Insurers are trying to escape liability for pandemic-related business losses with counter-intuitive arguments that go against the essential purpose of insurance, Britain’s markets watchdog told the UK Supreme Court on Tuesday.

A lawyer for the Financial Conduct Authority (FCA), which brought a test case against insurers on behalf of policyholders, said insurers had reached an “extraordinary conclusion” that business losses were largely uncovered during the coronavirus pandemic because of the widespread havoc it has caused.

“(Insurers) are saying: ‘We insure perils but not ones that are going to cost us a huge amount of money. We never contemplated that’. Well, that isn’t an answer,” Colin Edelman, the FCA’s lawyer, told the second day of a four-day appeal, watched by thousands of businesses brought to their knees during the pandemic.

Small businesses from holiday cottage firms to restaurants and night clubs had to shut down or restrict trading after government-ordered lockdowns and say they face ruin after insurers rejected claims for business interruption cover.

The case revolves around whether 21 policy wordings, affecting potentially 700 types of policies, 60 insurers, 370,000 policyholders and billions of pounds in claims, should cover disruption caused by responses to the virus.

The wordings cover business interruption when insured premises cannot be accessed because of public authority restrictions, in the event of a notifiable disease within a specified radius and hybrid wordings.

Tuesday’s hearing focused on how insurance law clauses, such as a so-called “but for” test, disease, composite peril, prevention of access and trends, should be applied in the case.

A lower court in September found largely in favour of the FCA and the Hiscox Action Group, a policyholder action group that represents hundreds of policyholders that has joined the lawsuit, when judges ruled some insurers were wrong to reject claims.

But the FCA, the action group and six insurers – Arch, Argenta, Hiscox, MS Amlin, RSA and QBE – are all challenging elements of the ruling they lost.

Insurers, which have said they are paying valid claims, argue that most disease or “prevention of access” clauses in insurance policies do not cover the pandemic and that any pay-outs should reflect the wider economic downturn caused by coronavirus.

“An expansionist approach to the construction of insurance clauses is … not an appropriate or principled solution,” John Lockey, a lawyer representing Arch, told the hearing.

Jonathan Gaisman, a lawyer for Hiscox, said prevention of access clauses were designed only for closure by a public authority in situations specific to a business premises, such as the presence of rats or mice, food poisoning or drainage problems, as well as certain diseases.

“Lockdown in the case of a worldwide pandemic is totally different,” he said.

Briefing: Customers will face more agony despite test case ruling