Part three: important things to know about your insurance and COVID-19

It is not yet possible to calculate the economic toll from the COVID-19 pandemic. As the world looks towards recovery, businesses may be seeking out sources of recovery for losses resulting from operational disruptions, and insurance policies may be the first place to look.

This is the third piece in a three-part series on contractual considerations raised by the COVID-19 pandemic. We published part one on April 27, 2020, which discussed force majeure and material adverse change clauses, and we published part two on May 18, 2020, which highlighted potential affirmative defenses in commercial contracts.

Insurance policies implicated by the COVID-19 pandemic

Typically, losses resulting from business interruptions are covered under first-party commercial property policies. While the language of these policies differs from policy to policy, in general, coverage for business losses is tied to an actual physical loss of property that results from an event (e.g., a fire). In order to fall within the grant of coverage under the policy, the policyholder must be able to show that it has suffered some form of physical loss. With contamination or potential contamination from a virus, the physical loss requirement may be absent in the traditional sense.

“Physical loss” is not defined in commercial policies but insurers have taken the position in similar situations that since the contamination can be eradicated by cleaning, it does not constitute a direct physical loss. Thus, insurers have denied coverage for COVID-19-related losses on this ground. On the other hand, however, courts have found that the presence of other dangerous substances could be considered damage, even if the property is physically unaltered.

A number of high-profile cases have been filed by business owners challenging insurers’ denial of coverage on this ground. As noted below, how these cases will play out remains to be seen, particularly as more about COVID-19 and its spread is discovered by the scientific community.

Assuming that the policyholder proves actual physical loss, there are other hurdles to coverage under commercial property policies, namely whether the loss is excluded. Many of these policies have a virus exclusion, which was adopted by the Insurance Services Office (ISO) in 2006, and most policies that are based on the ISO forms contain this exclusion.

Commercial property policies incorporate other coverage grants that could be relevant in light of state-mandated closures. For example, if the policy provides civil authority coverage and contingent business interruption coverage, which is based upon loss or damage to supply chain or communicable disease/contamination coverage, a business may be able to trigger coverage and some recovery for losses. Every policy is different, and it is important to read all parts of it carefully, including endorsements.

Other insurance policies that may be triggered by pandemic-related issues include event cancellation policies, directors and officers liability coverage (particularly for government investigations or securities claims), trade disruption policies, commercial general liability policies, workers’ compensation insurance and employment liability policies.

There is no clear-cut insurance answer to COVID-19-related losses and given the language of the policies, some state legislatures have stepped in to try to provide certainty. As described below, however, this legislation will create more questions in the short term.

Legislating coverage for COVID-19 losses

Insurance is primarily regulated at the state level, and there are efforts in a number of states to provide coverage of business interruption claims on a retrospective basis. [1] All of the proposed legislation would require insurers to cover business interruption losses that were excluded or do not fall within the grant of coverage under their policies.

New bills and amendments to existing laws have been proposed in several states, including Illinois, South Carolina, New Jersey, Massachusetts, New York, Ohio, Pennsylvania and Louisiana. In Illinois, for instance, the proposed amendment to Senate Bill 2135 would amend the Administrative Code of Illinois to require the Illinois Department of Insurance to appoint a task force on business interruption insurance. The task force’s objectives are:

1. Study the impacts of the COVID-19 pandemic on businesses and the need for changes to business interruption insurance policies based on those impacts, including recommendations for legislation; and
2. Submit its findings and recommendations to the governor and the Illinois General Assembly by Dec. 31, 2020. 

In other states, legislators introduced these bills to force insurers to cover COVID-19-related claims for businesses. Most of the state bills would apply only to claims from small businesses, defined as having fewer than 250 employees (depending on the bill), and some would allow carriers to seek partial reimbursement from the states. As of May 1, 2020, no state has enacted any legislation but the bills are making their way through the committee process.

On the federal level, a draft of the Business Interruption Insurance Coverage Act of 2020 (H.R. 6494) was introduced in the U.S. House of Representatives on April 14, 2020, and it is meant to create a government backstop to share the costs of satisfying business interruption claims. If the increased premium is not paid, an applicable exclusion may be reinstated. This act would apply to all property and casualty insurance policies. The act is not explicitly retroactive and does not include any provision for reimbursing insurers for paying future business interruption claims. As of May 1, 2020, H.R. 6494 is pending in the House Committee on Financial Services and the act requires the following:

1. Insurers must make available business interruption coverage due to viral pandemics, forced closure of businesses or mandatory evacuation by government order and public safety power shut-offs.
2. Any exclusion in force on the date of enactment would be void to the extent that it excludes the losses specified above. However, such exclusions may be reinstated if: (a) reinstatement is agreed to in writing by the insured; or (b) the insured fails to pay any increased premium for providing such coverage after notice as specified in the legislation.

