FCA business interruption test case: what can we learn?

Estimated reading time: 5 minutes

In this blog we consider the impact of the Financial Conduct Authority (FCA) test case on business interruption (BI) insurance.

In 2020, the Covid-19 pandemic spread throughout the world, causing unprecedented disruption. The pandemic exposed BI insurance coverage issues, ending up in the Supreme Court. For insurers, managing the fallout from this crisis is key to their future success.

FCA test case: what happened?

From June to September 2020, the FCA argued a test case covering 21 BI policy wordings at the High Court. The FCA was concerned insurers were not paying valid Covid-19 claims. Insurers defending the case were Arch, Argenta, Ecclesiastical, Hiscox, MS Amlin, QBE, Royal & Sun Alliance, and Zurich. Hiscox was particularly prominent due to a group calling itself the Hiscox Action Group.

The High Court returned a varied verdict. It primarily ruled in favour of consumers with ‘Disease type’ policy-wordings and against those with ‘Prevent of Access type’ policies ¹.

Subsequently, an appeal to the Supreme Court was heard ^₂. In contrast to the High Court case, the Supreme Court’s judgement was heavily in favour of small businesses, interpreting the impacts of the pandemic broadly. Consequently, this will make insurers liable for far greater claims than the High Court’s verdict _³.

What was the outcome?

Some 700 types of policies across 60 different insurers and 370,000 policyholders had potential to be affected by the case ¹. The initial judgement clarified that less than one third of Hiscox's 34,000 UK business interruption policies may pay out, reducing losses from £250m to £100m ⁴. 

After the Supreme Court ruling, Hiscox increased its BI reserves by $48m net of reinsurance ⁵, while the firm’s share-price initially fell more than 4% but rallied to finish the day up 3%. 

The effect on other insurers was more varied. Firms such as Aviva, who did not contest, saw little movement in losses after the first ruling. QBE saw an increase in gross losses, but no increase in net losses due to extensive reinsurance after the first judgement ^6 7 8. This net loss was maintained after the second ruling, while QBE raised its overall Covid-19 allowance by USD 185m ⁹. The FCA is expected to use the result to encourage payment of other valid claims ¹⁰.

What lessons have been learnt?

Policy wordings

Though the potential exposure was identified early in the pandemic, some insurers were confident policy wordings would protect them from the majority of claims ¹¹. The judgement demonstrates the importance of setting reserving assumptions in uncertain times.

Reputational risk

Insurer’s differing responses to the validity of claims provides a case study in reputational risk. Some firms contesting claims were thrust into the spotlight by business action groups and saw a slow recovery of their share price. Other firms chose to pay claims early on without contesting, with minimal share price impact. While there are other factors, this provides strong evidence that contesting the case damaged firms’ reputations. 

Behavioural bias

It is important to recognise where firms and actuaries have innate biases in their decision-making. For example, having the mindset of “it will never happen” does not adequately prepare a firm for the ramifications of when it does happen. This level of denial, to an extent, could be seen in the way firms responded to the case in the early days. Being aware of the bias is typically the first step to then addressing how management decisions and actuarial judgements need to be adjusted for it. 

Conclusion

Covid-19 is here to stay, as are the issues in this case. The industry will have to balance adequate reserving, FCA compliance and customer care under greater public scrutiny than ever. Firms face an increasingly volatile market where assumptions are more important than ever, yet harder to set accurately. 

The challenge for insurers now is to understand, adapt and thrive in these new, ever changing conditions.

To see how we can help you assess the impact of Covid-19 on your processes, please contact your usual Barnett Waddingham consultant or the authors below. You can also get in touch with Ed Hundleby, a key contributor to this blog.