The global shutdown in the face of the COVID-19 pandemic is testing the clauses of insurance policies – specifically business interruption insurance – with claimants and insurers across the world fighting it out in court.

The Western Cape High Court recently issued a judgement ruling in favour of policyholders Ma-Afrika Hotels and Stellenbosch Kitchen against short-term insurer Santam. Santam has taken the matter on appeal.

In July the courts made a similar ruling in the matter of Café Chameleon versus Guardrisk. That matter was heard on appeal on Monday 23 November at the Supreme Court of Appeal (SCA). The final outcome of these cases will have a lasting impact on the cover provided by the insurance industry.

Standard business interruption insurance covers direct physical damage to property, for example a fire or flood, and does not respond to business interruption losses such as COVID-19 claims or a shutdown due to a national disaster.

However, some policies contain extensions which cover losses resulting from a contagious or infectious disease which occurs within a defined distance from insured properties.

Establishments like Ma-Afrika Hotels, Stellenbosch Kitchen and Café Chameleon had this cover in place and could demonstrate that there were outbreaks of COVID-19 in their areas. Insurers argue that lockdown – not the disease itself – was the cause of the losses, and that this was not covered by the policy.

Legal certainty

Insurers have repeatedly stated that they require legal certainty around this interpretation. The Western Cape ruling found that “had it not been for Covid-19 and the government’s response, the applicants’ business would not have been interrupted and they would not have suffered their loss. In our view the applicants’ loses are exactly what they had insured themselves against.”

The court ruled that the indemnity period for which the cover should be applicable, is up to 18 months. If the establishment were unable to trade for up to 18 months, the insurance would cover their losses up to that period. Currently the combined total of business interruption insurance for loss of revenue for the Ma-Afrika group is R105 482 456 and for Stellenbosch Kitchen R16 947 368.

Ryan Woolley, CEO of ICA, the public loss adjustment company that represents Ma-Afrika and Stellenbosch Kitchen as well as over 750 businesses in the tourism and hospitality sector says: “In our view, the judgment from a full Western Cape High Court bench, provides the legal certainty required to finalise all claims relating to business interruption caused by the pandemic. We believe it is now time for the insurance sector to step up and display the ethical leadership that has been missing from their response to this crisis thus far.”

The Financial Sector Conduct Authority (FSCA) issued a press release agreeing with the court’s decision that “if a policyholder can prove that it suffered a loss as a result of the disease which spread into the area, for example, less bookings, cancellations of bookings and so forth, that may amount to a valid claim”. It urged insurers to pay claims based on this ruling.

Huge financial impact on insurers

Woolley estimates that the impact on insurers would be in the region of R15 bn. While this court ruling is good news for the tourism industry which accounts for 740 000 direct and 1.5 million indirect jobs contributing 8,6% to the South African economy, the impact on the local and global reinsurance industry would be significant.

Professor Robert Vivian, Professor of Finance and Insurance at the University of the Witwatersrand explains that all primary insurers such as Santam and Guardrisk reinsure a percentage of their risk through the re-insurance market.

It is global practice to spread the risk pool and reduce single-country risk by effectively pooling the world’s insurance risks. It was never envisaged that every country in the world would face the same event at the same time. Vivian believes insurers would have had sufficient reserves to cover a global pandemic itself, but the economic lockdown was something different and is, he argues, an “uninsurable event”.

Professor Vivian uses the example of the National Lotto. If everyone who entered the lotto won the jackpot, it would be impossible to meet all those payouts from the R5 paid per ticket. In the same way, if all policyholders claimed for the same event at the same time, there are not sufficient premiums to meet all those claims.

South Africa’s primary insurers are required to have reserves to cover their portion of the claim, but it could put future claims at risk. Reserves are required by law to cover future exceptional claims. As a rule reserves are around 25% of premiums written – in the region of R30bn for the industry.

The claims cost could result in reserves falling below the statutory levels. If insurers’ reserves were depleted by the national lockdown, it would make them vulnerable if, for example, we experienced another major insurable event such as the 2017 Knynsa fires and storms which saw R5bn paid in losses – the largest claim in one year for natural disasters on record, but only 30% of potential BI claims.

“A person who has insured his house may wonder why his claim is not being paid because of an unrelated business interruption pool which was compelled to run at a loss,” says Vivian, who notes that South African insurers are well capitalised, if reinsured.

Depletion of global reinsurance reserves

Of greater concern is the net effect of insurers across the world calling on their reinsured element at the same time from the same event which could deplete the global reinsurance reserves.

The Pennsylvania Law School’s Covid-19 Coverage Litigation Tracker shows that more than 1 200 Covid-19 lawsuits have been filed to date. This could put millions of policyholders who have other forms of short-term insurance at risk of losing their cover.

“This is unlikely to make the market go insolvent, if reinsured, but it is a warning to the industry that they are exposed to these things and they will make changes”. Policy exclusions are already being introduced.

Currently reinsurers “follow the fortunes” of the primary insurer. This means if the primary insurer, Santam, was ordered by the courts to make payment, the reinsurer would meet their portion of the obligation. However, Vivian says it is conceivable that reinsurers could in future reconsider this the rule. This may result in insurers having to challenge the claims in the courts where the reinsurers are based. Most large reinsurers are based in Europe which would make it an expensive exercise. It is also possible that in order to rebuild reserves, insurers would be required to increase premiums for all forms of cover.

“The Supreme Court here and in London will be weighing up the arguments. It was sensible for the judges of the Western Cape High Court to rule in favour of the claimants so that this matter can be decided by the Supreme Court,” says Vivian.

It is still possible that it may not end up with the Supreme Court. Woodley argues there is still time for insurers to make policyholders an offer before the matter is decided by the Supreme Court early next year.

Many insurers have already paid out interim relief to policyholders with Santam paying out R1bn to nearly 2 500 small and medium-sized businesses affected by Covid-19.

Santam has issued a statement that it is considering the judgement and will “discuss the implications of the judgment with all our stakeholders, including reinsurers, in order to arrive at a comprehensive response.”

It is possible we will still see an agreement being reached that meets the tourism industry whilst balancing the impact of an “uninsurable” event on global insurance.

This article first appeared in City Press.