Another bill in the works is the Never Again Small Business Protection Act of 2020 (H.R. 6497), introduced in the U.S. House of Representatives on April 14, 2020. In its current form, the bill requires:

1. Insurers that offer business interruption policies make available optional additional coverage that covers losses from business interruption due to any government order requiring cessation of activities during a national emergency.
2. Business interruption coverage pursuant to the bill would not be available to any business that has involuntarily terminated the employment or terminated the health insurance of any employee during the period of the national emergency.
3. A contract for business interruption coverage could exclude coverage for business interruptions resulting from national emergencies only if: (a) the reinstatement is agreed to in writing by the insured; or (b) the insured fails to pay any increased premium for providing such coverage. These requirements only come into effect after the Secretary of the Treasury certifies that there is a federal backstop mechanism in place for excess losses due to the requirements.

There were rumblings about House members’ interest in legislation to establish a Pandemic Risk Insurance Act, modeled after the federal terrorism insurance backstop, Terrorism Risk Insurance Act. The federal government would serve as a backstop to maintain stability and share the burden with the insurance industry. On May 26, 2020, Representative Carolyn Malone and several co-sponsors followed through, introducing the Pandemic Risk Insurance Act of 2020 (H.R. 7011). The act calls for the creation of the Pandemic Risk Reinsurance Program, which would be composed of public and private compensation for business interruption losses resulting from future pandemics or public health emergencies.

While several bills are being discussed, there are still a variety of approaches being taken by Congress. The bipartisan Problem Solvers Caucus recommended treating the COVID-19 pandemic as a covered peril for business interruption policies but no direction has been provided about how it will be funded. On April 10, 2020, seven senators on the Senate Banking Committee sent a letter to the President asking that he commit to protecting the insurance industry against state legislation, and warning that paying retroactive business interruption claims could lead to economic strain and potentially insolvency for commercial insurers.

Regulatory action related to insurance

In addition to the legislation noted above, many state regulatory agencies have issued directives regarding how business and property insurance carriers operate in this COVID-19 era. For instance, the New York Department of Financial Services directed all property and casualty insurers authorized in New York to provide policyholders under commercial property policies with the following:

1. An explanation of benefits under their policies and the protections provided in connection with COVID-19;
2. Information regarding the covered perils under the policy;
3. Information regarding whether contamination related to a pandemic may constitute physical damage or loss for purposes of business interruption coverage; and
4. Information regarding whether a government order prohibiting or impairing the policyholder’s access to its covered property in connection with COVID-19 would be sufficient to trigger civil authority coverage under the policy.

The Washington state Office of the Insurance Commissioner (OIC) issued a similar letter on March 25, 2020, instructing all property and casualty insurers authorized to write business policies in Washington, to provide the OIC with information regarding the commercial property insurance they have written in Washington state and the details on the business interruption coverage provided in the types of policies for which the insurer has ongoing exposure. The OIC letter required each responding insurer to provide the OIC with the following:

1. The amount of business interruption, civil authority, contingent business interruption and supply chain coverage policies written and in effect as of March 15, 2020;
2. Each insurer must examine the policies it has issued and explain the coverage each policy offers in regard to COVID-19; and
3. Prepare and send to policyholders a “clear and concise explanation of benefits” under their policies that indicates whether the policies contain a requirement for “physical loss or damage” for business interruption coverage and whether contamination related to a pandemic may constitute “physical loss or damage.”

The insurance industry’s response

The insurance industry has wasted no time in expressing concern about these state and federal efforts, warning that it cannot financially or logistically sustain itself under the magnitude of COVID-19 claims. A bipartisan group of 18 house members sent a letter on March 18, 2020, to chief executive officers of the four major insurance trade organizations, calling upon them to cover business interruption losses due to COVID-19. Those organizations responded with a letter setting forth the industry position that business interruption policies generally do not provide coverage for losses resulting from viruses, and the policies had not been priced to do so.

According to the National Bureau for Economic Research, 43% of businesses are temporarily closed and have cut payrolls by an average of 40%, and the median business has less than one month of cash on hand. According to the American Property Casualty Insurance Association, small businesses are losing between $255 and $431 billion dollars of income monthly as a result of the pandemic, while monthly premiums for commercial property insurance total $6 billion. The National Association of Insurance Commissioners, which is made up of state insurance regulators, issued a statement discouraging Congress from “proposals that would require insurers to retroactively pay unfunded COVID-19 business interruption cases,” as that could undermine the insurers’ ability to pay other types of claims.

If passed, legislation could face challenges on constitutional grounds because the contracts clause in the U.S. Constitution prohibits a state from retroactively changing or interfering with contracts.

Protect your rights under your insurance policies during this time of uncertainty

These bills have not yet become law and if passed, they will assuredly face myriad legal challenges. In the meantime, businesses can protect their rights to recovery under set policies by carefully studying the policy wording and working with their brokers or insurance coverage counsel to maximize recovery under the coverage that they have.

Client alert prepared by Kristen E. Hudson (312 855 4315), Principal, and Jasmine D. Morton (312 855 4334), Associate.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

[1] Addressed in Congressional Research Service Insight IN11382 “Business Interruption Insurance and COVID-19: State Legislative Initiatives.”