Preparing for Reinsurance Fallout From COVID-19 Pandemic
With the onslaught of COVID-19 insurance claims already underway, reinsurers and cedents will need to pay careful attention to the nature of the claims and potential reinsurance ramifications early in the process to ensure that their financial interests are fully protected. The nature and scope of the claims are unprecedented, and will present complex challenges to all parties.
As a threshold matter, there will be numerous coverage issues presented by the direct insurance claims. Examples of some of the early claims we have seen are business interruption claims for the massive losses experienced by large and small businesses impacted by the shelter in place and other governmental orders, workers’ compensation/employee illness claims and third-party liability claims from people allegedly contracting the virus because of the negligence of others, such as cruise ship lines. Other types include supply chain interruption claims, decontamination/cleanup cost claims and event/trip cancellation claims.
Because of the unique nature of this crisis, each of these types of claims may raise novel coverage issues, and it is possible that many claims may not satisfy threshold coverage requirements, such as the requirement in most business interruption policies that there be direct physical loss or damage to property in order to trigger a business interruption claim. Many claims also may be subject to policy exclusions, such as the absolute pollution exclusion, especially where the language expressly includes “virus” in the definition of a pollutant.
Some policies also include an express exclusion for loss due to virus or bacteria. Complicating matters even further is the jurisdictional nature of the case law, where certain jurisdictions enforce exclusions more stringently than others. Overlaying these coverage issues will be the strong public pressure for insurers to pay claims to preserve reputational and commercial interests. Moreover, several states have proposed legislation to force insurers to pay claims that might otherwise be outside the scope of coverage. While this legislation may be subject to challenge on constitutional and other grounds, the fact is that many insurers may be compelled to pay these COVID-19 claims.
Because of the wide variety of claims, it may be difficult for reinsurers to initially assess their exposures on inbound business. Cedents, on the other hand, are already seeing claims and may have a better ability to assess the potential reinsurance that applies to the claims. The first step all cedents should undertake is to review direct policy records to identify facultative reinsurance and corporate treaties that may apply to the relevant lines of business (including catastrophe and clash protections). Once the potential reinsurance is identified, it should be carefully reviewed to determine the potential scope of coverage and the obligations of both parties. While each agreement is unique, the following are some terms and conditions that may be particularly relevant to the anticipated COVID-19 reinsurance claims:
- Notice of Loss: All reinsurance contracts contain notice of loss requirements. Many contracts require cedents to provide notice of loss “promptly” or “as soon as practicable.” Quota share contracts often have bordereau reporting that should automatically capture all claims subject to the contract and include them in the periodic bordereau, which may be provided monthly, quarterly or in some other interval. Excess of loss reinsurance may require reporting when reserves reach a certain threshold, e.g., 50% of the retention, or may contain discretionary notice provisions requiring notice of claims that the cedent believes are likely to impact the reinsurance. Still other contracts, particularly workers’ compensation contracts, require the cedent to report claims of a certain nature, such as death or loss of a major organ. In all instances, the contract should be reviewed to ensure compliance.
- Definition of Occurrence or Loss Occurrence: A Loss Occurrence is required to trigger reinsurance coverage in most contracts. While facultative and quota share reinsurance agreements may contain independent definitions of Loss Occurrence, they often follow the language in the direct insurance policy and the definition of “occurrence” contained therein. Excess of loss reinsurance will have an independent definition of “Loss Occurrence” that will govern the accumulation of losses. In the COVID-19 context, this could be particularly relevant because issues may arise concerning whether claims by multiple people against a single insured are one Loss Occurrence. There also may be a question of whether the claims of several (or all) insureds are a single Loss Occurrence. Often, Loss Occurrence is defined in relation to an “event” that has been interpreted as being limited in time and space, which could affect the aggregation of multiple separate claims. Other definitions may provide for aggregation of all losses from a series of casualties, disasters, accidents, happenings, occurrences or losses arising out of a common origin. This broader language may allow for aggregation depending on the underlying facts of the losses. In addition, some excess of loss agreements, particularly catastrophe reinsurance agreements, contain Hours Clauses, which limit the time period during which claims resulting from a given occurrence may be included as part of the loss subject to the cover. Because of the extended nature of the COVID-19 crisis, the Hours Clause could give rise to intense debate over which losses can be aggregated. Accordingly, cedents and reinsurers should analyze this language early in the claims process to determine the proper number of Loss Occurrences.
