No doubt, insurance companies will cede, and reinsurers will assume substantial
loss cessions arising from the novel coronavirus and the COVID-19 infection.
The only questions are what reinsurance contracts will be affected and how big
will the final bill be?
Because a reinsurer does not issue the underlying policies or handle the
underlying claims, it relies on its ceding insurer to adjust claims within the
terms and conditions of the reinsured policies and cede claims consistent with
the terms of the reinsurance contract. The policy issuing company and the
reinsurer have two main considerations when faced with determining reinsurance
coverage for a loss: (1) is the underlying loss a covered loss under the
reinsured insurance policy, and (2) if the loss is a covered loss, is the loss
also covered under the reinsurance contract?
With myriad claims arising from the novel coronavirus, both ceding insurers
and reinsurers are gearing up for the inevitable.
What Are Some of the Key Exposures?
The novel coronavirus is an equal opportunity loss producer. Many lines of
insurance business have faced and will face claims. On the life and health
side, life insurance, hospital indemnity, health insurance, disability,
long-term care, accident and health, and medical stop-loss are seeing and will
see claims from insureds who contracted and will contract the COVID-19
infection.
On the property and casualty side, claims have been made and will continue
to be made under workers compensation (as expected), general liability,
directors and officers liability, event cancellation, travel, supply chain,
film and television production stop-loss, trade credit, property and multiline
packages, commercial general liability, professional liability (including
medical, hospital, and lawyers), insurance brokers errors and omissions,
employment practices liability, and other lines.
Because of the many statewide closure orders, property exposures from fire,
flood, and vandalism may rise because buildings, residences, and other
properties are essentially abandoned. Reinsurers will have to work with their
cedents to use technology or other means to make sure closed businesses do not
become loss-producing sites. COVID-19 makes this all the more difficult because
of the closure orders, the need for social distancing, and the loss of
employees from either layoffs or illness.
In some areas, however, there may be a claims slowdown. For example, fewer
people on the road means fewer vehicular accidents. Traditional slip and falls
in businesses will also lessen as so many businesses are closed. Traditional
workplace accidents have also decreased with the closure of businesses, which
somewhat offsets the workplace claims by first responders and healthcare
workers. Additionally, with courts closed and with the inevitable backlog once
they reopen, existing cases may settle more quickly and for lower amounts,
thereby saving both indemnity and loss adjustment expenses. This translates to
lower reinsurance claims for certain matters.
The explosion of business interruption losses because of the civil
stay-at-home orders has added a new dimension to the normal claims mix. There
are many articles on COVID-19 and business interruption coverage from the
policyholder and insurer perspective discussing many of these issues. Some of
the key issues include whether the novel coronavirus causes direct physical
loss of or damage to insured property, whether civil authority orders mandating
business closures are sufficient to trigger coverage, and whether exclusions
for losses arising from virus and bacteria contamination preclude coverage in
any event.
The potential that insurance companies will have to cover the loss of
business income and extra expenses for millions of closed or partially closed
businesses is what makes the insurance and reinsurance issues arising from the
novel coronavirus pandemic different than other previous disasters.
Accordingly, while much of the discussion below applies to all reinsurance
cessions, this commentary will focus on the potential cession of business
interruption losses.
What Should Ceding Insurers and Reinsurers Do First?
The first thing both ceding insurers and reinsurers must do is review their
reinsurance contracts to determine which contracts may see potential COVID-19
claims. Reinsurance contracts run the gamut from broad quota share and whole
account protections to excess-of-loss contracts on specific lines of business
to facultative certificates for specific policies to property catastrophe
contracts. Many companies have established internal task forces to evaluate the
underlying policies, the distribution of those policies both geographically and
among insureds, and their reinsurance contracts for potential exposure. Once
those reinsurance contracts are identified, ceding insurers and reinsurers will
look at the terms and conditions of the ceded policies to determine if losses
arising under those policies fit within the coverage provided by the
reinsurance contracts.
