Business interruption insurance as a means of spreading pandemic-related losses

Abstract

This article discusses business interruption insurance as a measure of spreading risk in the context of the COVID-19 pandemic. In drawing a picture of how business interruption insurance has been handled and governed to date by courts and regulators in the U.K., Australia and the U.S., the contribution is specifically concerned with providing tentative answers to two questions: first, whether the design and interpretation of business interruption policies have made it a suitable means of spreading pandemic risks for policyholders; and second, how methods of resolving disputes over pandemic-related losses could improve the position of policyholders in relation to the insurance sector.

Introduction

Business interruption insurance presents possibly the most important case covering pandemic risk given the enormous losses involved (The Geneva Association 2020; Committee on Capital Market Regulations 2021). According to an Organisation for Economic Cooperation and Development (OECD) estimate, one month of strict confinement led to approximately USD 1.7 trillion in revenue losses for businesses across different sectors. Losses of this magnitude are beyond comparison; they also pose central questions about how they ought to be allocated within society. One question concerns the role of business interruption insurance in compensating those affected by such losses. In order to capture the inevitable tensions between the conflicting interests of policyholders and the insurance industry, it may be advisable to begin this account by referring to two prevailing, competing paradigms when thinking about risk governance in a regulatory state: ‘spreading risk’ versus ‘embracing risk’. The paradigm of solidarity, which has assumed a prominent role in the 20th century, concerns spreading risk and loss in society. Solidarity is accompanied by the recognition of a sort of general right to indemnity for every mishap in life (Ewald 1986; Ewald 2002). Insurance is one of the main ways of implementing solidarity and assistance. ‘Embracing risk’ is the opposite of ‘spreading risk’. In coining it, Baker and Simon (2002) meant to both evoke and distinguish the idea of ‘spreading risk’ that has been influential over the last century. Perceived as a cultural or social trend, embracing risk consists of various efforts to make people personally accountable for their risks. From a legal perspective, one could invoke the principle that ‘one person cannot transfer to another the burden of what happens to him’ (Ewald 2002). The concept of embracing risk is thus based on the principle of responsibility. Risks that are not covered by or that are beyond the scope of insurance are not spread and eliminated in this way, with serious consequences for those affected.

Following Baker and Simon (2002), these two paradigms should be perceived as opposite ends of the probability spectrum. Embracing risk appears to be justified for risks that are relatively predictable and capable of being managed by individuals and organisations. By contrast, risk spreading could be considered to make most sense for risks that are unpredictable (Baker and Simon 2002). A specific balance between these competing attitudes will depend on a range of political, economic, cultural and legal factors and vary across different countries. In my view, reference to these two paradigms provides a useful starting point for drawing a picture of how business interruption cover, using the COVID-19 pandemic example as a systemic risk, has been handled and governed by courts and regulators in the U.K., Australia and the U.S. These three common law jurisdictions have been chosen in view of the fact that private business interruption policies played a relatively significant role as a measure of compensating pandemic-related losses resulting from business interruption and complementing government backstop programmes (on the prevailing approach in Continental Europe, see Cantillon et al. 2021). Whereas the following is by no means a final account of the positions that each jurisdiction assumed in this respect, it is possible to identify the specific paths taken. The contribution is specifically concerned with two questions: first, whether the design and interpretation of business interruption cover have made it a suitable means of spreading pandemic risks for policyholders; and second, how methods of resolving disputes over pandemic-related losses can improve the position of policyholders in relation to the insurance sector.

Business interruption insurance

Fortuitous risk is the fundamental concept of insurance. Anything that has an unexpected and accidental element can be insured. The occurrence of the COVID-19 pandemic, the timing of pandemic-related losses and the extent of such losses are all fortuitous things that can be insured against (Knutsen 2021). Whereas the consequences of business interruption related to the COVID-19 pandemic are diverse, there are several main types of relevant business interruption losses in the context of typical insurance policies. In particular, pandemic-related business interruption losses can be due to (a) the presence of a virus on business premises, requiring temporary business closure due to sanitisation efforts or a loss of workforce, or actual closure due to the quarantine and isolation of exposed employees; (b) forced closures resulting from government-mandated lockdown (shutdown) orders aimed at curbing the virus spread (these can be industry specific or regional); (c) changes in business practices that have reduced or eliminated certain income-generating activities, e.g. limits to customer occupancy, physical distancing, transitioning business models from walk-in stores to online selling or from dining in to takeaways; (d) customer downturn as a result of government recommendations to avoid non-essential outings (Knutsen 2021). A careful study of insurance policies will determine to what extent insurers will cover business interruption losses.

Whether a business interruption policy can be an effective way of spreading pandemic-related risks and losses depends on several factors, including whether the occurrence of COVID-19 on business premises can be considered a trigger for business interruption cover; whether government closure orders, i.e. lockdown or stay-at-home measures, are a valid reason to trigger cover; and what losses are recoverable by holders of business interruption policies. In what follows, I strive to provide an account of how courts and regulators approached business interruption policies with respect to COVID-19-related claims in the jurisdictions identified above.

