All the talk about whether insurance policies will respond to COVID-19 losses causes me to think about how reinsurers will respond to COVID-19 losses if they are ceded. There are lots of considerations, including whether the cedent’s loss payments were made on an ex gratia basis, whether civil authority orders change the dynamic, what lines of business are being affected, whether reinsurance contracts allow for aggregation of COVID-19 losses as a single occurrence and whether the reinsurer has too much COVID-19 concentration. This blog post will start the discussion about some of these issues from the property and casualty prospective.
Everything we have blogged about concerning whether a COVID-19 loss is covered by insurance applies to reinsurance. Reinsurers will be looking at the same issues when receiving claims from cedents.
The first thing reinsurers will do is review their assumed portfolio to determine where potential COVID-19 claims are likely to come from. Reinsurance contracts run the gamut from whole account protections to excess-of-loss contracts on specific lines of business to facultative certificates for specific policies. Reinsurers will need to assess their line of business spread and determine where the concentrations are for possible COVID-19 loss cessions. Once identified, reinsurers have to look at the terms and conditions of the ceded policies.
Because of the massive disruptions happening now with voluntary and mandatory business closures, commercial property reinsurers are watching for business interruption, contingent business interruption and supply chain losses arising from COVID-19 shut downs. As thousands, if not millions, of businesses close because of civil authority orders or because of supply chain disruptions, the first line of losses that reinsurers might see will be from the business income and extra expense coverages on their assumed property portfolios.
Prior blog posts have discussed some of the insurance issues here, including the requirement of direct physical damage or loss to insured property by covered loss requirements, waiting periods, civil authority orders and the like. But, what if a ceding company accepts and pays COVID-19 losses from its insureds based a determination that the virus is causing direct physical damage to insured property? Is that something that reinsurers will also accept?
The answer to that question depends on various factors. First, the specific reinsurance contract wording is key to determining whether a loss cession is proper. Second, the facts of the underlying loss, and whether that loss fits within the actual terms and conditions of the ceded policy, are critical to determining a reinsurance claim.
When we examine the reinsurance contract, the question is how broad is the contract in allowing the ceding company to determine whether a loss may be ceded? Does the reinsurance contract have traditional clauses that allow the cedent to determine the loss and require the reinsurer to follow the determination of the cedent? Of course, we are talking about follow-the-fortunes/follow-the-settlements.
Modern reinsurance contracts do not all have the same traditional follow-the-fortunes or follow-the-settlements clauses or the traditional utmost good faith language that older reinsurance contracts often contain. If the reinsurance contract does not have language requiring the reinsurer to follow the cedent’s claims determinations, it is more likely that the cession of a COVID-19 loss under a business interruption cover may be rejected by a reinsurer on the basis that there is no direct physical loss and that COVID-19 is not a covered loss. But, if the reinsurance contract has a more traditional follow-the-settlements clause, does that make a difference?
Cedents will argue that under a traditional follow-the-settlements provision a reinsurer must follow its claims determination and pay the loss. Reinsurers, on the other hand, will argue that the claims determination has to be made in good faith and businesslike to be followed. The traditional principles of follow-the-settlements support the notion that if the cedent pays a claim reasonably and in good faith, and the claim falls within the terms of the underlying contract and the reinsurance contract, the reinsurer must pay, and the reinsured’s claims determination will not be second-guessed.
Disputes over cessions of COVID-19 business interruption losses, if they happen, likely will focus on whether the payment was reasonable, made in good faith and comes within the terms of the ceded insurance contract and the reinsurance contract. If the underlying contract has the virus and bacteria exclusion, it will be very hard for a cedent to obtain reinsurance coverage for a COVID-19 claim under those circumstances. If the business income and extra expense coverage, as it normally does, requires direct physical damage or loss to covered property by a covered loss, the dispute will come down to whether a virus can cause direct physical damage to insured property and whether COVID-19 is a covered cause of loss. But, if these provisions are absent or if the underlying policy covers contagion, the reinsurance response may be different. This will all play out in real time as we address COVID-19 as a nation and a planet.