Authors: David Priebe, Chairman, Guy Carpenter, Lara Mowery, Global Sales Director, Guy Carpenter and Michael Sevi, General Counsel and Chief Compliance Officer, Guy Carpenter.
On January 15, 2021, the UK Supreme Court issued its widely awaited ruling in the Financial Conduct Authority (BI) test case. The FCA brought the test case to remove uncertainty for certain BI policyholders affected by the COVID pandemic. Although the court ruled that some forms of BI insurance cover COVID losses, the court has adopted a narrow definition of a COVID event – a disease that affects only one person or possibly several people in a household – which questions after the meaning of COVID raises the word “occurrence” in other contexts.
Some commentators have suggested that the definition of “Occur” in the test case, this could also apply in the reinsurance context – in particular in the context of “loss occurrence” clauses (also referred to as “aggregation provisions”) for catastrophic excess damage contracts (“Cat XL”). In reinsurance, aggregation is the combination of several losses into a single claim. How losses are aggregated affects both a cedant’s retention and compensation limits.
Since the test case dealt with fundamentally different coverage issues, its results do not regulate the reinsurance response to COVID losses. The following highlights textual arguments in the UK Supreme Court’s decision to demonstrate that invoking the test case outside its primary insurance context is inconsistent with the Court’s own reasoning – and not with the custom and practice of the reinsurance industry.
The tight construction of the court for “occurrence”
The key language raised by the UK Supreme Court included the following (or similar) words: “We will compensate you for any interruptions. . . with the business in succession from / out. . . any . . . Occur a reportable illness within 25 miles of the premises. “This type of so-called sickness clause provides insurance cover for business interruptions caused by sickness.
The court dismissed the FCA’s allegation that one “incident” under a sickness clause involved a nationwide outbreak of COVID. The court ruled that the word “event” as used herein does not refer to an outbreak of any kind. Instead, the court ruled that “every case of illness is borne by a person [is] a separate event. “
In a critical paragraph, the court stated that a COVID outbreak cannot be an insured event:
A disease that spreads does not appear at any particular time, in a particular place, and in a particular way: it occurs at a variety of different times and places, and can appear in different ways, with different symptoms of greater or lesser severity occur. An “outbreak” of a disease cannot be viewed as a single event. . . Even less can be said that all cases of COVID-19 in England (or in the United Kingdom or around the world) that occurred at any given time in March 2020 constituted an event. It was reasonable or realistical that these cases included thousands of different occurrences of COVID-19.
The Supreme Court agreed with the High Court’s reasoning that the “insured hazard” is COVID anytime, anywhere, and that the hazard is not limited to a specific event or outbreak.
Does the reinsurance event have to be tight too?
Many CAT XL contracts have loss occurrence definitions that allow losses to be aggregated “An event.” The following language is typical: “Loss event means the sum of all individual losses that were directly caused by a disaster, an accident or a loss Series of disasters, accidents or losses consist of An event.”
Based on the considerations of the UK Supreme Court in the test case (specifically the paragraph cited above), it has been suggested that the “one event” for the purpose of aggregating COVID losses cannot be the COVID outbreak itself.
Context is everything
The court’s decision does not apply to the meaning of “event” or “event” in the loss occurrence provisions of a CAT XL reinsurance contract. The Court itself found that its narrow definition of the term ‘occurrence’ was based on the context before it, namely the ‘interpretation which defines the meaning of the [disease] Clause ”in the primary guidelines to be checked.
Therefore, the court ruled whether insurers are liable in the context of primary BI disease – nothing more.
The question of which insured damage is reinsured is clarified in a CAT XL contract. The typical “Business Covered” section of a CAT XL specifies that it covers the entire real estate business and thus all BI losses (including undamaged BI extensions). In the CAT XL context, the term “event” does not limit the extent of the insured hazard, but rather the extent to which insured damage can be aggregated for retention and limitation purposes. The following table summarizes this critical distinction:
In contract interpretation, context is everything. As the Court said, an inquiry into the meaning of the word “event” is not a question to which a general answer can be given. It always depends on the context in which the question is asked.
