Business interruption insurance does not cover pandemics and proposals to retroactively change these agreements would unfairly rewrite the rules.
By the Editor
As the coronavirus pandemic spreads throughout the country many state and local governments have required non-essential businesses to close, including restaurants, theaters, gyms, and the like. The impact on the economy has been devastating with small and medium businesses hit particularly hard. These businesses, their owners, and their employees are innocent bystanders in this tragedy. In response, many ideas have been put forward to provide support.
One particularly bad idea being promoted by some politicians and litigation lawyers is to retroactively require business interruption insurance to cover losses related to the pandemic. These policies were not originally written to cover pandemics so the premiums paid were not priced to include this risk. Retroactively changing these policies would be unfair to the insurers who entered into these agreements and would fundamentally damage the reliability of contracts, resulting in serious harm to our economy’s ability to operate efficiently.
To understand this issue, it is helpful to start with an overview of business interruption insurance.
These policies are written to cover physical loss or damage.
Business interruption insurance is generally written to cover certain costs arising from physical loss or damage due to events such as fires or floods. This kind of policy does not cover losses related to government-mandated business closures due to a pandemic because there is no physical loss or damage in these cases.
Insurance policies only cover items that are specifically listed.
Insurance policies start with a specific list of items that are covered and build from there by adding certain clarifications and conditions. An examination of business interruption insurance policies will reveal that losses from pandemics are not included in the original list of covered items.
Many policies go further and specifically exclude any losses related to virus outbreaks. This is an extra clarification added for the avoidance of doubt. Some politicians have suggested if policies do not have such a “virus exclusion” that must mean the policy covers losses from pandemics. However, just because something is not excluded does not mean it is covered. This makes sense because it is impossible to list every possible exclusion.
The policy protections cannot get bigger than the original set of covered items, whether or not exclusions are added for clarity. For this reason, it is a mistake to assume that a policy without a “virus exclusion” will cover pandemic losses.
Insurers need to clearly understand what is covered so they can calculate the risk of loss and charge premiums that are commensurate.
It is important for insurers to know upfront what risks a policy covers so they can analyze and quantify the potential risk. This process determines what premiums they charge their customers. In the typical business interruption insurance policy, insurers never agreed to cover losses from pandemics or the business closures we are seeing now. As a result, the premiums paid by customers never included amounts to cover the risk of pandemics. Mandating new retroactive coverage is akin to requiring insurers to sell fire insurance to a homeowner after their house has caught on fire.
It is important to read the text of each insurance policy to understand the coverage.
Insurance policies are based on standard forms approved by state insurance regulators. However, each insurance policy is individually negotiated between two parties, so it is important to read the full text of each contract to understand the coverage.
In particular, it is insufficient to find some words in a policy that sound helpful to one’s position and fail to read the complete text. For example, a politician might see a section in a policy regarding “Civil Authority Coverage” and assume this means losses from government-mandated shutdowns are covered. However, these clauses are typically limited by a requirement for physical loss or damage to the insured property or adjacent properties. Losses from a pandemic would not meet these requirements. This is an example of why the best way to resolve insurance disputes is on a case-by-case basis driven by an analysis of the relevant policy, not by imposing blanket government mandates.
Retroactively rewriting insurance policies is illegal and damaging to our economy.
Retroactively rewriting insurance policies to cover pandemics would be a violation of long-standing contract law. Despite this hurdle, seven states are currently considering legislation to retroactively require policies to cover pandemics. This would likely be an unconstitutional breach of the Constitution’s “Contracts” clause (“No State shall… pass any… Law impairing the Obligation of Contracts”).
We can be certain insurance companies would vigorously contest such an egregious overreach in court, so there is no prospect for payouts happening any time soon. In the current situation, businesses are in dire straits and need help as quickly as possible. Given the predictable legal hurdles, this idea should be disqualified based on timing concerns alone.
This issue has much bigger implications than the concerns of the insurance companies that might be adversely affected. Damaging the reliability of contractual arrangements would be extremely destructive to the ability of our economy to function efficiently. Businesses and individuals need to have confidence that they can rely on contractual agreements freely negotiated between parties. Even the attempt to break these arms’-length agreements sets a bad precedent and could make it more difficult for businesses to get standard business interruption insurance in the future.
What is the ultimate objective behind these proposals?
The lawyers agitating for retroactive pandemic coverage likely know this idea is lacking merit, but they are filing lawsuits against insurers anyway. Given their weak legal position, why are they pursuing this course of action? It seems there is a multi-pronged strategy.
One objective is to extract out-of-court settlements from insurers who might prefer to avoid lengthy and unpredictable litigation. A second route is to persuade politicians to legislate a rewriting of business interruption insurance policies to require them to retroactively cover pandemics. Because this idea of breaking contracts is probably illegal and would be extremely damaging to our economy, it seems like a longshot.
Perhaps the ultimate plan is to use existing business interruption insurance as a framework for distributing government aid to businesses. One of the plaintiffs’ lawyers, John Houghtaling, alluded to this angle when he said, “We are willing to support federal subsidies for insurers who cooperate with us.”
Proponents say this approach would have the advantage of utilizing existing insurance industry infrastructure. Insurers have established processes to administer business interruption payments, including methodologies to analyze and validate losses and quantify appropriate payouts. The hope is that these existing systems would provide an efficient way to distribute government aid to a large number of needy businesses.
While it is true that insurance companies have some relevant expertise in calculating business interruption losses and an existing system for disbursements, this idea has a serious drawback. If the insurers administering the plan are merely intermediaries passing on government money, they would have no “skin in the game.” As a result, insurance companies would have no incentive to accurately calculate losses. This would increase the potential for waste and fraud.
There are other problems. Not all businesses have business interruption insurance. Approximately two-thirds of small businesses with less than 50 employees do not have this type of insurance to begin with. Also, it would be difficult to quantify in advance the amount of payments that would result from this type of program, creating an open-ended payment obligation for the government.
Two Wrongs Don’t Make a Right
Many of our country’s businesses and their employees are suffering through no fault of their own as their operations have been severely damaged by government directives to reduce their activities. A strong case can be made that these businesses should receive assistance.
This is no excuse to unfairly penalize other innocent parties, such as insurance companies. They never agreed to cover losses from pandemics and were never paid to assume that risk.
More fundamentally, the reliability of contracts freely agreed between parties is a crucial underpinning of our economy. Retroactively rewriting insurance policies would erode this pillar of our economy and would be extremely damaging to our country’s ability to grow and prosper.
America’s businesses are suffering and deserve help. Policymakers should work to find the fairest and most efficient way to direct taxpayer resources to provide the needed assistance without causing further collateral damage to our economy.
The Editor