Business interruption insurance and the coronavirus crisis
Even before a state of epidemic threat was announced, some businesses anticipating the probable impact of the approaching pandemic decided to take out business interruption insurance. But can this type of coverage make up for at least some of the losses due to the pandemic?
The nature of business interruption insurance
It is recognised in the insurance industry in Poland that coverage of lost profits, known as business interruption insurance, is one of the most complex insurance products. One reason for this is that the construction of this coverage is to some degree similar to a claim for damages for lost benefits under the general provisions of the Civil Code. This coverage is based on hypothetical assumptions and theoretical calculations to determine what profit an enterprise would have achieved if the injurious event covered by the insurance had not occurred. This is thus protection against a financial risk in which the interest of the insured essentially boils down to its expectation of achieving a certain level of revenue or turnover (see K. Malinowska, commentary to Art. 821 of the Civil Code in Commercial Insurance Law, vol. 2 (2nd ed., Lex 2010). Because the subject of this insurance is a financial interest that can be valued in money, BI coverage is classified as a form of financial insurance.
This construction of the coverage can pose difficulties for underwriters assessing the insured’s risk. The calculations will depend not only the specifics of the industry (where some types of enterprises may be more exposed than others to a given risk), but also on the frequency of occurrence of given types of perils. Thus under the commercial and climate realities in Poland, the risk of fire or flood here would be assessed differently than, for example, in the United States, the risk of a tornado in the Great Plains or a hurricane in the coastal Carolinas. The risk calculation affects not only the limits of the insurer’s liability but also the premiums payable for coverage against this financial risk.
Thus we might venture to say that BI coverage is analogous to personal injury insurance for individuals; the main difference is that BI is targeted to professional entities and their business operations. Just as benefits from personal insurance may compensate for example for temporary inability to work, so business interruption insurance protects enterprises against perils that could have a negative impact on their turnover or profit. BI can also cover certain fixed costs which the insured must pay despite the standstill in its operations, such as rent, salaries, and other regular business costs.
Need for parallel property insurance
As a rule, BI coverage is coupled with property insurance. Insurance companies require an enterprise wishing to take out BI coverage to take out a property policy simultaneously, because the construction of insurance against lost profit assumes the fiction that only damage or destruction of the insured’s property could lead to further liability of the insurance company for business interruption. In other words, it is assumed that an enterprise cannot insure against a purely financial risk in the form of lost profit, illiquidity or failure to achieve projected revenue. These events must be correlated with damage to or destruction of insured property.
Consequently, BI is in essence a supplementary form of coverage. A classic example of an injury covered by this type of insurance would be a fire at a restaurant, causing several months’ downtime in operations until the premises are restored. The loss in this respect consists not only of damage to or destruction of insured property (such as the building, inventories or fixtures), but also failure to achieve a certain profit due to halting of restaurant operations.
Thus it is necessary not only to identify the property covered by the insurance (which could also include expenditures for adaptations), but also the risks covered by the insurance (against fire, structural failure, etc) and many other essential elements of the insurance relationship (accidentalia negotii). Concepts must also be defined, such as what the parties regard as a loss (typically a financial detriment to the insured property) or a peril (e.g. an event outside the control of the insured which is sudden, contingent and uncertain, directly causing an injury to the insured property). Moreover, it will be essential to establish rules and procedures enabling a determination that the insured has failed to achieve the projected profit or had to incur increased operating costs (as a result of injury to the insured property). Nonetheless, in considering claims under BI coverage, it will generally be necessary to involve an auditor or accounting expert.
So it is apparent that merely establishing the essential contractual mechanisms for this type of coverage may present a huge challenge for the parties, and any doubt could generate a future dispute. Obviously, the insurance policy and its terms must be precise and clear, but in the case of BI coverage precise specification of the conditions is particularly important, as the amount of the covered loss is hypothetical, and the parties to the insurance (particularly the insured) must be aware of the factual and legal state that may constitute grounds for payment of compensation and how the amount of compensation will be determined.
It should be pointed out that if the terms of the policy require interpretation, this will be based on the general provisions of the Civil Code. Thus the interpretation will be controlled by the parties’ mutual intent and the aim of the contract rather than the literal wording of the provisions.