U.K.

The resolution of pandemic-related disputes over business interruption cover1 in the U.K. has proceeded at a surprisingly swift pace. Within weeks of the outbreak of the COVID-19 pandemic, the Financial Conduct Authority (FCA), the U.K. insurance market conduct regulator, announced that it would bring a ‘test case’ to clarify the application of typical and broadly used business interruption policies to losses resulting from the COVID-19 pandemic.2 The test case, which was the first to operate under a Financial Markets Test Case Scheme, is available for claims within the broader Financial List ‘which raise issues of general importance to which immediately relevant authoritative English law guidance is needed’.3 Eight insurers agreed to be parties to the test case. Twenty-one different business interruption policy wordings were selected as a representative sample of all wordings that gave rise to uncertainty, with important differences in policy language.4 Potentially covered causes of business interruption included infectious diseases, denial of access to property and government-ordered closure of premises or restrictions of access (Merkin 2022).

It must be underscored that the FCA test concerned only insurance policies providing by extension cover for business interruption flowing from causes other than property damage, such as the presence of disease or the denial of access to a property (‘non-damage’ triggers).5 This is an important difference between the U.K. and the U.S. markets, which will be discussed subsequently.

The High Court, acting as a first instance court, delivered preliminary rulings on the meaning of the selected policy wordings on 15 September 2020, less than six months after the outbreak of the COVID-19 pandemic. Interestingly, there were 488 business interruption cases filed in the last quarter of 2020, before the Supreme Court judgement. Given the importance of the case, it was referred to the Supreme Court under the ‘leapfrog’ procedure, which enables an appeal in exceptional circumstances to bypass the Court of Appeal and proceed directly to the U.K. Supreme Court. In January 2021, less than a year after the outbreak of the pandemic, the U.K. Supreme Court issued a binding judgement for the eight insurers that were party to the test case, but also provided ‘authoritative guidance for the interpretation of similar policy wordings and claims’.

What follows below is a survey of key holdings by the U.K. Supreme Court in the FCA test case. More in-depth treatment of this important judgement is available in recent scholarship (Gürses 2021; Tereszkiewicz 2022; Schwarcz 2022). An analysis of whether a business interruption insurance contract will respond to losses resulting from the COVID-19 pandemic necessarily begins with the disease clauses contained in such contracts. A disease clause provides insurance cover for business interruption loss caused by the occurrence of a ‘Notifiable Disease’ at or within a specified distance of the policyholder’s business premises. Such clauses do not cover the effects of cases of COVID-19 that occur outside that geographical area.6 Crucially, the U.K. Supreme Court had to define what constituted an ‘occurrence’ of COVID-19 under the policy.7 There were two main questions about how the disease clause should be interpreted. The first concerned what was meant by the following words of the insuring clause: ‘any … occurrence of a Notifiable Disease within a radius of 25 miles of the Premises’. Second, it was necessary to clarify what the scope of the peril insured against by this provision was. The FCA asserted that the disease clause covered the business interruption consequences of a notifiable disease wherever the disease occurs, provided it occurred (at least one case of illness caused by the disease) within the 25-mile radius specified in the policy. The Supreme Court largely agreed with this position but took a different position on how to construct the clauses in question. It held that it is only an occurrence within the specified area that is an insured peril under business interruption policy and not anything that occurs outside that area. Further, each case of illness sustained by an individual is a separate occurrence and a ‘Notifiable Disease’ in the meaning used in the wording is not the outbreak (of COVID-19) nor the disease itself but rather the illness sustained by any person resulting from that disease.8 Specifically, this means that if the policyholder could identify a single instance of COVID-19 in the specified vicinity and a consequent interruption to his or her business, an ‘occurrence’ under the business interruption policy was fulfilled, and cover would be granted.

Another specific issue which the Supreme Court was called upon to decide was the question of how the adaptation of the policyholder’s business model may affect the scope of the indemnity under a business interruption cover. As a matter of principle, the ‘inability to use’ the business premises and the ‘prevention of access’ to the business premises must be total. Yet, as the Supreme Court held, these requirements do not have to be fulfilled with respect to the entire business premises.9 Business interruption cover can be triggered where the ‘policyholder is unable to use the premises for a discrete part of its business activities or if it is unable to use a discrete part of its premises for its business activities’.10 The Supreme Court explained that in both those situations there is a complete inability of use, either relating to a discrete business activity (e.g. dining in) or to using a discrete part of the business premises (e.g. a high street showroom). To demonstrate the effects of this construction, the Supreme Court provided the following example: ‘if there was a travel agent whose business was 50% walk-in customers, 25% internet sales and 25% telephone sales, it could only claim in relation to the loss of walk-in business, even though all parts of the business may have been depressed by the effects of COVID-19 and the governmental measures taken’.11 This construction of business interruption clauses ensures that businesses that stayed open for takeaway services or mail orders may submit claims for the loss of in-person business.

