The NSW Court of Appeal test case decision on business interruption policy wordings represents “one piece of a much larger puzzle” and has left insurers facing continued uncertainty and possible reputational impacts, AM Best says.

The judgment, which found insurers could not rely on wordings citing the repealed Quarantine Act 1908 to exclude cover for COVID-19 disruptions, has brought into sharp focus the potential downside risk for the industry, the ratings company says in a report.

Insurers may still appeal the outcome to the High Court and the Insurance Council of Australia (ICA) has also flagged another test case to look at coverage triggers such as proximity and prevention of access.

AM Best says there’s also further uncertainty on how any claim settlements for COVID-related shutdowns would be calculated.

“Insurers have stated that this exposure was never intended to be covered by their policies, nor factored into pricing, and therefore existing claims payment processes and benchmarks do not cater for settlement determinations in this scenario,” it says.

Given the contract trigger issues and lengthy legal processes, final resolution of claims from policyholders as well as certainty for insurers will “likely be some time off”, AM Best says.

Pandemic exclusions were sparked by scenario analysis following the severe acute respiratory syndrome (SARS) outbreak. ICA has said policies have been designed and priced on the basis that pandemics are not insurable due to the magnitude of potential losses and the challenges of risk modelling and ensuring coverage affordability.

But the expectation gap between policyholders and insurers around cover provided has highlighted inconsistency, and the dynamic also involves brokers, which have a duty of care in providing appropriate insurance and explaining the basis and level of cover, AM Best says.

Pandemic insurance issues have been in the UK media spotlight for months, and the latest test case developments in Australia are likely to draw increased attention and scrutiny, the report notes.

“Many insurers had hoped that the first test case would fall in their favour and largely put this debate to rest,” AM Best says.

Insurers have announced provisions for business interruption claim exposures and some firms have launched capital raisings to boost solvency positions.

AM Best says the ability to make recoveries from reinsurance programs will be a key factor and overall a mixed impact is expected for insurers in the Australian commercial segment.

“Over the near term, re-evaluation and refinement of loss provisions for potential COVID-19 BI exposures are expected to lead to an adverse impact on commercial insurers’ operating earnings,” it says. “The extent to which this impacts capital positions remains to be seen.”

Loss exposures are likely to be most significant for the largest insurers in Australia in absolute terms, but they are also the type of companies typically best placed to raise additional capital.

For smaller commercial insurers their exposure is likely to correlate to their market share.

“However, this could still be significant for earnings and in some cases could drive solvency deteriorations,” AM Best says.

“Unlike the largest participants, some smaller insurers exhibit limited financial flexibility due to their ownership structures and therefore may have less ability to raise significant additional capital if required.”