyholders, despite its efforts to say otherwise, and in my view the FCA should have avoided acting as claimant.

“If insurers are obliged to indemnify for the wide area effects of Covid-19, insurance insolvency will loom large on the horizon and treaty reinsurers had better watch out”

Q: But is there a case to be made that they stepped in because of all the anger and uncertainty over the UK insurers’ position that Covid-19 losses were not covered under their BI policies. Surely, the outcome will mean less policyholder litigation as a result? 

I hope so, but I remain to be convinced. Whilst there are probably hundreds of thousands of business interruption claims being faced by UK insurers arising out Covid-19, and there are many questions of general importance being asked of the Court in the Test Case, the answers will not resolve every claim.

It is a regular refrain that each claim can still be adjusted on its own facts/merits, and that should be welcomed by insurers and policyholders alike.

Q: Will the decision(s) – regardless what they are – be appealed?

I think so, yes. It has to be remembered that there are very many important questions being addressed in the Test Case, any one of which could have a significant effect on the very nature and underwriting of business interruption insurance and general principles of contractual causation.

Q: A common refrain from insurers – both in the UK and internationally – is that their wordings did not intend to cover a global pandemic on the scale of the coronavirus. Is that much of a defence if the wordings are vague? 

I wouldn’t go as far as saying the wordings are vague, but there are likely to be words or terms used that may be capable of more than one interpretation. That is a characteristic of our English language but I am confident that English law and our tremendous legal process will produce the right result.

Q: There has been a lot of discussion about the Orient Hotels vs Generali decisionWhat is its significance in the context of BI claims?

The Orient Express Hotels claim was no more than adjusting a hotel loss in circumstances of wide area damage (Hurricane Katrina had devastated the wider city of New Orleans), which adjustment process the market had been doing for years and it was very well understood. However, the insured did not like the result of the adjustment and described it as unfair. This concerns concurrency of “independent” proximate causes of loss, and is a central issue in the FCA Test Case.

Anyone who has regularly attended MDD’s annual Business Interruption seminar in the Lloyd’s Old Library will have heard me on about three occasions discuss this issue and how it can result in an “expectation gap”. Policyholders expect cover for the effects of, say, a hurricane but policies only provide cover for certain insured perils such as physical damage, denial of access, loss of utilities, loss of attraction and the like. This is precisely one of the principal issues in the FCA Test case – should insurers cover the wide area effects of Covid-19, or (if triggered) only the sub-limited insured losses for prevention of access?

The Orient Express Hotels case confirmed the applicable counterfactual of an “undamaged hotel in a damaged city” in order to calculate indemnifiable BI losses, and this measurement mechanism is being challenged by the FCA in the Test Case because it could produce what the FCA calls an “absurd” result. It will be fascinating to see what the Court will make of it all, and perhaps also the Supreme Court.

“Parametric insurance may find a foothold in such circumstances”

Q: An interesting, side-theme of the test case is that some of the adjudicators involved now (Or who may be, if appealed) were also involved in the original Orient Express Hotels decision. 

Who are they and is there a danger of pupils marking their own home work?!

Lord Hamblen was the appeal judge in Orient Express Hotels. Lord Leggatt was one of the arbitrators in the underlying arbitration. Both agreed that the appropriate counterfactual when applying the “but for” test was an “undamaged hotel in a damaged city” and both were appointed to the Supreme Court this year.

There is every chance one or both might hear an appeal from the current FCA Test Case on the point.

Q: Ahead of the Test Case beginning, this publication reported on a recent South African decision: Cafe Chameleon vs Guardrisk Insurance CompanyThat ruling appeared to be one of the first tests of Covid-19 causation and liability under Common Law principles and using UK policy wordings. A pro-policyholder verdict has meant it has been referenced by lawyers acting for the FCA and policyholders during the test case.

Does it suggest the UK High Court may go in a different direction than the Orient Express Hotels case?

One result of the Café Chameleon case was that the counterfactual when measuring the “but for” losses was to assess the results of the Café as if both the restrictions on the business and the existence of Covid-19 were removed. That is what the FCA is seeking in the Test Case, and if that is what is found by the Court, insurers will be obliged to indemnify policyholders for the wide area effects of Covid -19 as a whole. If insurers are obliged to indemnify for the wide area effects of Covid-19, insurance insolvency will loom large on the horizon and treaty reinsurers had better watch out. 

Q: There have been silver linings emerge from past major catastrophic losses. For example, from the WTC-related litigation after 9/11 emerged contract certainty. Will there be any positive outcomes from the Covid-19 litigation?

The market is bound to react swiftly in this case: exclusions will be tightened, and clauses may be added or amended to remove indemnity for wide area damage or effects. I don’t think policyholders will be attracted by an increase in premium to reflect any indemnity for wide area damage or effects arising out of a widespread event. 

Parametric insurance may find a foothold in such circumstances. There would be no need to assess “but for” factual or legal causation, nor applicable measurement mechanisms. If the event occurs (e.g. a pandemic), insurers pay the amount contracted for. It is then for insurers to price such a product and for policyholders to pay for it.

Damian Cleary of DCThree Services

Damian Cleary is an insurance lawyer who has been advising the London Market on predominantly property, engineering, business interruption and associated reinsurance matters for 25 years. Having been a partner in some well-known insurance law firms over the years, he now practices as an independent freelance solicitor through DCThree Services.