The question of causation in the context of business interruption cases requires answering what the insured peril is and what effects on the policyholder’s business are covered. It requires showing the connection between any cases of the COVID-19 disease and the business interruption loss for which an insurance claim is made. In the Orient Express case,12 the insurers claimed that due to the widespread nature of the pandemic, policyholders would have suffered the same or similar business interruption losses even if the insured risk or peril (whether it be an occurrence of the disease within the given radius or a public authority action causing a prevention of access) had not occurred and, as such, the business interruption cover should not be granted. The Supreme Court rejected this argument, holding that the ‘but for’ test was inadequate for ascertaining whether the test for causation had been satisfied in the case concerning business interruption cover (Gürses 2021). The causal connection required had to consider the nature of the cover provided in the business insurance policies under review, and it may be satisfied if the insured peril, in combination with other similar uninsured events, brings about a loss with a sufficient degree of inevitability, even if the occurrence of the insured peril is neither necessary nor sufficient to bring about the loss by itself. In the Supreme Court’s view, all that matters is what risks the insurers have agreed to cover. This is a question of contractual interpretation, which must accordingly be answered by (objectively) identifying the intended effect of the policy as applied to the relevant factual situation.13 In this light, the Supreme Court concluded that ‘there is nothing in principle or in the concept of causation which precludes an insured peril that in combination with many other similar uninsured events brings about a loss with a sufficient degree of inevitability from being regarded as a cause—indeed as a proximate cause—of the loss, even if the occurrence of the insured peril is neither necessary nor sufficient to bring about the loss by itself’.14 In the FCA test case there were no excluded perils operating, only uninsured perils. The outcome may have been different if the policies excluded the pandemic, which, however, was not the case (Merkin 2022).

Concerning the number of COVID-19 outbreaks necessary to trigger the cover, no reasonable person, in the Supreme Court’s view, would suppose that, if an outbreak of an infectious disease occurred, which included cases within the relevant radius in the disease clause and was sufficiently serious to interrupt the policyholder’s business, all the cases of disease would necessarily occur within the radius. Having recognised that, the Supreme Court considered it inappropriate to inquire into whether, but for the cases of disease within the radius, the loss would have been suffered, since the answer may well typically be in the affirmative, thus depriving the insured of an indemnity for wide-area diseases such as COVID-19. This assumption paved the way for the Supreme Court’s conclusion that, on the proper interpretation of the disease clauses, in order to show that loss from interruption of the insured business was proximately caused by one or more occurrences of illnesses resulting from COVID-19, it is sufficient to prove that the interruption was a result of government action taken in response to cases of disease, which included at least one case of COVID-19 within the geographical area covered by the clause. Even if the elements of the insured peril had not ultimately led to the closure of the insured premises, they would have had other potentially adverse effects on the turnover of the business. The Supreme Court considered that it would undermine the commercial purpose of the business interruption cover to treat such potential effects as ones diminishing the scope of the indemnity. Even though these other potentially adverse effects are not part of the insured peril, according to the Supreme Court, they are ‘not a separate and distinct risk’.15

Further, the Supreme Court held that the principle applies equally to an originating cause of loss covered by the policy, which is not expressly mentioned in the clause. In the case under review, the originating cause of any local occurrence of disease (and of public authority actions and public reactions to it) is the global COVID-19 pandemic. In circumstances where the policy does not exclude loss arising from such an event, other concurrent effects of the pandemic on an insured business should not reduce the indemnity under the public authority clause.16

The Supreme Court’s FCA test case judgement provides an excellent illustration of what is at stake in business interruption policies for both policyholders and insurers. Many choices made by the Supreme Court in the process of constructing business interruption policies could be seen as value judgements, the outcome of which immediately translates into whether the cover will be granted or how far it will extend. As such, these decisions determine what losses resulting from business interruption due to the COVID-19 pandemic will be spread and shared in society (Tereszkiewicz 2022). The concern that business interruption cover may turn out to be illusory for the policyholder just when it is most needed features prominently throughout the judgement.17 Specifically, Lord Briggs opined that finding that cover for business interruption attributable to the reaction to a disease like COVID-19 lay outside the purview of the policies in issue would mean that ‘the cover apparently provided for business interruption caused by the effects of a national pandemic type of notifiable disease was in reality illusory, just when it might have been supposed to have been most needed by policyholders. That outcome seemed to me to be clearly contrary to the spirit and intent of the relevant provisions of the policies in issue. It therefore comes as no surprise to me that all the judges who have considered these issues have been unanimous in rejecting that outcome’.18 This statement lends strong support to the importance of analysing business interruption insurance as a measure of risk spreading in the context of COVID-19.