Of course, many factors may affect whether COVID-19 losses can be ceded to a
reinsurance contract. These include (1) whether the loss comes within the terms
and conditions of the underlying insurance policy, (2) whether a ceding
insurer's loss payments were made on an ex gratia basis, (3)
whether the nature and terms of the myriad civil authority orders change the
dynamic, (4) whether the reinsurance contracts allow for the aggregation of
individual COVID-19 losses as a single loss occurrence, and (5) whether
exclusions exist that preclude the cession of COVID-19 losses.
All of these issues may be overshadowed by state and federal proposals to
intervene in the business interruption claims controversy. A number of these
proposals would retroactively force insurers to pay business income and extra
expense losses in spite of unambiguous policy exclusions for losses arising
from viruses or other contagion or clear policy language requiring specific
triggering activities such as direct physical loss of or damage to
property.
What Are Some of the Key Reinsurance Issues?
No doubt, follow-the-fortunes/follow-the-settlements issues will arise if
ceding insurers pay business interruption claims and cede them to their
reinsurers. For example, what if a ceding insurer accepts and pays COVID-19
losses based on a determination that the virus is causing direct physical
damage to insured property? Is that something that reinsurers will also
accept?
The answer to that question depends on various factors. First, the specific
reinsurance contract wording is key to determining whether a loss cession is
proper. Second, the facts of the underlying loss and whether that loss fits
within the actual terms and conditions of the ceded policy are critical to
determining a reinsurance claim.
An important point of reinsurance contract wording analysis is whether the
reinsurance contract broadly or narrowly defines the ceding company's right
to determine the losses ceded to the contract. Does the reinsurance contract
have provisions that allow the ceding insurer broad discretion to determine the
loss and require the reinsurer to follow that determination? Does the
reinsurance contract provide that the ceding insurer is the "sole
judge" of how the underlying policy wording defines a loss or whether a
loss can be ceded to the reinsurance contract?
Not all current reinsurance contracts have the traditional
follow-the-fortunes or follow-the-settlements clauses or the traditional utmost
good-faith language that older reinsurance contracts often contained. If the
reinsurance contract does not have language requiring the reinsurer to follow
the ceding insurer's claims determinations, it is more likely that the
cession of a COVID-19 loss under a business interruption cover may be rejected
by a reinsurer on the basis that there is no direct physical loss and that
COVID-19 is not a covered peril. But, if the reinsurance contract has a more
traditional follow-the-settlements clause, does that make a difference?
Ceding insurers will argue that, under a traditional follow-the-settlements
provision, a reinsurer must follow the ceding insurer's claims
determination and pay the loss. Reinsurers, on the other hand, will argue that
the claims determination has to be made in good faith and business-like to be
followed. The traditional principles of follow-the-settlements support the
notion that if the ceding insurer pays a claim reasonably and in good faith,
and the claim falls within the terms of the underlying contract and the
reinsurance contract, the reinsurer must pay, and the reinsured's claims
determination will not be second-guessed.
A related point of reinsurance wording analysis is whether the reinsurance
contract incorporates the terms and conditions of the underlying policies. If
the reinsurance contract has a follow-form clause, that is a relevant factor
because any loss cession will have to come within the coverage terms of the
ceded insurance policy. The lack of a follow-form clause, however, relegates
the argument to custom and practice rather than to adherence to the terms of
the reinsurance contract.
Disputes over the cession of COVID-19 business interruption losses, if they
happen, likely will focus on whether the loss payment was reasonable, made in
good faith, and comes within the terms of the ceded insurance contract and the
reinsurance contract. Put another way, is the loss payment and its cession to
the reinsurance contract objectively reasonable?
If the underlying insurance contract contains the virus and bacteria
exclusion, it will be very hard for a ceding insurer to seek reinsurance
coverage for a COVID-19 claim under those circumstances. If the business income
and extra expense coverage, as it normally does, requires a direct physical
loss of or damage to covered property by a covered cause of loss, the dispute
will come down to whether the novel coronavirus caused direct physical damage
to property. If these provisions are absent, however, or if the underlying
policy affirmatively covers contagion or pandemic, as some policies do, the
reinsurance response may be different.
