Following the outcome of an Australian legal test case that considered the application of certain infectious disease exclusions in business interruption policies going against the insurance industry, some insurers are looking to reinforce their claims provisions and execute capital raising actions to bolster their solvency positions, according to a new AM Best commentary.

The judgment handed down by the New South Wales Court of Appeal brings into sharp focus the potential downside risk for the industry. With a unanimous ruling against the arguments made by the insurers on this test case, AM Best expects the question of pandemic business interruption coverage to remain a significant source of uncertainty for Australian commercial insurers.

In its Best’s Commentary, “Australia Business Interruption Test Case Raises More Questions than Answers for Insurers,” AM Best states that the re-evaluation and refinement of loss provisions for potential COVID-19-related business interruption exposures are expected to lead to an adverse impact on commercial insurers’ operating earnings. The extent to which this affects capital positions remains to be seen, although AM Best views companies with strong financial flexibility and a track record of accessing capital markets as being best-placed to contend with adverse capital implications. 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.

“Another key factor relevant when determining the financial impact of potential business interruption exposures for insurers is with regard to their ability to make recoveries from reinsurance programmes,” said Myles Gould, director, analytics, AM Best. “Loss triggers may be a source of dispute with reinsurers, such as in the event of non-alignment of policy exclusions in primary wordings and reinsurance contracts.”

“As the commentary notes, this test case outcome remains only one piece of a much larger puzzle, with a number of other business interruption contract triggers yet to be evaluated ahead of understanding the full liability for insurers,” said Alex Rafferty, associate director, analytics, AM Best. “Additionally, this test case decision could be appealed.”

AM Best will continue to review recent and future developments in respect of business interruption exposure for Australian insurers and assess the impact on the earnings, reserves and capital positions of rated entities.