Back to Insurance Committee publications

Martín G Argañaraz Luque
Allende & Brea, Buenos Aires
marganaraz@allende.com

Sebastian Bonina
Allende & Brea, Buenos Aires
sbonina@allende.com

 

Introduction

Since 11 March 2020, the date when the World Health Organization (WHO) classified the outbreak of Covid-19 as a pandemic, several countries have adopted measures aimed at reducing the spreading and infection, therefore avoiding the collapse of their respective healthcare systems.

The pandemic has massively hit the economies of all countries where the above measures had to be adopted, and the international insurance market has been one of the sectors affected.

In view of the distressing situation, some of the people affected have begun reviewing their insurance contracts. Among them, within contracts relating to property damage, consumers have identified different insurance coverages as potentially applicable, highlighting the coverage called business interruption or ‘advance loss of profit’.

However, when analysing such coverage, many policyholders have realised that the spirit of the policies is contrary to the insurance of damages and/or effects caused by pandemics. They have consequently met with obstacles posed by the insurance contract itself.

This has strained the relationships between policyholders and insurers, leading to the filing of several lawsuits, especially in common law jurisdictions. Among the policies from which these discussions have arisen, it is worth mentioning the operational and contractors’ all risk insurance policies.

In the Latin American region, driven by a legal system different from common law, with pre-established rules and legally defined judicial language, it is clear what the spirit of the operational and contactor’s all risk insurance contracts is, summarised in the impossibility of covering risks such as pandemics, for the reasons which will be explained below.

Pandemics versus epidemics: insurable risks versus uninsurable risks

An epidemic is defined as a disease which spreads within a country, community or region, affecting a significant number of people simultaneously. A pandemic, on the other hand, is an epidemic disease that spreads across several countries, affecting nearly all individuals within a single community, region or country.

It is known that the business of insurance companies is mainly fed by premiums paid by clients. When calculating premium amounts, insurers take into consideration several parameters, such as the term of the insurance, amount of the insured sum, administrative and management expenses, applicable taxes and/or charges and, mainly, probability that the fact or event (risk) that turns out to be the object of the insurance may occur.

There are risks, mainly arising from nature, which affect a large majority of people and companies. When these risks occur, the consequent losses are unquantifiable, and these risks cannot be modelled by insurance companies’ actuaries who are in charge of establishing the criterion for premiums. Consequently, they are not commercially insurable, for instance: wars, climate change and nuclear risks.

In effect, insurance constitutes a capital pool comprised of the premiums paid by all the insured, from which the losses of a few insured are paid. If, in return, it were necessary to pay the loss of all the insured at the same time, the insurance company would not have the capacity to do this and would go bankrupt. That is why these type of risks do not generally constitute an insurable risk in the insurance market.

It is appropriate to define ‘risk’ as the possibility that a harmful event occurs to the person or to their property, ie, an event economically unfavourable. For the risk to be insurable, it must respond to a lawful interest.

The insurable risk therefore constitutes a feared event of an uncertain nature, but of possible occurrence and, as such, it is a necessary element in every insurance contract. From a theoretical point of view, the insurable risk gathers features such as:

• objectivity – it is independent of the will of the parties;
• uncertainty – it is not known when it will take place;
• frequency – probability of occurrence of the loss; and
• dispersion – the risk must not be generalised.

Regarding the frequency, the pandemic constitutes a risk of (almost) impossible prediction for the insurance companies, that is, of impossible probability to predict. This justifies the impossibility of providing insurance coverage. In relation to the dispersion, it is worth mentioning that, at a commercial level, the economic solvency of an insurance company depends on the adoption of adequate criteria that allow it to calculate in an approximate manner what the income for premiums and investments will be, and the expenses for indemnity payments and current expenses. Therefore, insurance companies cannot meet their obligations if the risk is of a generalised nature. In other words, it would not be logical for an insurance company to offer or pretend to offer coverage for a risk that, if it occurred, would be generalised among all or a significant number of its policyholders.