Implementing the judgement

After the U.K. Supreme Court’s judgement in the FCA test case, the FCA issued a set of directives meant to ensure efficient claims payments by insurers, including a cover calculator for policyholders and a ‘Dear CEO letter’ outlining the FCA’s expectations as to how business interruption insurers must handle claims. Further, the FCA published a list of business interruption policies that are, in principle, capable of responding to the COVID-19 pandemic in at least some circumstances, as submitted by insurers.19 This has ensured the sector’s compliance with the U.K. Supreme Court’s judgement. The FCA estimated that the test case ultimately helped to clarify insurers’ obligations for ‘some 700 types of policies held by 370, 000 policyholders across sixty different insurers’. While the test case did not resolve individual policyholders’ claims, the FCA undertook a set of measures to ensure the court’s holding resulted in swift payments of individual claims. As of spring 2022, most legitimate pandemic-related claims of U.K. policyholders have been paid by insurers, with the total payout amounting to GBP 700 million20. The extent of payouts in the U.K. suggests the insurance industry meaningfully responded to the regulator’s pressure.

Australia

Having analysed the U.K. experience of governing business interruption insurance in the context of COVID-19, extending the analysis to the respective position in Australia is strongly justified. First, the test case scheme in Australia bears a similarity to that in the U.K. Second, as will be shown below, the U.K. FCA test judgement has featured in the analyses of Australian courts. In Australia, decisions in two test cases regarding the operation of business interruption insurance have been handed down by federal courts. Test cases were initiated pursuant to the provisions of the Australian Financial Complaints Authority (AFCA), which is a dispute resolution scheme for consumers where there are important issues of law to be decided.21

The first COVID-19 insurance test case, HDI Global Specialty SE v Wonkana No. 3 Pty Ltd,22 was brought to determine if pandemic exclusions that referenced the Quarantine Act [1908 (Cth)], which was replaced by the Biosecurity Act [2015 (Cth)] in 2015, could be used to reject claims related to COVID-19. In HDI Global Specialty SE v Wonkana No. 3 Pty Ltd, the New South Wales Court of Appeal dismissed proceedings seeking declarations that business interruption caused by COVID-19 was excluded from cover under business insurance policies. The defendants were insured against interruption to their businesses under insurance policies issued by the plaintiff insurers. Each policy contained an extension providing cover for interruption or interference caused by outbreaks of infectious diseases within a 20-kilometre radius of the business premises. Importantly, both policies excluded from cover ‘diseases declared to be quarantinable diseases under the Quarantine Act 1908 (Cth) and subsequent amendments’. Prior to June 2016, the Quarantine Act 1908 (Cth) provided for public health measures that may be taken in response to outbreaks of communicable diseases. Its framework relied on the concept of a ‘quarantinable disease’, as declared by the Governor General. In June 2016, before the policies had been issued, the Quarantine Act 1908 (Cth) was repealed and replaced by the Biosecurity Act 2015 (Cth). On 21 January 2021, COVID-19 was determined to be a listed human disease under the Biosecurity Act 2015 (Cth). The case turned on whether the exclusion in the policy extended to diseases determined to be listed human diseases under the Biosecurity Act, which the insurers asserted to be the case (Walpole and Isdale 2021).

The court rejected the insurers’ claims, holding that the meaning of the words ‘and subsequent amendments’ was unambiguous and did not extend to legislation replacing the Quarantine Act 1908 (Cth) and its mechanism for identifying certain diseases as serious and contagious, that is the Biosecurity Act 2015 (Cth). Further, the court held that principles of construction regarding written contracts did not permit the exclusion to be read, contrary to their natural meaning, as referring to ‘diseases determined to be listed human diseases under the Biosecurity Act 2015 (Cth)’. Whatever may have been the reason for the naming of the wrong act, there had been no agreement or common understanding that the Biosecurity Act 2015 (Cth) should have been mentioned in the policy.23 As a result, references in business interruption policies of insurance to ‘quarantinable diseases’ under the Quarantine Act cannot be interpreted as including COVID-19. Significantly, the court’s judgement in HDI Global Specialty SE v Wonkana No. 3 Pty Ltd means that businesses affected by COVID-19 could be entitled to insurance payments under business interruption policies if no other specific exclusions are found applicable.24 The judgement can be considered as a recognition that business interruption policies respond to claims resulting from the COVID-19 pandemic as they would respond to claims resulting from other causes (Walpole and Isdale 2021).

In the second Australian test case, Swiss Re International Se v LCA Marrickville Pty Limited,25 the Federal Court considered 10 claims. Insuring clauses in issue were of a similar type as in the U.K. FCA test case: hybrid clauses, infectious disease clauses, prevention of access clauses, and a catastrophe clause. Regarding nine claims, the Federal Court held that the insuring clauses did not apply in the circumstances of each case under review. Although the actions of Australian authorities (imposing closure) applied to the premises, it was not possible to conclude that the orders were made because of any circumstance at the premises/situation or within the specified radius. As the court held, the uninsured peril was the existence of COVID-19 cases overseas and the threat this presented to Australia by reason of persons returning, including Australian residents.

