Flogging a dead hotel

What’s next for insurers following the recent UK Supreme Court ruling?

Earlier this year, the UK Supreme Court handed down its highly anticipated decision on insurers’ obligations under policies providing non-physical damage business interruption cover for infectious notifiable diseases, such as COVID-19. This case was brought by the Financial Conduct Authority (FCA) on behalf of small and medium-sized business interruption policyholders who have suffered financial losses as a result of COVID-19. Ultimately, the UK Supreme Court ruled against the insurers, determining that the trends clause should not give insurers another route to avoiding liability under the policy; therefore, the trends and circumstances should not include those negative consequences of COVID-19.

For background, the trends clause relates to the quantification of business interruption loss. It provides scope for the adjustment of the losses, factoring in trends or circumstances that may have impacted the financial results of the business. This allows insurers and adjusters to approximate the actual business results that would have been achieved, notwithstanding the occurrence of the insured peril.

So, what does this ruling really mean for insurers?

While the judgment is long and complex, the outcome is that insurers cannot cover a loss/damage from the “peril,” which in this case is COVID-19, and then reduce that same claim and cite the peril as the reason for the claim reduction while noting that the damage would have occurred regardless. In a sense, this is not unexpected since we are talking about infectious disease. There is no damage per se, and so the policy terminology as it stands does not fit well, even though what is being covered is the peril of the disease itself. In that case, one can have sympathy for a view that the test is “but for” the disease.

The anomalies that we see in the UK Supreme Court approach will continue to occur. To better illustrate, let’s say two similar businesses are side by side and one is damaged, and one is undamaged. The undamaged business is down 50% because of the event but has filed no claim. But for the damage, the other hotel would be down 50% anyway: how is it right that the policy pays 100% of the damaged business’s loss? We have seen claims where a business is damaged but defers repairs and continues to trade, however with a 30% reduction because of the wider area issues, not because of the damage. Several months later, the business closes, repairs take a month and then the repaired business reopens, still with a 30% reduction. The UK Supreme Court would have insurers paying 100% of historical turnover for the month of closure, and not the standard 30% reduction.

Another reason why this ruling is significant is because it runs counter to the UK Supreme Court’s decision in the well-known Orient-Express Hotels, which will ultimately have wide-ranging ramifications to the insurance industry generally. The case involved business interruption losses caused to a hotel as a result of the consequences of Hurricane Katrina. The loss was the result of two concurrent causes: (1) the damage to the hotel itself, and (2) the damage to surrounding areas, both individually sufficient to cause the business interruption loss. In its ruling, the UK Supreme Court found that the correct approach would have been for the trends clause to operate as to exclude circumstances which had the same underlying or originating cause as the damage; in the Orient-Express, this refers to the hurricanes, and in the latest case, COVID-19.

In the end, insurers might or might not be perturbed by the UK Supreme Court judgment. Some insurers might be glad to see the UK Supreme Court view and hope that it is followed by others. Whether any insurers choose to amend wordings in their policies, or whether the term “depopulation” fades from the New Zealand landscape in the same way that the pro-rata condition of average has, remains to be seen.

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