It should also be borne in mind that under the commonly adopted rule, any doubts in interpretation of a contract will be construed against the party that drafted the contract (e.g. Supreme Court of Poland judgment of 21 June 2007, case no. IV CSK 95/07). This rule is also confirmed in the regulations governing insurance: under Art. 15(5) of the Insurance and Reinsurance Act, ambiguously worded provisions of an insurance contract, general conditions of insurance, or other contractual forms are interpreted in favour of the insured, the party taking out the insurance, or the beneficiary. As pointed out by the Supreme Court of Poland, this provision “requires adoption of the variant of understanding favourable to the insured, the party taking out the insurance, or the beneficiary, and rejection of the variants that would be unfavourable to these entities” (judgment of 12 April 2019, case no. I CSK 321/18).
However, as the Supreme Court stated in the same judgment, “This directive cannot be understood to mean that any discrepancy in the meaning of an insurance contract must be resolved in favour of the insurance company’s client. Nor is it the case that the use of a word or expression with multiple meanings (vague or unclear) must in every instance result in a finding that the provision of the contract is ambiguous…. The requirement referred to in this regulation does not exclude the application of interpretive manoeuvres aimed at eliminating the ambiguity with the help of reference to the linguistic context and other typical methods of interpreting linguistic statements.”
Thus it is evident that, particularly from the perspective of the insurance company, it is essential that the conditions of BI insurance be constructed precisely and clearly. This will greatly limit the risk of potential litigation over the insurance coverage.
Pandemic losses under BI coverage and master policies
For the reasons described, insurance companies commonly include clauses in insurance contracts releasing them from liability (contractual exclusions). A classic example is exclusion of the insurer’s liability when the insured has intentionally caused the loss (reiterating commonly applicable regulations) or, as a rule, when the loss results from gross negligence by the insured.
Another example of a contractual exclusion is an enumeration of the types of events (risks) that are not covered by the insurance. This includes in particular “uninsurable risks” falling within the category of events which the state is supposed to guard against. An example of such exclusions could be risks arising out of military action, riots (recently widespread in the US in connection with “Black Lives Matter” protests), terrorist attacks, and, indeed, epidemics of the SARS type. The SARS exclusion became common in 2003 after the first epidemic due to a coronavirus linked with severe acute respiratory syndrome (SARS-CoV-1). Insurers had not previously identified this as a serious type of risk, and as a result the common absence of this exclusion led to pay-outs of many millions of dollars in compensation (including under BI coverage). It is now standard for insurers to include in the coverage they offer clauses excluding their liability for losses arising due to epidemics caused by a SARS virus (the current COVID-19 epidemic is caused by the virus SARS-CoV-2). Nonetheless, through negotiations and with higher premiums, an insurer may waive this type of exclusion and assume an increased risk.
When discussing the issue of BI insurance, we should also raise the issue of “master policies,” i.e. insurance concluded under a policy that is an integral part of an international insurance programme. Enterprises interested in BI coverage are often those providing services on international or global markets, where there is a need for the insurance they take out to fit within a common framework and limits. Hence policies of this type are common in industries such as energy, construction, and hotels.
Conclusion of BI coverage under a master policy means that the conditions of insurance must typically be assessed on two legal levels: the Polish regulations (related to the local insurance) and the relevant provisions set forth in the international scheme. As the master policy sets the framework and limits for the insurance, the scope and limits of coverage in the local (national) insurance should, as a rule, be no broader than those specified in the international scheme. Nonetheless, the BI insurance itself should clearly specify which provisions of substantive law should be applied and which terms are controlling if there is any discrepancy between the terms set forth in the international scheme and those provided for in the national coverage.
As this overview shows, business interruption is a relatively complicated insurance product. This follows from the specific construction of this coverage, which on one hand is coupled with property insurance and on the other hand covers losses whose amount is typically purely hypothetical.
Given the current status of the coronavirus epidemic, it may be assumed that as a rule business interruption insurance will not cover pandemic losses, as since 2003 insurance companies have routinely excluded SARS epidemics (which would include COVID-19) from the scope of coverage. It should also be remembered that a condition for payment of compensation under BI insurance is an injury to property, and the coronavirus epidemic does not directly cause such injury.
Nonetheless, it cannot be ruled out that an insurance company will be required to pay compensation under business interruption coverage, for example if the policy contains a clause on official acts of civil authorities. But even then, as a rule, it will also be necessary to identify injury to insured property.
Mateusz Kosiorowski, Insurance practice, Government Claims practice, Wardyński & Partners