A possible surge in COVID-19 business interruption (BI) claims adds to existing pressures on Australian general insurers’ earnings, Fitch warns.

The rating agency says in a statement today that BI claims are likely to be “the largest source of pandemic-related claims for Australian non-life insurers”, although the ultimate cost is still unknown.

As insuranceNEWS.com.au has reported, the NSW Court of Appeal found in favour of policyholders following a test case last year, saying pandemic exclusions that refer to the now repealed Quarantine Act are not effective.

The insurance industry is seeking leave to appeal the verdict, but the UK courts turned down an appeal by insurers in a case that examined policy wordings, again finding in favour of policyholders.

“While [the UK case] will not set precedence, it may influence the way BI claims are paid in Australia,” Fitch said, adding that the court rulings could lead to a “surge” in claims.

“These losses will exacerbate pressure on Australian non-life insurers’ earnings, but we think overall pandemic losses will be manageable as insurers are supported by sound capital buffers.”

Following the UK appeal outcome, QBE said it would strengthen loss reserves by a further $US185 million ($239.55 million) for potential BI claims from its Australian business. The insurer expects losses from its UK business to remain at $US70 million ($90.64 million) due to reinsurance protection in place.

IAG made a post-tax provision of $865 million and raised $776 million to bolster capitalisation. Suncorp has also made a BI-related provision of $195 million.

“Insurers set claims reserves based on assumptions that include estimates of exposure to industries that have been affected by lockdowns and customer risk categorisations,” Fitch said.

“Claims are still largely booked on an incurred but not reported basis and could be released if court cases are decided in favour of the insurers.

“The ultimate cost will depend on the outcome of ongoing or future litigation and on potential claims from future lockdowns.

“We think the risk from the latter will reduce as policies are renewed and insurers update policy wording and clearly stipulate pandemic exclusions.”

Fitch notes the “existing pressure” on insurer earnings. “The sector’s net profit fell to $0.9 billion in the 12 months to September 2020 from $3.4 billion during the previous 12 months due to a large drop in investment income,” it said.

“The net loss ratio for the sector remained stable at 70%, supported by a reduction in the motor claims frequency, which offset higher catastrophe losses. The sector’s coverage of the regulatory prescribed capital amount remained solid at 1.74x.”