- The Background Information of the Raised Question
The rapid spread of the COVID-19 pandemic has left a huge impact on business operations worldwide. For many companies, a business interruption ("BI") that could result from this impact is a hazard which features among their greatest operational risks this year.
Although many companies are insured against BI, their coverage under their insurance policies may not extend as far as they believe. In legal practice, the question of whether BI caused by the infectious diseases is covered by a BI insurance policy provided has given rise to great controversy.
The mainstream view holds that BI insurance is generally an additional insurance to "all risk" or other types of property insurance, therefore only those losses consequent on property damage are covered by BI. However, if there are BI extension clauses such as the infectious disease clause expanding the scope of the covered losses, the BI losses caused by the infectious disease can be compensated based on the relevant applicable extension clause, even if the insured has not suffered from property damage.
Why is compensation under a BI policy be on the condition that "damage to property" has occurred? There are a number of historical and contextual factors behind this rule, and this article sheds some light on them.
- The reason why the insurer's BI loss must result directly from "damage to property"
BI in China is considered to be a foreign transplanted product. Most of the mainstream insurance companies in China adopt the terms similar to those in the insurance markets of the UK or the USA.
Taking the BI clause of a large property insurance company in China on record with China Banking Insurance Regulatory Commission for example, article 3 of the clause states that,
"[D]uring the insurance period, where the insured suffered losses on the property used for its business operations due to the risks covered by the main property loss insurance clause (hereinafter referred to as the "property insurance loss"), resulting in the interference or interruption of the insured's business operations, the loss of gross profit thereof occurring during such indemnity period shall be compensated by the insurer in accordance with this insurance policy. The indemnity period mentioned in this insurance contract refers to the period from the date of the occurrence of the insured property loss, to the insured's business continuously affected by the insured property loss, but the maximum period shall not exceed the maximum indemnity period agreed in this insurance contract [emphasis added]."
For its part, the London Business Interruption Association ("LBIA") issued a BI guide which indicates that BI insurance compensates for the indirect losses resulting from direct property damage. In summarizing business interruption insurance liability practice in the UK, the LBIA guide provides that, "the insurer will pay the amount of the Consequential Loss resulting from interruption of or interference with the Business carried on by the insured at the Premises consequence upon DAMAGE to Property used by the Insured at the Premises in accordance with the undernoted definition."1
- BI is Established to Cover the Indirect Losses Caused by the Property Losses Which Would Not Be Covered by the Traditional Property Insurance
Traditional property insurance only compensates for the direct property losses of the insured subject matter against the risks within the scope of insurance liability, and the insurer is not responsible for indirect property losses of the insured arising from suspension of production, reduction of production, or business interruption, etc.
At the end of the 18th century and the beginning of the 19th century, after experiencing a significant increase in productivity owing to the Industrial Revolution, business risks increased. Traditional property insurance like all risks insurance, could not cover the indirect losses of profits due to the accidents. The time had come for a compensation policy based on recovery of daily losses. This became the prototype for modern BI insurance.2
Another earlier name for BI, Use and Occupancy Insurance, can better reflect its direct relationship with property losses.3 Under this type of policy, the insurance company shall pay, according to the calculation method agreed in the insurance clauses, for the losses resulted from interruption of the insured's normal use and occupancy of the insured property because of the insured property risk. Different disputes might arise in different cases because of the specific wording of the insurance clauses, but the general principle is that BI covers losses consequent upon damage to the insured property.
- The Losses Covered by BI Need to Be Calculated Based on the State of the Insured's Damaged Property
As discussed, the idea behind BI insurance is to cover the indirect profit losses that result when an insured peril arises. The period of business interruption is the period required to repair or replace the damaged property, namely from the time when the insured must interrupt their business due to the occurrence of the insured accident to the time when the insured resumes business. BI will thereby ensure that the insured can still operate with the same business revenue it would have generated had the accident not occurred. That is, however, the limit of what BI insures: not a penny less, not a penny more. Therefore, the insurable interest of BI is the business profits brought by the insured property.
The above mentioned LBIA BI Guide summarizes the two mainstream calculation standards for UK BI losses as Gross Profit Basis ("GPB") and Gross Revenue Basis ("GRB"). GBP calculates the losses by including the reduction of turnover and the increase in maintenance costs, and the latter, GRB, calculates the losses by referring to the amount which shall fall short of the Standard Gross Revenue.4
In China, the domestic underwriters will generally calculate the insured business interruption losses by referring to the losses during the indemnity period in terms of gross profit. The calculation involves three aspects: the loss of gross profit due to a decrease in operating income, the loss of gross profit due to an increase in operating expenses, and the saved costs because of the insured accident. The sum of the first two minus the amount from the third equals, generally, the gross profit losses that need to be indemnified.
- Even If there are BI Extension Clauses, the Establishment of Insurance Liability is Still Premised on the Incurred Risk of Losses of Damage to Property
The above calculation of BI losses is based on the premise that the insured property suffered from damage, and that damage led to BI losses. Based on different needs of the insureds from different industries, BI policies often have their respective BI extension clauses to extend the concepts such as the Insureds, Business types, Business Premise, etc., thus covering some circumstances intended to cover by the parties.
Common extensions of BI include Communicable or Infectious Diseases, Denial of Access, and Civil Authority Orders, among others. However, even if the extension clauses are applied to expand the scope of insurable losses, the premise for the establishment of BI liability of the insurer is still that it incurred insured risk of damage to the insured property.
It needs to be added that, in China, most BI insurance clauses provided by domestic insurance companies are as additional insurance thus making the limit of the indemnity foreseeable. However, BI does not by itself need to be a form of additional insurance by considering its original purpose. If the underwriting risk and the scope of property can be clearly defined in the BI policy, there is no major threshold for the insured to apply for a separate and independent BI policy.
In practice, disputes arising out of BI will also concern the subsequent identification of insured risks, whether BI extension clauses including infectious diseases clause have been triggered, whether the claimed losses are caused by the damage to property, and the specific losses calculation method, etc. However, the premise that needs to be clarified is that BI does not cover all losses due to business interruption, but those losses caused by business interruption due to the losses arising out of the damage to insured property. Otherwise, all unforeseen circumstances that may affect the business of the company will be the cause of possible claims, deviating from the spirit of BI and its coverage of insurance liability.
Guide to business interruption insurance and claims, p5 http://london-bia.org/lectures/LBIABIManual.pdf#:~:text=LBIA%20guide%20to%20business%20interruption%20insurance%
2. Tao Cunwen, Geng Yuting, "Overseas Business Interruption Insurance System and Its Enlightenment", published in Insurance Research, No. 4 of 2008.
3. Pamela Levin & Thomas H. Nienow, Business Interruption Coverage - Demystifying the Causation Analysis, 24 Brief 30 (1994).
4. See supra 1, page 13, "Standard Gross Revenue The Gross Revenue during that period in the twelve months immediately before the date of the occurrence of the incident which corresponds with the Maximum Indemnity Period"
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.