COVID Insurance Coverage, One Year Later – Herd Immunity for Insurers or is Coverage Spreading for Policyholders?
One year ago, when the COVID-19 pandemic ground the world to a halt, our firm’s virtual offices were inundated with calls from policyholders, asking if their current and projected losses due to the pandemic would be covered by insurance. While the outlook wasn’t great, we made a few predictions about where coverage might be found, how we expected coverage to ultimately be decided, and instructed clients how to make and protect their COVID-related claims for coverage.
One year later, it’s instructive to look at how these predictions played out, and what we’ve learned so far. These insights will help policyholders more intelligently decide whether to pursue coverage for losses sustained because of the pandemic.
Last Year’s Predictions About COVID Coverage
1. Coverage, if any, would come from Commercial Property Policies.
The first prediction was pretty easy: Most businesses would only find coverage (if any) from their commercial property policies. Specifically, business interruption and contingent business interruption (“BI”), and Civil Authority coverages, which are standard in property policies. BI coverage pays for lost income and other losses arising from disruptions to the insured’s business operations, caused by the direct loss of, or damage to, covered property. Civil Authority coverage is similar, but does not require direct loss or damage to an insured’s property; it covers losses when an order closes or prohibits access to insured property. Civil Authority coverage typically requires these orders to be issued as a result of physical damage at or about a nearby property other than the insured’s.
Thus far, this has been the case. Except for specialized communicable disease coverage sold to industries like health care and medical research, all claims for coverage have come under commercial property policies.
2. Litigation would be necessary.
Our next prediction was disheartening, but also pretty obvious: Policyholders would have to sue to secure coverage. The economic impact of this pandemic is larger than anything the world has ever seen, dwarfing other massive loss events like 9/11 or Hurricane Katrina. Paying even a fraction of the claims would bankrupt the insurance industry, so insurers had no choice but to deny every coronavirus-related claim and force policyholders to sue to secure coverage.
We got this one right.
We don’t know how many COVID-19 claims have been made and denied, but the nationwide surge in coverage litigation is unprecedented. Since the first complaint was filed in Louisiana on March 16, 2020, the curve of new litigation increased sharply throughout the country, and as of February 2, 2021, 1,494 lawsuits have been filed (https://cclt.law.upenn.edu/). For reference, Superstorm Sandy previously held the [unofficial] record for the most-litigated loss event, with a meager 150 BI coverage cases filed within one year of the event.
The insurance industry had early success flattening the curve of new lawsuits by defeating most of them at the outset of litigation, thereby discouraging new claimants from filing suit. As of March 16, 2021, at least 238 lawsuits have been decided either through motions to dismiss or motions for summary judgment. Insurers won 151 of these, while policyholders were only allowed to proceed in the other 87. The tide is turning slightly, and policyholders are surviving more of these early challenges recently, but the inoculating effect of the insurance industry’s early legal success is undeniable: At its peak last spring, more than 70 lawsuits were filed each week nationwide, but for the last several months that number has dropped to less than 10 per week.
Thus far, only one case made it to trial (the policyholder lost) [See Footnote 1], none have been taken up on appeal. Combined with the recent surge of policyholder-friendly rulings, we expect that it will take years before we reach “herd immunity” in the form of controlling judicial precedent.
3. Virus Exclusions might immunize insurers from COVID claims.
Our next prediction was that coverage would not be available under policies with well-written virus exclusions. After the SARS and MERS outbreaks in the 2000s, insurers began using endorsements which exclude coverage for losses arising from communicable diseases. The most prevalent of these, ISO form CP 01 40 07 06 (entitled “Exclusion for Loss Due to Virus or Bacteria”) is used industry-wide and excludes coverage for “loss or damage caused by or resulting from any virus, bacterium, or other microorganism that includes or is capable of inducing physical distress, illness or disease.” Other virus exclusions commonly appear in policies in the form of mold exclusions (applying to “fungi, bacteria, and virus”) and pollution exclusions, which define pollution as including viruses and bacteria. While arguments could be made to challenge or circumvent these exclusions, we predicted that – absent extraordinary interference by state or federal governments – policyholders would not find coverage in the face of well-written virus exclusions.
