Business interruption insurance in a pandemic world
Now that the so-called ‘Freedom Day’ has come and gone, we have been reflecting on the events of the last 18 months or so and the impact of the Financial Conduct Authority’s (FCA) business interruption insurance test case. The Supreme Court’s judgment in the test case was headline news in the insurance and national press for weeks, and the tremors it created still reverberate in the marketplace today.
Insurers and their actuaries spend many hours diligently calculating the potential cost of risks they underwrite - in essence, the financial loss that a policyholder is likely to suffer should an insured event occur. This calculation is reflected in the policy wording and dictates the premium to be charged by the insurer for the policy offered to a policyholder. In the case of business interruption insurance, the global pandemic has tested this process to breaking point. The very fact that the FCA has been compelled to bring the test case and the Supreme Court has, in effect, re-written the terms of a contract negotiated at arms’ length between insurer and policyholder, is extraordinary.
Business interruption insurance policies are designed for commercial buyers of insurance who are expected to have a reasonable understanding of how insurance works and exercise normal business due diligence. But the Supreme Court judgment offers a counterbalance by making clear that such policies must be readily comprehensible and mean what they were intended to mean.
In the test case, the Lords focused on the RSA 3 business interruption insurance policy wording which provided cover for disease-related business interruption but qualified it by later wording that RSA argued excluded disease amounting to an epidemic.
Lords Reed, Hodge, Briggs, Hamblen and Leggatt stated that: ‘the overriding question is how the words of the contract would be understood by a reasonable person. In the case of a [business interruption] insurance policy…sold principally to SMEs, the person to whom the document should be taken to be addressed is not a pedantic lawyer who will subject the entire policy wording to a minute textual analysis…it is an ordinary policyholder who, on entering into the contract, is taken to have read through the policy conscientiously to understand what cover they were getting.’
The judgment in the test case followed the rationale behind the Insurance Act 2015, which came into force in August 2016 and set about redressing the balance of power away from insurers in favour of their policyholders. Amongst other things, the Act made unlawful some policy wordings which for over a century had enabled insurers to avoid liability. For example, it outlawed policy wordings enabling an insurer to walk away from a claim where a policyholder fails to rectify a policy breach, even though the breach has not increased the risk of the loss being borne by the insurer.
Not surprisingly perhaps, media headlines concerning the test case focused on the plight of policyholders and the alleged intransigence of insurers, but little mention was made of the role of insurance brokers.
Insurance brokers are agents of their policyholder clients and so owe their duty to policyholders not to insurers. Maintaining good relationships with insurers is, of course, an important part of a broker’s job. Such relationships will likely benefit their clients at the time of placement and when claims arise, but brokers have regulatory duties actively to manage potential conflicts of interest. Importantly, their role extends to assisting policyholders in making a fair presentation of their risk to insurers, in particular responding to disclosure requests from insurers prior to placement. Good brokers will also take time to explain to their clients how the cover operates and against what risks they will and will not be protected.
In performing their role, insurance brokers have an implied duty to exercise reasonable skill and care, but the full extent of their obligations will depend on the contract terms they enter into with their client and the exact scope of their client’s instructions.
Business interruption insurance claims are often complex, and the liability of insurance brokers when claims fail can stand or fall on the facts. In the case of Eurokey Recycling Limited v Giles Insurance Brokers Limited (2014) the insurance broker was found not liable in contract or negligence following fire-related losses sustained by a commercial client who was grossly underinsured. The court ruled that the insurance broker had adequately explained the business interruption cover to the client and had no reason to mistrust the figures for estimated turnover, stock and machinery provided by the client - estimates upon which the insurance broker had presented the risk to the insurer. The judgment in the case reaffirmed that insurance brokers must take reasonable steps to ascertain the nature of their client’s business and the client’s insurance needs. It also stated that the scope of an insurance broker’s obligations will depend on the degree of commercial sophistication of the client and how frequently the insurance broker has met with the client. Clearly, this is an issue to be alive to in these remote-working times.
An important lesson from the FCA test case and the Eurokey Recycling case is therefore the need for insurance brokers and their clients to work more closely together to gather the data required to fairly present their risks to insurers. Greater clarity and transparency at placement should mean less disputes over claims and quicker payments.
Another important lesson is to consider obtaining legal input during the negotiation of policy wordings. An experienced insurance lawyer, working alongside an insurance broker, can help to identify drafting issues that can lead to discussions with insurers about clearer policy wordings and better terms for the client.
So, when does an insurance broker who places business interruption insurance for a client become potentially liable for rejected claims?
The answer is not a simple one. As referred to above, insurance brokers owe clients several duties and liability may attach to them if, when performing those duties:
- they fail to exercise reasonable care and skill; and/or
- they fall below the standard required of a reasonable insurance broker; and
- their failure causes their client loss which is not too remote.
The application of these principles is a question of fact and, in the case of rejected business interruption claims arising out of the coronavirus pandemic, our view is that the time at which the policy was placed and whether the insurer had reasons to refuse an indemnity (other than the broker’s failure) will be key.
Suffice it to say, the global pandemic has highlighted the importance and value of having experienced professional expertise on your side during the placement of business interruption insurance policies.