In reaching its verdict, the Federal Court discussed whether it was possible and justified to draw on the above discussed U.K. FCA test case. ‘If a clause in the BII policy refers to a radius of 25 miles from the business premises, as is the case in the UK, this will be an area of a little under 2,000 square miles. The whole of England can be covered by 20 such circles; (…) each case of Covid-19, both inside and outside the 25 miles area, was an equally effective cause of the UK government’s actions, i.e., lockdown measures’. This position has been rejected by the Australian Federal Court given a ‘materially different context’ underpinning judgements in the U.K. and Australia.26 Parts of Australia are sparsely populated, and the occurrence of COVID-19 infections has not been widespread. Given the lack of extensive community spread, the court refused to conclude that ‘each and every known case of COVID-19 in any location in a State was an equally effective cause of the State Government’s actions’.27

The court’s analysis brought out important differences between lockdown measures in the U.K. and Australia and their effect on business interruption cover. Analysing the operation of disease clauses, the court stated that the key issue was whether the outbreak of the disease (COVID-19) was the proximate cause of the policyholder’s loss. This cannot be the case for a policyholder who is a travel agent; in this case, the proximate–the principal and perhaps the sole–cause of the policyholder’s loss was the government’s Overseas Travel Ban restricting international travel to and from Australia, and the ban on cruise ships from foreign ports visiting Australia. In the court’s view, the above measures were focused on the presence of COVID-19 overseas and the risk that an overseas traveller coming to Australia might bring COVID-19 into any part of Australia. Further, this is a different cause from the insured peril, which requires the outbreak of a human infectious or contagious disease occurring within a 20-kilometre radius of the situation. By contrast, these measures were not focused on the presence of COVID-19 in Australia. The court would have required further evidence to infer that the outbreak of COVID-19 was the proximate cause of the insured loss.28 Drawing a comparison to the position of the U.K. Supreme Court in the FCA test case, it must be emphasised that the government’s actions ordering the closure of business were deemed not to result from the existence of COVID-19 at the premises or within the area specified in the insurance policy. The difference in the Australian case compared to the U.K. FCA test case lies in the objective of government measures aimed at preventing the spread of the virus. As it seems, the Australian Federal Court assumed that the holding in the U.K. FCA test case was determined by a societal environment (context) in the U.K. that is different to the one in Australia. From a purely technical perspective, the proximate cause of the insured’s loss was different under the policies reviewed in U.K. and Australian cases. Yet, the judicial analyses reveal a more profound difference between the national system analysed. The government measures in Australia resulted not from the existence of COVID-19 at the location or within the area required by the insuring provisions. Rather, the Australian government measures were taken out of fear of COVID-19 spreading in the country. Different objectives of government lockdown measures in the two analysed countries may justify the diverging outcomes reached by the courts in the U.K. and Australia in interpreting business interruption policies under applicable law.

In a different context of policies that cover business interruption due to the outbreak of a disease within a 20-kilometre radius of the premises, the Federal Court found that the outbreak could be a proximate cause of the policyholder’s loss.29 Seen jointly with the above-discussed judgement in HDI Global Specialty SE v Wonkana No. 3 Pty Ltd, this appears to support the assumption that private business interruption insurance may be an important instrument of risk and loss spreading in the context of the COVID-19 pandemic.

U.S.

The U.S. experience regarding cover of business interruption losses paints a different view from that found in the U.K. and Australia. Most importantly, the amount of court litigation over business interruption cover in the U.S. is in both absolute and relative terms far larger than in the other two jurisdictions. Before surveying how courts have handled disputes over business interruption cover, it is necessary to discuss the specific structure of the U.S. business interruption insurance market.

The U.S. market for business interruption insurance is characterised by a high level of product uniformity. One of the most popular policy forms is the businessowners policy (BOP), which is a multi-risk package policy written for the small business market by the Insurance Services Office (ISO),30 the primary drafting organisation for property insurers in the U.S. market. Hundreds of insurance companies subscribe to the services provided by the ISO, which means that they pay the ISO to draft policy forms, collect data on the forms’ performance, keep track of litigation involving the forms and update policy language to respond to court decisions and changing market conditions (Jerry II 2020; French 2020; Knutsen and Stempel 2020; Miller et al. 2022). A business that is a member of the ISO pays for the ISO’s expertise in drafting the form and is likely to use it verbatim. This explains the high degree of uniformity of business interruption policies in the U.S. market.

A BOP usually contains business interruption cover unless the cover is specifically removed by endorsement (Jerry II 2020). The business income clause, quoted below, contains several elements of cover that the policyholder must prove.

