United States: Reinsurance In The Time Of COVID-19 – Part 2

In part 2 of our blog series on reinsurance issues arising from COVID-19, we consider the difficulties that might arise from the application of aggregation clauses in reinsurance policies to COVID-19 losses.

Aggregation clauses are extremely common in reinsurance policies, and they are intended to allow two or more separate losses to be treated as a single loss for the purposes of a deductible or limit. Depending on the circumstances, such clauses may be of benefit to a reinsured (for example, to aggregate a large number of losses so as to exceed a deductible) or a reinsurer (for example, to aggregate several large losses, each of which would exceed the per occurrence limit of the policy, so that the limit is paid out only once).

The question of whether losses should be aggregated will depend on the contractual unifying factor set out in the relevant policy language. Here we consider the two main types of such unifying factors: occurrence or event based clauses, and cause or originating cause based clauses.

Occurrence/event clauses

There is no single standard wording for occurrence/event clauses, but typically, such clauses will state that indemnification will be provided under the policy for "each and every loss arising out of one event/occurrence", or words to that effect.

Over time, the courts have adopted a number of approaches to determining whether a particular "happening" can be considered an event or occurrence for the purposes of an aggregation clause. For example, in Caudle v Sharp [1995] CLC 642, Evans LJ stated that there were three requirements for something to be an "event" for the purposes of this type of aggregation clause, namely that: (1) there be a common factor that can be properly described as an event, (2) that event satisfies the test of causation, and (3) that event was not too remote.

Subsequently, what is known as the "unities test" has often been applied to determine whether the event in question is sufficiently connected to the loss(es) for the purposes of aggregation. The test was first articulated in the public domain by Mr Justice Rix (as he then was) in Kuwait Airways Corporation v Kuwait Insurance Co SAK [1996] 1 Lloyd's Rep 664, where he stated the "losses' circumstances must be scrutinised to see whether they involve such a degree of unity as to justify their being described as, or as arising out of, one occurrence. The matter must be scrutinised from the point of view of an informed observer placed in the position of the insured... In assessing the degree of unity regard may be had to such factors as cause, locality and time and the intentions of the human agents."

Ultimately, however, whichever test is applied, the question of whether a series of losses can properly be said to arise from a particular event will be fact and context sensitive and it is often difficult to predict how a court will react to any given scenario.

Cause/originating cause clauses

As with event clauses, there is no standard wording used in the market, but the language used will usually state that cover will be provided for "each and every loss arising out of one cause/originating cause" or similar formulations.

The leading case in this context is Axa v Field [1996] 2 Lloyd's Rep 233 (HL), in which Lord Mustill contrasted event and cause based clauses as follows: "An event is something that happens at a particular time, at a particular place, in a particular way... A cause is to my mind something altogether less constricted. It can be a continuing state of affairs; it can be the absence of something happening."

Generally speaking, therefore, cause based clauses will allow a wider range of losses to be aggregated compared to event based clauses. A good example of this is Municipal Mutual Insurance Ltd v Sea Insurance Ltd [1998] Lloyd's Rep IR 421, where machinery was left unprotected and unguarded on a dockside. Over the course of 18 months the machinery was stripped down by a number of individuals or groups acting independently of one another. It was held that under the "original cause" aggregation clause the losses should be aggregated as they were attributable to a single source or cause, namely the inadequacy of the port's system for protecting the goods. Given the fairly strict approach taken to the application of the unities test, it seems unlikely that the same result would have been reached had the policy in question contained an event or occurrence based clause.

Aggregation of COVID-19 losses

In the context of COVID-19, the difficulty for the party advocating an aggregation of losses will be identifying a single event or cause from which all the identified losses flow, especially given the complex and long-running nature of the pandemic and the wide variety of losses that have arisen from it.

As a starting point, it can be confidently stated that it will be easier to characterise the global pandemic as being the cause or originating cause of losses than to seek to argue that it can be considered an event or occurrence – it seems unlikely that such an abstracted approach would satisfy the unities test. Even with a cause based clause, however, issues as to the effect of subsequent intervening causes may well arise.

Looking beyond this general statement, a number of further questions present themselves, some of which have no obvious answer at this stage of the pandemic. For example, could the emergence of a "patient zero" (as of yet unidentified in time and place) be considered the event that gave rise to all subsequent losses? Could all governmental decisions to restrict travel/commerce and enforce lockdowns be considered closely enough linked to constitute a single event, given that they have taken place over time and are constantly evolving? It is likely that further such questions will emerge over time, depending on the nature of the losses which are to be aggregated.

In any event, it may be that the broad questions above are simply too blunt an instrument when considering COVID-19. As stated above, aggregation is often very fact specific, and it may be that the existence of an aggregating event (or indeed cause) will vary depending on a whole host of factors, including the business activities of the underlying insured, the types of losses suffered (for example, could first-party economic losses suffered due to shutting of businesses be aggregated with third-party personal injury losses?), the extent to which particular measures (by particular governments) can be said to have resulted in losses, and the effect of the disease itself on any claims being made.

As with follow-the-settlement clauses (see our earlier blog post), we anticipate that these questions will need to be addressed by reinsureds and reinsurers (and perhaps, in due course, by arbitrators and the courts) as COVID-19 losses flow into the reinsurance market.

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.