These issues will be exacerbated if legislative intervention forces insurers
to pay business income and extra expense losses even if a virus and bacteria
exclusion exists and even if there is no direct physical damage to property
from a covered peril. When an insurance company denies a claim and a court
determines that the policy, nevertheless, covers the claim, the loss, as found
by the court, will likely find its way into a loss cession to a reinsurance
contract. Under those circumstances, a reinsurer generally cannot take the
position that the court is wrong because the policy does not cover that loss.
If a law is enacted that changes how an insurance policy must respond to a
claim, it is very likely that reinsurers will have to accept losses ceded to
reinsurance contracts based on loss payments made under the force of that
law.
Where the real issue lies is the potential for significant solvency issues
for all insurance companies forced to pay business interruption losses by
retroactive legislation. Most insurers never took premiums to cover a viral
pandemic. Given the massive numbers of businesses that lost income and have
incurred extra expenses because of the COVID-19 civil stay-at-home orders,
there is a real question whether many in the insurance industry could survive
if made to pay those claims.
What happens if regulatory or political pressure compels a ceding insurer to
pay claims on a "voluntary" basis that it would not ordinarily have
paid? Most reinsurance contracts do not permit the cession of these ex
gratia payments. Will reinsurers feel the same market/regulatory pressure
to fall in line? What then happens at the retrocessional level, especially if
the retrocessionaires are located outside the United States?
Another significant issue that ceding insurers and reinsurers may face is
the prospect that individual COVID-19 business interruption losses will be
aggregated as one or more events or one or more loss occurrences under property
catastrophe or other reinsurance contracts that contemplate aggregation of
individual losses. Most business income and extra expense provisions have
sublimits and time restrictions that affect the application of coverage. Some
provisions have waiting periods that must lapse before coverage is triggered.
Additionally, policyholders have a duty to mitigate damages. Finally, coverage
under business income and extra expense provisions is fairly narrow and only
covers loss actually caused by the interruption.
These factors may result in relatively low individual loss payments that
might not qualify for cession under reinsurance contracts with large attachment
points. This is particularly true of property catastrophe reinsurance
agreements that only respond to a loss occurrence that is $5 million or $10
million or more (some property cat contracts can attach at $100 million or
more).
If the reinsurance contract permits aggregation of losses, complex issues
arise as to how individual business interruption losses may be aggregated based
on reinsurance provisions that are really designed for natural disasters like
hurricanes and earthquakes and not a viral pandemic. Most property catastrophe
reinsurance contracts include an hours clause that limits the loss to a
specific, but limited, time period. For example, a common hours clause limits
the loss to 168 consecutive hours. Even if a ceding insurer is able to
aggregate individual losses to reach the attachment point of a property
catastrophe reinsurance contract, the reinsurance recovery may only be for 7
days of loss.
Additionally, many of these aggregation provisions rely on relatively narrow
event-based language, which requires that the individual losses relate to each
other both temporally and spatially. Determining what individual losses may be
aggregated and to how many events are complex issues depends on the reinsurance
contract wording and, especially, the definitions used in the aggregation
provision. A critical review of aggregation language will prepare both ceding
insurers and reinsurers for potential cessions of COVID-19 losses as one
event.
Conclusion
The COVID-19 pandemic is not unlike other disasters the insurance industry
has faced in the past. No doubt, the reinsurance industry will respond
appropriately. That response, however, will be consistent with the reinsurance
contract wording and commensurate with the premium charged for the reinsurance.
While reinsurance is the backstop for the insurance industry, it is not the
backstop for the country. While the insurance industry is financially strong
and able to weather this event, expecting insurance and reinsurance to solve
all problems, especially those not covered by clear and unambiguous policy
wording, is unwarranted.