We will pay for the actual loss of Business Income you sustain due to the necessary suspension of your ‘operationsʼ during the ‘period of restorationʼ. The suspension must be caused by direct physical loss of or damage to property at the described premises. The loss or damage must be caused by or result from a Covered Cause of Loss […] We will pay only for loss of Business Income that you sustain during the ‘period of restorationʼ and that occurs within 12 consecutive months after the date of direct physical loss or damage. (Jerry II 2020; Miller et al. 2022).

The policyholder must prove that the suspension was ‘caused by direct physical loss of, or damage to, property’ at the premises described in the policy. This is the most significant of all requirements of business interruption cover in the U.S. The trigger was adjusted to include ‘direct physical loss’ next to ‘damage to property’ in the mid-1980s and the above clause has not changed since then. Most importantly, the words ‘loss’ and ‘damage’ are not defined in the ISO policy. The general assumption behind the ‘direct physical loss of, or damage to property’ requirement is that something that goes beyond mere income loss must happen to the business’s property to trigger insurance cover.31 From the perspective of construing an insurance policy, this question is subtle and turns on inter alia the rules on constructing an insurance policy and possibly different policy factors that may affect judicial decisions (Abraham and Baker 2022).

Proving that the SARS-CoV-2 virus caused ‘direct physical loss of, or damage to’ property may be difficult or even impossible. Since the onset of the pandemic, there have been several hundred U.S. court decisions on the meaning of ‘physical loss’ (French 2022; Miller et al. 2022). Admittedly, there are several competing strands of interpretation on what ‘physical loss’ means (Knutsen and Stempel 2020). Some courts have found that ‘loss’ and ‘damage’ are distinct terms, and ‘loss’ can mean the inability to use the property for its intended purpose. However, most courts interpret ‘loss’ as similar or identical to ‘damage’, which requires partial or total destruction of property or its physical alteration (Miller et al. 2022 distinguish five judicial interpretations of what ‘loss’ means).

Theoretically, it remains possible that U.S. courts could be convinced (e.g. by sophisticated counsel) to embrace a construction that is more policyholder friendly. This would entail recognising that closing down the premises following government lockdown orders fulfils the requirement of ‘physical loss’ to the property. Admittedly, as several scholars have emphasised, in the past both U.S. and Canadian courts have found cover in instances where the policyholder suffered seemingly intangible and transient contamination issues similar to those experienced in the COVID-19 pandemic. Specifically, there have been a number of cases in which courts held that government orders to evacuate properties due to a potential threat, such as a hurricane, building collapse or a riot, can trigger business interruption cover (Katofsky 1989; French 2020; Knutsen 2021; Miller et al. 2022 cite U.S. and Canadian case law). Further, there is a case law under which ‘direct physical loss of, or damage to’ the property was judged to encompass property rendered unsafe by the presence of radon, odours, smoke and gasoline, even though any alteration of the property occurred only on a molecular level.32

Another significant design element of U.S. business interruption policies is a prevalent virus exclusion. The U.S. insurance sector envisioned the potentially dramatic commercial effects of a pandemic well enough to specifically exclude it from a portion of business insurance policy forms in 2006 (Lewis et al. 2021). According to an estimate by the National Association of Insurance Commissioners (NAIC), around 80% of property policies in effect when the COVID-19 pandemic began incorporated the ISO virus or bacteria exclusion, which had been submitted to many state departments of insurance for approval in 2006 (NAIC 2020a). A typical exclusion clause reads as follows: ‘We will not pay for loss or damage caused by or resulting from any virus, bacterium or other microorganism that induces or is capable of inducing physical distress, illness, or disease’. Clearly, the presence of exclusion does not automatically exclude cover for any claims resulting from COVID-19 pandemic-related losses. It depends on what caused the loss being claimed for. Further, the above data show that around 20% of insurers opted not to use this widely available policy language and may be required to bear the consequences of this choice (Miller et al. 2022).

From a narrow legal perspective, there is little doubt that the clause of ‘direct physical loss of, or damage to’ to property is ambiguous and capable of different interpretations subject to further circumstances of decided disputes. Given the structure of the U.S. court system and the available avenues of redress, this means that the decision-making over whether cover is granted or not is transferred to courts that decide on individual disputes (Schwarcz 2022).

In the U.S., insurance disputes are governed by state law, and the law can vary considerably from state to state. Over 2000 COVID-19 business interruption cases have been filed in state and federal courts over the past two years.33 Significantly, most of them have been filed in or removed to federal courts on the basis of diversity jurisdiction.34 Roughly two thirds of filed cases involve questions regarding the exclusion of a virus. Thus far, the structure of the U.S. court system appears to have had a significant role in shaping the outcomes of the pending cases. Federal courts have treated COVID-19 business interruption insurance cases as simple contract disputes requiring the enforcement of the plain meaning of insurance policy terms, for which they do not need any guidance from the state supreme courts to adjudicate. This has been criticised in the scholarship, as the meaning of the language in the COVID-19 context presents novel questions of state law. From the perspective of policyholders, it may have been preferable if federal courts had certified unsettled questions of state law regarding COVID-19 to the respective state courts for resolution (French 2022, p. 154; Schwarcz 2022, p. 20).35 The early federal circuit court decisions may have substantial influence on how other courts will interpret similar or the same policy language in business interruption cases. This could indeed contribute to the butterfly (or snowball) effect of extending the pro-insurer stance of federal courts taken in the early stage of COVID-19-related litigation (Knutsen and Stempel 2020; French 2022, 160).

