How Fairfax is reserving for COVID-19 business interruption reinsurance charges

The uncertainty around business interruption insurance coverage and the impact of a United Kingdom Supreme Court are among the reasons Toronto-based Fairfax Financial Holdings has put aside more than US$80 million this year in COVID-19 reserves.

Fairfax reported July 29 its net income increased from US$426 million in Q2 2020 to $1.28 billion in the latest quarter while the combined ratio improved 6.1 points from 100.4% in Q2 2020 to 94.3% in Q2 2021. But Fairfax also reported net adverse prior year reserve development of $31.6 million in the most recent quarter and a total of $74.9 million in the first six months of 2020. That includes net adverse prior year reserve development, from COVID-19 losses, of $60.1 million in Q2 2021 and $87.1 million in the first six months of 2021. All figures are in U.S. currency.

During a conference call July 30, an investment banking analyst asked Fairfax officials to describe what was driving its COVID-19 reserve development.

This relates to Fairfax’s reinsurance business, primarily at Odyssey Group and Allied World, replied Peter Clarke, chief operating officer of Fairfax Financial.

The prior year development is for losses incurred but not reported, “that is still being put up on the reinsurance books mostly in Europe and related some of the BI issues,” said Clarke.

“There is still uncertainty around what is covered, what is not covered. Is it one event? Is it many events?” said Clarke.

“You might remember the U.K. [Supreme Court] ruling,” Clarke said, alluding to a test case launched in 2020 by Britain’s Financial Conduct Authority. “That is still filtering still through the system.”

Fairfax reported July 29 its net premiums earned were US $4 billion during the second quarter of 2021, up from US$3.3 billion in Q2 2020. Toronto-based Northbridge’s net premiums earned rose from US$329 million in Q2 2020 to US$452 million in the latest quarter. In addition to Northbridge, reinsurer Odyssey Group and commercial primary specialty and reinsurance carrier Allied World, Fairfax owns a number of other insurers including New Jersey-based commercial insurer Crum & Forster and London-based Brit PLC.

The test case that Clarke was alluding to was launched by the UK FCA in an effort to clarify whether 21 different wordings provide coverage for BI related to government orders or advice to shut down a workplace during the COVID-19 pandemic. None of the wordings in the test case require physical damage. Instead, some of those wordings cover the outbreak of a disease within a certain distance from the client’s premises, while others cover prevention of access and similar perils.

The FCA argued in court that all of the wordings in its test case do provide cover [depending on the client’s individual circumstances] while insurers argued none of the wordings provide cover. In September, 2020, the High Court of England and Wales ruled some wordings do provide cover while others do not. Both sides were granted a “leapfrog” appeal to the U.K. Supreme Court, which issued its ruling in January 15, 2021. The result of that ruling was mixed but mostly in favour of claimants.

The insurers had argued that several categories of businesses in Britain would still have been affected by pandemic lockdown measures even if they had no occurrences of COVID-19 within 25 miles. So clients who lost business – even if there were COVID-19 cases within 25 miles – would have suffered the same business interruption had there been no cases within 25 miles, is what insurers were saying.

The U.K. Supreme Court did agree with insurers on what it means, in general, if “event Y” follows “event X.” If event Y would still have occurred anyway, regardless of the occurrence of a prior event X, then X cannot be said to have caused Y, the court said of the “but for” test that insurers put forth in the FCA test case.

But in the context of COVID-19, this “but for” test can lead to an absurd result, the U.K. Supreme Court said.

The outcome is legally binding, in Britain, on the insurers that are parties to the test case – but only in respect of the 21 policy wordings considered by the court.

Feature image via iStock.com/whitemay