BI judgement leaves clarity some way from certain

Australian insurers have been left with a range of unanswered questions following the judgement in the country’s Business interruption insurance test case.

Ratings firm AM Best said following the outcome of an Australian legal test case that considered the application of certain infectious disease exclusions in business interruption policies going against the insurance industry, some insurers are looking to reinforce their claims provisions and execute capital raising actions to bolster their solvency positions.

The judgment handed down by the New South Wales Court of Appeal brings into sharp focus the potential downside risk for the industry according to the report. With a unanimous ruling against the arguments made by the insurers on this test case. AM Best said it expects the question of pandemic business interruption coverage to remain a significant source of uncertainty for Australian commercial insurers.

Best’s report, Australia Business Interruption Test Case Raises More Questions than Answers for Insurers, said:While the recent test case may yet be appealed, the latest findings clarify for insurers and policyholders alike, that policy language referring to an outdated and repealed piece of legislation (the Quarantine Act 1908) should not be regarded as providing grounds for exclusion of BI coverage in respect of COVID-19. Insurers involved in the test case had sought to argue the opposite position – stating that the intent of their policy language was clear and that despite references to the repealed Quarantine Act 1908 in many cases, the policy language should be read as extending to the replacement legislation in this area (the Biosecurity Act 2015).”

It added that the re-evaluation and refinement of loss provisions for potential COVID-19-related business interruption exposures are expected to lead to an adverse impact on commercial insurers’ operating earnings. “The extent to which this affects capital positions remains to be seen, although AM Best views companies with strong financial flexibility and a track record of accessing capital markets as being best-placed to contend with adverse capital implications,” said the report. “Some smaller insurers exhibit limited financial flexibility due to their ownership structures and therefore may have less ability to raise significant additional capital, if required.”

“Another key factor relevant when determining the financial impact of potential business interruption exposures for insurers is with regard to their ability to make recoveries from reinsurance programmes,” said Myles Gould, director, analytics, AM Best. “Loss triggers may be a source of dispute with reinsurers, such as in the event of non-alignment of policy exclusions in primary wordings and reinsurance contracts.”

The report cautioned the judgement will ask questions of many insurers in the Australian market.

“While clarity on insurers’ liability to COVID-19 related BI and ultimate claim exposures is some way from certain, the latest test case brings into sharp focus the potential downside risk for the industry,” it added. “Many insurers had hoped that the first test case would fall in their favour and largely put this debate to rest. However, with the outcome falling unfavourably for the industry, the potential scale of losses is causing insurers to re-evaluate the claim provisions booked for BI exposure. In most cases the range of current BI loss estimates is wide and as a result of the recent test case defeat, some insurers are looking to reinforce their provisions and execute capital raising actions to bolster their solvency positions.”

“As the commentary notes, this test case outcome remains only one piece of a much larger puzzle, with a number of other business interruption contract triggers yet to be evaluated ahead of understanding the full liability for insurers,” said Alex Rafferty, associate director, analytics, AM Best. “Additionally, this test case decision could be appealed.”