A preliminary view of the stance of U.S. courts on business interruption insurance has been emerging. The outcomes of litigation by the end of 2020 suggested that the presence of a virus exclusion in business interruption policies may be significant: insurers have won their motions in just over 85% of cases where the policy has a virus exclusion (97 out of 112) but in only about 67% of cases where the policy has no such exclusion (34 out of 51; Jerry II 2020). As of early 2022, several federal courts had reached final decisions in COVID-19 business interruption cases, ruling usually in favour of insurers (French 2022, 155).36 In doing so, federal courts have rejected requests by policyholders to certify novel legal issues, which had arisen in the context of COVID-19, to the controlling state supreme courts. To provide an example, in Oral Surgeons, P.C. v Cincinnati Insurance Company, the Court of Appeals for the Eight Circuit required ‘direct physical loss of, or damage to’ property in order to trigger cover for business interruption.37 A mere loss of use when there had been no physical loss or damage was not sufficient to trigger cover under a business interruption policy.

Given the difficulties of recovering pandemic-related business interruption losses under the model BOP containing ‘the direct physical loss of, or damage to’ property requirement and often a virus exclusion, the question arises as to possible regulatory responses. In 2020, soon after the outbreak of the COVID-19 pandemic, several state legislators proposed legislation that would obligate insurers to cover business interruption losses regardless of whether specific claims were covered by the business interruption policies purchased (French 2020). By May 2020, approximately 20 bills were filed in at least seven states seeking to retroactively mandate cover for business interruption losses (Jerry II 2020). These draft bills included declaring the virus exclusion void as against public policy or declaring, as a matter of law, that COVID-19 constitutes ‘direct physical loss of, or damage to’ property. Further, state insurance regulators and the NAIC, which coordinates their efforts, have largely opposed such legislation, invoking concerns about the insurance sector’s solvency (NAIC 2020b). Late in 2020, it was predicted that, given the intense industry lobbying against these bills, none of those them would eventually be enacted (Jerry II 2020).38 As of 2022, this prediction has proven true. To provide an example, in 2022, legislators in the state of Washington continued to promote legislation that aimed at creating business interruption cover for policyholders affected by stay-at-home-orders. Senate Bill 5351, which was introduced in 2021, would institute a minimum two-year contractual suit-limitation provision for all first-party property insurance policies. Further, if enacted, the bill would further expand the definition of physical loss or damage to property to include ‘the deprivation of such property and the loss of ability to use such property’. The draft bill would apply to all suits commenced on or after the date of entry into force of the act, regardless of when the cause of action arose and would apply retroactively from 29 January 2020 (the date on which the state of emergency was declared in the state of Washington). These draft state laws provide an excellent illustration of how a legislator intervenes ex post to adjust the contractual design of insurance policies and ensure that business interruption insurance indeed constitutes a measure of spreading risk.

Scholarly commentators have emphasised that draft bills introduced in state legislatures should be understood as efforts to use insurance companies as a conduit to quickly bring recovery funds from the federal government into the hands of businesses, as insurance companies may be able to do this more promptly than federal mechanisms (Jerry II 2020; Bisco et al. 2020). Efforts to pass a bill at the federal level, which would be modelled after the Terrorism Risk Insurance Act (TRIA, on which see Carroll et al. 2005), have not brought any specific results. The failure of regulatory efforts means that courts will play an important role in determining to what extent pandemic-related losses will be borne by insurers.

In contrast to the U.K., the litigation concerning the cover of business interruption losses in the U.S. is considered inefficient and indeterminate (Jerry II 2020; Knutsen and Stempel 2020; Schwarcz 2022; French 2022). Leading insurance scholars seem to question whether the U.S. insurance industry has indeed given the highest degree of care to considering how policy language drafted based on the ‘direct physical loss of, or damage to’ property requirement would apply to pandemic-related losses (Jerry II 2020; Knutsen and Stempel 2020; French 2020; Schwarcz 2022). The stance that U.S. courts seem to have favoured in the first stage of pandemic-related litigation is certainly less supportive towards the view of business insurance cover as a means of spreading losses. This is largely due to the specific product design in the U.S. market. Yet, if history can provide any guidance, the litigation may take a more policyholder-friendly course once a higher number of disputes is decided by state courts (Schwarcz 2022).

