Courts to have final say over ‘business interruption’ coverage

With no compromise in sight, it appears the debate over business interruption insurance coverage will be solved by litigation, not legislation.

At issue are thousands of businesses around California with insurance policies to protect them against a sudden catastrophic event that forces them to close down for an extended period of time.

Like a global pandemic.

The exemption is the direct result of losses insurers incurred from the 2003 SARS outbreak,

But while business owners with business interruption insurance believed they have coverage to protect their operations from the COVID-19 fallout, insurers don’t see it that way. They cite language in those contracts that requires a business to suffer “a direct physical loss or damage,” like from a fire or flood. In short, no mangled building means no coverage.

At stake nationally are hundreds of billions of dollars.

There is also the matter of a clause in the standard business interruption insurance policy that excludes closures caused by a virus. The exemption is the direct result of losses insurers incurred from the 2003 SARS outbreak, losses that convinced the industry to seek permission from regulators to explicitly exempt pandemics from their coverage. Since 2006, most policies have done so.

The insurers’ stance has sparked a furious response from business owners and a growing number of state and federal lawmakers. To date, lawmakers in at least seven states – New Jersey, New York, Pennsylvania, Massachusetts, South Carolina, Ohio and Louisiana – have filed bills that would force insurers to cover closure losses related to the pandemic.

The American Property Casualty Insurance Corporation estimates that “closure losses for small businesses with fewer than 100 employees are between $255 billion to $431 billion per month.”

California state lawmakers have so far opted not to follow in their footsteps, though several of the state’s Congressional representatives have attempted to pressure insurers to cover the closure losses.

A growing number of business owners are also filing lawsuits, including renowned chef Thomas Keller of Yountville, who filed suit in March in Napa County Superior Court against the Hartford Insurance Company.

That suit isn’t seeking damages, but rather a binding judgement on the whether the business interruption policy on his world-famous French Laundry and Bouchon Bistro restaurants should cover losses incurred during the shutdown. His is just one of numerous individual and class action suits filed around the country and Canada.

Both sides paint the issue as a looming catastrophe.

Business owners say that if insurers don’t cover their losses, a huge number of them are likely to never reopen. For some perspective, the American Property Casualty Insurance Corporation estimates that “closure losses for small businesses with fewer than 100 employees are between $255 billion to $431 billion per month.” Estimates for losses of companies with 500 or fewer workers are pegged at “between $393 billion to $668 billion per month.”

Insurance leaders say if they are forced to cover losses of that magnitude without having ever collected premiums on that kind of coverage it would put the entire industry at risk of insolvency.

California Insurance Commissioner Ricardo Lara has so far opted to tread lightly.

Insurance commissioners around the country have taken a dim view of both the lawsuits and the legislation. Commissioners in Georgia, Kansas, Louisiana, Maryland, Mississippi, North Carolina, West Virginia and the District of Columbia have all expressed their belief that barring a policy with explicit coverage against viruses, business owners are out of luck.

And in a statement issued on March 25 by the National Association of Insurance Commissioners says “if insurance companies are required to cover such claims, such an action would create substantial solvency risks for the sector, significantly undermine the ability of insurers to pay other types of claims, and potentially exacerbate the negative financial and economic impacts the country is currently experiencing.”

California Insurance Commissioner Ricardo Lara has so far opted to tread lightly.

In March, he ordered insurers to collect and submit data on business-interruption claims to his office. Then in April, he responded to growing claims from policyholders that their insurers were trying to discourage them from filing claims at all by releasing a statement reiterating “that insurance companies need to fairly investigate all business interruption claims as they would during any disaster.”

There are policies that cover stoppages due to a virus, but premiums will always be a lot higher to reflect that.” — Carlton Larson

Neither action has any penalties associated with it, and to date neither Lara nor any member of the Legislature has voiced their intention to submit legislation on the issue.

UC Davis constitutional law professor Carlton Larson is also skeptical of both the lawsuits and the legislation. A former commercial litigator at Covington & Burling in Washington, D.C., his background is representing policyholders in trying to maneuver “the chicanery” of the insurance industry. But he says the circumstances in this case seem pretty cut and dry.

“If there is an exclusion in the policy, that’s usually it,” he says. “There are policies that cover stoppages due to a virus, but premiums will always be a lot higher to reflect that.”

He also isn’t buying complaints that the exclusion is buried in a policy’s fine print. He says states are responsible for imposing and enforcing their own statutes, meaning that whatever is in a contract has been reviewed and signed off on by state regulators before it can be offered to consumers. And in that case, the impetus is on the policyholder to know what they are buying.

“It’s certainly no defense to say you didn’t read it or that it’s just boilerplate language,” he says.

“To the best of my knowledge, there is no evidence that anyone has actually had the virus in their business, so the virus itself is not the reason why the business closed.” — Brian Kabateck

Larson says lawmakers could theoretically require all future policies to cover such interruptions, but doubts that doing so after the fact could withstand legal challenges. Legislation that would require future business interruption policies to cover virus-caused shutdowns (HR 6494) has been introduced in the U.S. House of Representatives by Rep. Mike Thompson, who represents Napa and other parts of Northern California wine country.

Consumer attorney Brian Kabateck of Kabateck LLP in Los Angeles agrees that the legislation seen in states like New Jersey is seeking to “rewrite the policies,” which isn’t likely to fly in a court of law. But Kabateck – whose firm is representing over 100 clients with business interruption claims in California, Texas, New York, Wisconsin and Illinois – also calls the industry’s claims of potential insolvency “fear mongering.” He notes that all large insurance companies carry re-insurance – insurance against paying out on their own policies – as well as catastrophe bonds, which help them raise large amounts of money quickly in the case of a natural disaster.

He also believes litigants going after insurers do have a few very solid points in their favor.

“First, the burden of proof is always on the insurance company to prove the exclusion applies,” he says. “To the best of my knowledge, there is no evidence that anyone has actually had the virus in their business, so the virus itself is not the reason why the business closed. It was closed due to a civil authority order, and policies have coverage for civil authority closure orders.”

The industry has in recent weeks floated the idea of a new business interruption program, backed by the federal government.

One other factor, he says, is that California insurance law doesn’t require the typical physical damage for there to be property damage.

“You could have property damage by being denied your property, which is what has happened to these business owners,” he says.

Whether courts of law agree with those assessments is yet to be seen. Kabateck says the industry might be angling for the federal government to step in, essentially becoming the insurer of last resort to help insurers pay if they are ordered to cover current business interruption claims.

University of Minnesota law professor Daniel Schwarcz has also publicly suggested it might not be the end of the world for insurers if they are forced to cover the closures under the civil authority clause because that coverage is limited to just three weeks of losses.

All of which is still to be determined, but the industry has in recent weeks floated the idea of a new business interruption program, backed by the federal government, that would cover companies for closures caused by a virus.

That plan would also apply only to future policies and not be applied retroactively.