Summarising, and as a general principle, a pandemic is a risk without dispersion which would affect in a generalised way all or many of the insured, being therefore uninsurable. These types of risks that affect in a generalised way are called in the insurance market, ‘fundamental risks’. That is to say, these are risks the occurrence of which results in losses that are unquantifiable for the insurance companies and, therefore, non-amortisable, as they exceed their calculation capacity.

Given the general principle of not covering the risk of a pandemic because of its fundamental nature, there are cases in which, for example, as a result of the lack of express exclusion in the policies or of ambiguity in its terms, some insurers have been required, or have finally decided to pay some of these risks claims, eg, the United Kingdom’s Financial Conduct Authority test case.

Operational all risk (OAR)

This type of insurance provides coverage to the insured in order to protect the property damages caused during daily operations.

When defining the insured risk, this type of policy establishes that coverage shall be granted against all sudden, abrupt and accidental physical damage or loss that falls on the property used by the insured during the term of the policy. This is, provided that it occurs from a risk that is not expressly excluded in the said policy, to the extent as it could not reasonably have been foreseen by the insured, and which requires the repair or replacement of the said property.

Business interruption in the operational all risk policy

This coverage is usually included as an additional coverage. Through it, insurers are bound to indemnify their clients for the losses suffered as a consequence of the total interruption or reduction of the normal course of their commercial operation.

The applicability of this coverage requires the existence of ‘direct physical damage, loss or destruction’. Therefore, the main topic of discussion surrounding this coverage is whether the Covid-19 pandemic and its effects can be considered as direct physical damage.

It should be noted that, in the field of insurance contracts, the interpretation of this type of concept should be in accordance with the customs, where for example, in Argentina and other Latin American countries, material damages are associated to physical damages. In fact, many policies, in their drafting, expressly refer to the physical nature of a material damage in different sections or clauses. Since the presence of the virus in the properties of the insured does not generate material damage, there would be no coverage under this type of policy.

Furthermore, when evaluating the impact of the Covid-19 on the assets of the insured, it turns out that the direct nature of such damage required by the coverage under consideration is not verified. It is not the virus nor its propagation but rather government measures adopted later that connect such a spread with the economic detriments. We are therefore talking about an indirect relationship.

Consequently, the previous considerations would give insurance companies enough reasons to reject claims coming from the insured under the general terms of the business interruption coverage.

Additional coverage

Even if business interruption coverage is not applicable to the particular case due to the arguments that were previously developed, there are additional coverages that can be included within this type of policies.

In this sense, we find coverage for damages generated from decisions or orders issued by civil or military authorities that ban access to the insured’s facilities, known as civil authority coverage. Mandatory decisions such as express prohibition, the closure of businesses, quarantine or isolation measures, restrictions on the use of transport, limiting the hours of work or the number of workers in the same location, to mention some examples, may trigger this coverage.

Exclusions

As well as offering additional coverage that may be useful for the insured, there are also exclusions in this type of policy, such as direct or indirect consequences caused by viruses, bacteria or microorganisms, as well as delay or loss of market.

Construction all risk (CAR)

This policy seeks to cover material damages or losses suffered by goods or interests under construction in the framework of civil works (property damage), while also granting coverage against possible claims from third parties for damages to their goods and persons in connection with the work under construction (civil liability).

When defining the insurable risk regarding property damages, this policy provides coverage against material damages to the property of the policyholder that take place during the construction process and in the place defined for it, which occur in an accidental, sudden and unforeseen manner, making its repair or replacement necessary, provided that said damages occur from risks covered by said policy.

Advance loss of profit

In the case of CAR policies, the loss of anticipated profit (advance loss of profits, or ALOP), caused by delays that result from the damage or destruction of goods used in the construction, may be foreseen as covered or expressly excluded.

In case of coverage, the conditions of applicability of business interruption indicated in the operational all risk policies also apply to the coverage of advance loss of profit in the CAR policies. In this way, CAR policies will provide coverage for damages to the insured goods during the construction work carried out, whenever such damages occur in an accidental, sudden and unforeseen manner and make it necessary to repair and/or replace them, and as a direct consequence of any of the risks covered. Consequently, the considerations previously outlined in relation to the non-existence of direct physical damage and, therefore, of insurance coverage, are applicable to the case.