The emerging view: recoverability of pandemic-related losses and the protection of policyholders

As has been noted above, it is far from clear whether the COVID-19 pandemic was unpredictable both for the insurance industry and the business community at large. Many instances of pandemics have occurred in recent decades, which offered evidence that a disease-causing event could result in significant insured losses (e.g. Ebola, SARS, H1N1, Zika, MERS, swine flu). Particularly in the U.S., insurers reacted by introducing a virus exclusion in their business interruption policies, yet, admittedly, certain U.S. insurers did not introduce such an exclusion in their policies despite broadly available model clauses. Furthermore, in 2018, one global insurer marketed a product to cover pandemic-related losses but very few policyholders opted for it.39 While the exact scope of pandemic-related losses was difficult to foresee, the insurance industry envisaged the occurrence of a large-scale event that could present a systemic risk and made available specific pandemic insurance to professional policyholders. The difference in the design of business interruption policies between the U.K. and the U.S., in particular regarding the prevalence of virus exclusions in U.S. policies, may justify the question as to whether business interruption policies in the context of COVID-19 have to fulfil the role meant specifically for pandemic insurance.40

The evidence from the COVID-19 pandemic in the U.S. shows that hundreds of lawsuits generated considerable uncertainty among both policyholders and insurers. Further, while law firms in Canada and the U.S. have launched class actions against insurers, such efforts have so far brought no success. Clarity about the legal obligations of insurers under business interruption policies, which has been swiftly achieved in the U.K., would certainly reduce the scope of litigation and provide a powerful incentive for the industry to settle at least some claims.

On the other hand, the U.K. system, which operates a test case procedure in complex financial matters, resolves widespread disputes over business interruption cover efficiently and swiftly, providing a relatively uniform solution for the entire jurisdiction.41 One must acknowledge that the level of uniformity of business interruption policies in the U.K. has not necessarily been higher than in the U.S. The U.K. test case scheme, which has been praised as successful, is meanwhile regarded as an inspiration for solutions that could facilitate the resolving of widespread cover disputes in other jurisdictions (Tereszkiewicz 2022). The fact that the U.K. has insurance law of a national scope made the resolution of business-interruption-related disputes far easier than in the U.S.

The manner of resolving disputes over business interruption cover has clear implications for the extent of risk and loss spreading in each system concerned. A well-designed test scheme, as shown in the example of the U.K., can be a very valuable tool for policyholders seeking redress. Such a test scheme strongly improves the position of a policyholder in relation to the insurance sector. Further, it has an important signalling function, as policyholders can adjust their expectations as to whether they will obtain payouts under the policies they have contracted and prepare alternative strategies for running or closing their businesses. The differences in the ways the U.S. and U.K. legal systems have so far dealt with pandemic-related losses lends strong support to that claim—the position of policyholders under business interruption policies in the U.K. seems more advantageous both regarding the availability of compensation and clarity as to the legal situation of their claims.

Under a decentralised scheme of resolving disputes over cover, as exemplified by the U.S. system, the position of policyholders in relation to the industry appears more dependent on the ‘pro-coverage ethos’ of the judiciary in insurance litigation. Specifically, Abraham and Baker (2022) submit that the ‘pro-coverage ethos’ characterised important developments in U.S. insurance law of the 1980s and 1990s such as the long-tail liability revolution.42 The authors go on to conclude that this attitude appears to be less prevalent today than it was then. As new forms of cover develop (i.e. pandemic cover), U.S. courts may be reluctant to engage in a pro-policyholder interpretation that could inhibit insurers from offering such cover. From the perspective of the policyholder, this implies that the narrative of risk and loss spreading may have to be reassessed in the face of available forms of cover.43 Following the pandemic and the proliferation of lawsuits, one may expect that the ISO and those insurers who offer their own business interruption policies will review their policy language. Further, insurers will inevitably consider an appropriate premium for covering pandemic-related losses.

Conclusion

In sum, the account of emerging paths that legal systems—partly in cooperation with the insurance sector—have taken in the U.K., U.S. and Australia provides a nuanced view of whether business interruption insurance can serve as a means of spreading policyholders’ pandemic-related losses. It is increasingly clear that the position of policyholders who seek relief under business interruption insurance depends foremostly on two factors. First, product design, i.e. the scope and language of exclusion clauses and their interpretation by courts or regulators. Second, procedural schemes that may enable test cases to be brought to courts in an accelerated procedure, which provides clarity as to the likely stance that the jurisprudence or market regulators may take in each jurisdiction. Further, early stages of the governance of pandemic-related claims will undoubtedly give rise to reflection on tailored cover of pandemic risks. A final picture of both litigation over pandemic-related losses and possibly new forms of cover will emerge in several years.

Piotr Tereszkiewicz

Ph.D. (Jagiellonian University in Kraków), M.Jur (Oxford) is a professor at the Jagiellonian’s University Private Law Department and a senior affiliated researcher at the University of Leuven (KU Leuven). His research interests include insurance law, consumer law and financial services in a comparative and international perspective.

Declarations

Conflict of interest

Author states that there is no conflict of interest.