The impact of COVID-19 on business interruption claims
Governments around the world have engineered various measures to arrest the spread of the COVID-19 pandemic. Unfortunately, some of these measures, such as lockdowns, have resulted in business disruptions and even closures. As a consequence, there has been a surge in business interruption (or Contingent Business Interruption [CBI]) insurance claims and lawsuits globally as many insurers were reluctant to indemnify their policyholders for business losses that have occurred because of COVID-19-related lockdowns. These lawsuits are now seeking to determine whether any insurance cover was indeed triggered by the pandemic and, if so, the extent of the cover as per the wording in the insurance policies.
Lawsuits in SA
Several legal cases addressing these issues are in progress worldwide, while in South Africa (SA), only three cases have thus far been heard. Two of these cases involved Guardrisk and the other involved the largest non-life insurer in SA, Santam. All were decided in favour of the insured.
On 17 November 2020, a full bench of the Western Cape High Court ruled in favour of the policyholders in Santam vs Ma-Afrika Hotels (Pty) Ltd and Stellenbosch Kitchens (Pty) Ltd. The court ordered Santam to pay out Ma-Afrika’s pandemic-linked claims for the impact of the lockdowns over the entire policy period of 18 months, without limitations, as well as the legal costs. The combined total business interruption cover amounted to c. R122.5mn.
On Monday (23 November), Santam held an investor call to update the market on the Ma-Afrika judgment. After carefully discussing the implications of the judgment with its stakeholders, including leading reinsurers, Santam said that it is taking the matter on review to the Supreme Court of Appeal. The insurer said that it wishes to appeal several aspects of the judgment including causation, insured peril, and the indemnity period. Collectively, these factors materially impact the amount paid to the insured, which ultimately determines the negative impact on the insurer’s earnings and capital positions.
Santam’s CBI provisioning, reinsurance programme, and relief payments
In its latest set of interim results (for the half-year to end June 2020), Santam prudently front-loaded a claims provision of R1.3bn as a best estimate of its CBI exposure. In calculating this provision, Santam assigned probabilities to the following three scenarios:
- Courts rule in favour of Santam
- Courts rule in favour of the insured and Santam is required to pay claims and catastrophe reinsurance responds favourably.
- Courts rule in favour of the insured, Santam is required to pay claims and reinsurance cover is not available to reduce the net impact of claims.
Taking the Ma-Afrika judgment into account, the insurer raised an additional R1.7bn in provisions, taking its total CBI provision to R3bn. This higher provisioning was mainly driven by an increased probability of the second scenario materialising and also provided for a potentially longer indemnity period – a fourth scenario.
Santam prudently protects its earnings and capital positions by having a catastrophe reinsurance programme cover which, in effect, insures the insurer. Santam’s catastrophe reinsurance programme covers a CBI claims event but responds to claims covered in accordance with the treaty. We deem its reinsurance programme to be conservative as Santam has strong relationships in the global reinsurance market. It is one of the largest purchasers of reinsurance in SA and many of its reinsurers have an A- or higher global scale rating (GSR).
The legal uncertainty makes it challenging to reliably determine those claims to which Santam may be exposed. Additionally, the extent of the reinsurance recoveries will ultimately depend on the response of reinsurers to the outcome of the legal process, as legal certainty is required before lodging a reinsurance claim. Despite this, Santam is confident that the catastrophe reinsurance will limit the net cost of CBI and the scenario of reinsurers not responding to lodged claims is highly unlikely, in our view.
Santam has provided for c. R1bn in relief payments to support small- and medium-sized commercial CBI policyholders that have been most affected by the pandemic. These payments are considered advance payments in the event that the courts rule in favour of the insured. However, should the courts rule in favour of the insurer, the amounts paid will be considered relief payments and will not be recovered from the policyholder.
Ongoing legal cases likely to impact the broader non-life insurance industry
Our understanding is that Santam’s position regarding CBI cover and policy wording is similar to its peers and reinsurers in the non-life insurance industry. This is evidenced by the following points:
- In the Ma-Afrika Hotels (Pty) Ltd and Another (Stellenbosch Kitchens) vs Santam Limited case, the Western Cape High Court stated that the policy wording is identical to the Guardrisk and Café Chameleon case.
- In the abovementioned case, the Western Cape High Court stated that Santam’s advanced arguments in opposing the application, are similar to those of Guardrisk.
Therefore, we believe, all cases currently under appeal (both in SA and in the UK) will provide more legal certainty for many short-term insurers. Santam expects the final judgment across its own and other insurers’ cases to be available by late 2020 or early 2021.
Santam’s worst-case scenario and its upcoming auction
We expect weaker earnings generation for Santam in the immediate term, mainly due to lower investment returns, lower business origination, and higher claims experience due to COVID-19-related claims.
In our view, a worst-case scenario for Santam would be if the company is required to pay claims due to the national lockdown, reinsurance does not respond, and the indemnity period is lengthened. Without assigning a probability to this worst-case scenario, if it does materialise, we expect significant downward pressure to be exerted on the Group’s capital position. As at 31 October 2020, the Group’s capital coverage ratio, including the additional R1.7bn provision, is just above the bottom-end of the target band of 150%-170%. However, as investors, we take comfort from the fact that Santam has a strong track record of managing risk in a prudent manner and we would expect the insurer to use several levers at its disposal to absorb the impact.
Santam is coming to the market on 25 November to issue an unsecured subordinated note (SNT05), as it looks to raise up to R1bn. Despite the uncertainty, from a fixed-income perspective, we recognise the following factors that underpin Santam’s A+.za subordinated debt rating:
- A market-leading position in the SA general insurance market;
- sizeable liquidity and capital buffers; and
- increasing product and geographic diversification.