- Aggregate Extension Clause (“AEC”): Underlying insurance may respond on an aggregate basis (such that the individual claims erode an aggregate limit), as opposed to a per occurrence basis, which provides a separate limit for each occurrence. One common form of aggregate insurance coverage is product liability coverage. If a reinsurance agreement has an AEC, the AEC will require the reinsurance to respond in the same manner as the direct insurance policy and essentially treat the multiple losses as one aggregate Loss Occurrence. An example in the COVID-19 context may be product liability claims against manufacturers of personal protection devices such as masks. If the direct insurance policy treats these claims on an aggregate basis, meaning they collectively erode the aggregate limit, an AEC may allow the claims to be treated as a single Loss Occurrence, which would apply to both the retention and the limit of the reinsurance agreement.
- Follow the Fortunes/Original Conditions: These clauses are similar in many respects and are found in many reinsurance agreements. Typical language may be “all reinsurance under this Contract shall be subject to the same rates, terms, conditions, waivers and interpretations, and to the same modifications and alterations as the respective policies of the Company” (Original Conditions) or “the Reinsurer’s liability will begin obligatorily and simultaneously with that of the Company, and all reinsurance ceded hereunder will be subject to the same terms, rates, conditions, interpretations, exclusions, waivers, modifications, cancellations, and alterations as the respective Policies of the Company insofar as they relate to the business covered hereunder. Further, the obligations of the Reinsurer will extend to any policy coverage required of the Company by any legislative, regulatory or judicial body; the intent of this Contract is that the Reinsurer will follow the fortunes of the Company on the Policies to which this Contract applies” (Follow the Fortunes). See, Contract Wording at brma.org. This language may be very helpful to a cedent that decides to pay an arguably covered claim, as it could bind the reinsurer to the coverage “interpretation.” Similarly, if there is legislation that, in effect, modifies the scope of coverage and requires insurers to pay claims beyond the scope of the original policy wording, this type of language could be used to compel reinsurers to follow the policy modifications. However, where reinsurance agreements contain separate terms and conditions that are different from the underlying policies, such as exclusions or independent coverage requirements, it is possible that reinsurers could argue that the Original Conditions and Follow the Fortunes clauses may not apply.
- Loss Settlements: The Loss Settlements clause sets forth the reinsurer’s obligation to pay losses adjusted and paid by the ceding company. There are different forms used, and the precise language may be very important as certain forms grant more deference to the ceding company. For example, some clauses state: “All loss settlements made by the Company, under policies subject hereto, whether under policy terms and conditions or by way of compromise, shall be binding upon the Reinsurer, and, upon receipt of satisfactory proof of loss, the Reinsurer agrees to pay or allow, as the case may be, its share of each such settlement in accordance with this Contract.” This language grants a significant amount of deference to the ceding company, and binds the reinsurer to most compromises. On the other end of the spectrum, some Loss Settlement clauses use wording such as the following: “all loss settlements made by the Company, within the terms and conditions of the policy, shall be binding upon the Reinsurer, and, upon receipt of satisfactory proof of loss, the Reinsurer agrees to pay or allow, as the case may be, its share of each such settlement in accordance with this Contract” (emphasis added). See, Contract Wording at brma.org. This type of clause still binds the reinsurer to the loss settlements of the ceding company, but qualifies this obligation with the phrase “within the terms and conditions of the policy.” While the precise scope of this language may be subject to interpretation, it is important for the parties to analyze the language to determine potential defenses to payment that may be asserted by the reinsurer.
- Ultimate Net Loss: The Ultimate Net Loss clause delineates what loss and expense are subject to the reinsurance agreement’s retention and coverage. The language can vary from contract to contract, and both loss and expense can be treated in a variety of ways. As expense payments will likely precede loss payments for COVID-19, the Ultimate Net Loss clauses should be reviewed early on to determine the scope of reinsurance coverage for loss adjustment expense.
In sum, the COVID-19 crisis will result in a significant amount of insurance claims. These claims will be unique and may present difficult coverage issues that will be resolved through compromise, litigation and legislation. However these claims are resolved, there will be an ensuing series of reinsurance issues that should be proactively analyzed and addressed up front so that cedents and reinsurers take the proper steps to protect their interests in a manner consistent with the terms of their contracts.
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