Articles - What can we learn from the FCA Business Interruption case

In this article 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.

 By Wendy Kriz, IFoA, Senior Consulting Actuary and Wan Hsien Heah, FIA CERA, Principal and Consultant at Barnett Waddingham
 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.Subsequently, an appeal to the Supreme Court was heard . 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 .
 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. 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.
 After the Supreme Court ruling, Hiscox increased its BI reserves by $48m net of reinsurance, 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.
 This net loss was maintained after the second ruling, while QBE raised its overall Covid-19 allowance by USD 185m . The FCA is expected to use the result to encourage payment of other valid claims .
 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.
 What does this mean for the insurance market?
 Reserves – Firms must rapidly learn the lessons of the past. Immediate provision should be made upon the occurrence of a large-loss event. Legal defences are not sufficient to guarantee the lack of indemnity, so a balanced and considered approach is important.
 Adequate systems and structures are needed to track Covid-19 claims and ensure customers are treated fairly. Due to regulator focus on the practices and behaviour of insurers, firms should provide customers with appropriate service and cover.
 Underwriting – Revisit all policy wordings. Terms and conditions should be uncomplicated, concise and robust. This will help maintain profitability and competitiveness in the hardening market and mitigate future losses. Such changes should be in accordance with the FCA’s ‘Treating Customers Fairly’ initiative; justification may be needed. The FCA has already asked firms to review the value of their products following Covid-19.
 Risk/Exposure management – Prior to Covid-19, the industry ignored difficult to confront latent risks. Latent risks are hard, but not impossible, to spot. To mitigate, firms should brainstorm and track the evolution of risks to react when they crystallise. Firms should assess tracking and managing this exposure to ensure continuing solvency and profitability.
 Scenario testing – Firms should consider ‘stressing a stress’ and the potential for Covid-19 to last many years. They should then revisit tests to ensure stress testing compounds the severe stress we are currently experiencing, as the current stress is now the ‘new normal’. Stresses are not mutually exclusive, so a new baseline should be established with new stresses applied. Significant cyber-attacks in 2020 remind us that different stresses can - and do - occur simultaneously.
 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. 

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