Additional coverage

This policy may also include as additional coverage of the damage generated from decisions issued by a civil or military authority, under conditions similar to those already analysed.

Similarly, there is an additional coverage that can be included in this policy, known in the international market as trade disruption and supply chain. In this case, coverage is granted to the policyholder as a result of damages or losses suffered from events such as interruption of the activity of suppliers and delay in deliveries, among others.

Finally, it is worth mentioning another additional coverage known as non-damage business interruption, that is, coverage granted for damages or losses generated from the interruption of business or advance loss of profits without the existence of direct physical damage. This additional coverage acts as a response to the non-existence of coverage for lack of direct physical damage, as previously indicated, but is applicable as long as it is related to specifically defined risks.

It should be mentioned that non-damage business interruption coverage is virtually unavailable in Latin America.

Exclusions

Similar exclusions apply to CAR policies as to operational all risk policies. It is therefore worth mentioning the exclusion for virus, bacteria and microorganism, which application has been extended mainly since the SARS outbreak in 2002. Other applicable exclusions are those of risks of contamination and unfavourable business conditions, concepts that can also give rise to multiple interpretations.

Conclusion

The Covid-19 pandemic is, in principle, an uninsurable risk, as it is (almost) impossible for insurance companies to foresee, and it does not meet the requirement of dispersion of an insurable risk.

Regarding business interruption and advance loss of profit clauses in the context of OARs and CARs policies, there would be no coverage for those damages resulting from government measures taken to mitigate the spread of the pandemic. This is because there is no direct link or causal relationship between the pandemic and the damage, and, such damage would not be of a material or physical nature.

There still remains the possibility that policies previously analysed offer specific and varied contractual clauses and conditions, including additional coverage and diverse exclusions.

Finally, it should be noted that, due to the lower development of the insurance market in Latin America (the regional represents just the three per cent of the worldwide insurance premium), coverages such as non-damage business interruption are simply not commercialised.

Sources

New Hampshire Insurance Department, ‘Frequently Asked Questions about Business Interruption Insurance Coverage and the Novel Coronavirus 2019 (COVID-19)’, available at www.nh.gov/insurance/consumers/faq-business-interruption-insurance-coronavirus.htm.

Sarah B Biser, Robert J Rohrberger, Philip Z Langer, CJ Mooney (Graham Company) and Carl Bloomfield (Graham Company), ‘COVID-19: Construction Contracts and Potential Claims Under Business Interruption, Civil Authority and Other Insurance Policies and Endorsements’, Fox Rothschild, 20 April 2020, available at www.foxrothschild.com/publications/covid-19-construction-contracts-and-potentialclaims-under-business-interruption-civilauthority-and-other-insurance-policies-andendorsements.

George J Pollack, ‘COVID-19 Insurance Related Considerations – Business Interruption Coverage Update’, Davies Ward Phillips & Vineberg Bulletin, 3 April 2020, available at www.dwpv.com/en/Insights/Publications/2020/COVID19-Insurance-Related-Considerations.

McVEY, Paul, “Coronavirus: preparación para la interrupción de negocios y otros siniestros”, Marsh & McLennan Companies, available at  https://www.marsh.com/co/insights/risk-in-context/coronavirus-preparacion-interrupcion-negocios-siniestros.html

Katherine Chiglinsky, ‘Chubb CEO Greenberg warns retroactive measures would ‘bankrupt’ insurance industry’, Insurance Journal, 16 April 2020, available at www.insurancejournal.com/news/national/2020/04/16/565109.htm.

WILLIS TOWERS WATSON, “La gestión de riesgos provocada por el COVID-19”, available at www.willistowerswatson.com/es-ES/Insights/trending-topics/la-gestion-de-riesgos-provocada-por-el-covid-19

Peter Littlejohns, ‘Insurance industry associations call for government intervention in case of future pandemics’, New Statesman Insurance, 1 April 2020, available at: www.nsinsurance.com/news/government-insurance-for-pandemics.

Back to Insurance Committee publications