The test case does not interpret any words or concepts in the context of a reinsurance contract. On the contrary, the Court of Justice interpreted an EI directive for primary properties and was clearly influenced by many features of such a directive. However, the characteristics of a BI policy for primary properties are not present in a reinsurance contract, so the interpretation of a primary policy cannot determine the meaning of “event” in a reinsurance aggregation determination. For example:
- The “occurrence” in an illness clause is defined as an illness that occurs within a radius of 40 kilometers from the individual insured premises. The court stated that these were only cases of illness within the radius specified in the clause that are covered.
- All other sub-clauses of the BI extensions refer to narrow “occurrences” “on site” – for example the Detection of vermin or pests, sewer deficiencies or murder on site. The Court found that these “events” take place “at a specific time and place” and that sickness clauses should therefore be read in the same way.
- The BI guidelines that were reviewed included a “grace period” that runs from the “date of occurrence”. The Court found that “[i]t in this definition implies that an ‘event’ is something that happens on a specific date not something that can span more than a date. “
- The definition of “reportable illness” in the EI guidelines considered by the Court is “illness suffered by a person” due to an illness whose “outbreak” requires notification of a government agency. Therefore, the directive expressly states that an “event” is and is an infection in “every person” – that is, a person separate from a widespread disease outbreak.
None of these contextual limits exist in determining the aggregation of a CAT XL reinsurance contract. A CAT XL contract does not contain parallel clauses with extremely narrow “events” such as vermin detection, drainage problems or murder in a single location.
The existence of an hourly clause also shows that a reinsurance loss can extend over weeks. Cedents are free to choose when the relevant loss begins to occur, unlike EI guidelines for primary ownership and contrary to the Court’s description of triggering a primary sickness clause which has a fixed starting point. A CAT XL does not limit an “event” in the same way that the definition of “reportable illness” limits an “occurrence” in an illness clause.
In contrast to the BI guidelines in question in the test case, the term “event” is used in a CAT XL contract in a context that requires a broad interpretation. According to the general definition of the occurrence of losses, an “event” is broad enough to include losses caused by a “series of disasters”. In addition, an “event” is broad enough to capture the magnitude of the disasters normally referred to in a CAT XL – such as hurricanes and forest fires – events that are often widespread, have significant duration, and span multiple jurisdictions .
Finally, most reinsurance contracts require the settlement of disputes through arbitration. And arbitration provisions often instruct arbitrators to (1) treat the contract as an “honorable obligation, not just a legal obligation” and (2) make decisions based on the “custom and practice” of the reinsurance business. According to these provisions, the arbitrators must take into account the context of the reinsurance business. As such, they should prevent mechanical application of the test case decision to CAT XL contracts. An honorable engagement between cedant and reinsurer – or an engagement consistent with reinsurance custom and practice – should be the stark contrast between the context of a loss occurrence clause in a CAT XL contract and an “occurrence” of COVID in recognize the sickness clause of a primary policy.
While not binding outside the UK, our analysis of an “incident” – specifically our decision that a COVID outbreak cannot occur with certain primary BI extensions – can confuse the conversation about reinsurance responses to COVID losses. The clarifying answer is simple: context is everything. The context and analysis of the test case decision show that questions about reinsurance aggregation cannot be answered. Applying the Court’s reasoning to reinsurance would run the risk of defeating the intent and purpose of CAT XL contracts, defying industry practices and expectations, and distorting the language used in the aggregation provisions.
The information in this article does not constitute and is not intended to be used as legal advice. All information, content and analysis are provided for general informational purposes only and are based on the expertise of Guy Carpenter as a reinsurance broker and risk advisor. Do not act or fail to act based on any content in this article without first seeking legal or other professional advice.