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.
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