Unfortunately (for policyholders), we were right.
More than 80 percent of insurers’ motions to dismiss have been granted when the policy contains a virus exclusion. The few cases that survive early challenges involve more ambiguous mold or pollution exclusions, not the ISO form CP 01 40 07 06 virus exclusion. We expect some of these decisions to be appealed, so it remains to be seen how the courts will ultimately interpret the application of the virus exclusions.
4. The coronavirus might not cause “direct physical loss or damage” to property.
Before we knew much about the nature of the coronavirus itself, we predicted that policyholders would struggle to establish the first element of coverage: that the virus causes “direct physical loss of or damage to” property. Typically, BI covers losses stemming from things such as fire, theft, or vandalism; not those caused by an invisible virus that doesn’t physically damage or alter the property. We foresaw insurers arguing that the word “physical” means tangible, structural damage – and that an invisible virus (which can be eradicated by the simple act of cleaning) does not rise to this level. Prior to the pandemic, courts were split as to whether losses caused by invisible or odorless components (like asbestos, Chinese drywall, gas, or bacteria) rose to the level of “direct physical loss of or damage to” covered property. While policyholder-friendly rulings hold that the phrase “physical loss of or damage to” includes the loss of use, possession, or habitability of covered property, insurer-friendly rulings, however, hold that “physical loss of or damage to” means tangible harm or physical alteration to property’s physical integrity or condition.
We warned that this would remain unsettled for years to come, that the split in authority would continue among the various states, and that policyholders and insurers alike should temper their expectations while the cases work their way through years of trials and appeals.
This has also proven true.
Every court issuing a reasoned decision has analyzed the common question of whether COVID-19 contamination rises to the level of “physical loss of or damage to” the covered property, applying either the policyholder-friendly “loss of use or possession” test, or the insurer-friendly “physical alteration” test.
The “Loss of Use or Possession” Standard
The seminal policyholder-friendly ruling is Studio 417, Inc. v. Cincinnati Insurance Company, 478 F.Supp.3d 794 (W.D. Mo., Aug 12, 2020), in which a Missouri federal district court denied Cincinnati Insurance’s motion to dismiss a lawsuit brought by hair salons and restaurants for BI, Civil Authority, and related coverages. The policyholders made the following allegations: (1) They were forced to cease or significantly reduce normal business operations as a result of the pandemic; (2) The virus is a “physical substance” that is both “active on inert physical services” and “emitted into the air”; (3) COVID-19 “renders physical property … unsafe and unusable”; (4) There is a “likelihood” that persons infected with COVID-19 had entered the premises in the proceeding months; and (5) This forced plaintiffs to “suspend or reduce” business given the likelihood of contamination. The policyholders’ complaint further alleged how the orders of civil authorities in Missouri and Kansas forced them to cease or significantly reduce business operations in response to the pandemic. Cincinnati moved to dismiss on the ground that the policies cover “only … income losses tied to physical damage to property, not for economic loss caused by governmental or other efforts to protect the public from disease.”
The court focused on the threshold question: do the policyholders allege a “direct physical loss or damage” under the policies? Cincinnati argued that they did not, since physical loss or damage “requires actual, tangible, permanent, physical alteration of property.” The court disagreed, and while it avoided the question of whether the mere presence of a virus on covered property qualifies as “physical damage,” the court emphasized that Cincinnati’s policies expressly cover either physical loss or physical damage, and reasoned that Cincinnati’s argument – requiring a physical alteration of the property – would conflate the two terms. Because the policies did not define either, the court gave the term “loss” its plain and ordinary dictionary meaning of “losing possession” and “deprivation,” and held that the plaintiffs had sufficiently alleged both the physical presence of the coronavirus on the covered property, and their loss of use because of it. The court denied Cincinnati’s motion to dismiss and the case proceeded to discovery.
Other policyholder-friendly rulings have followed Studio 417’s “loss of use or possession” rule to some degree: if the policyholder alleges that the virus was present at covered property, and either contaminated or otherwise rendered the property unusable, then this alleged “loss of use or possession” is sufficient to support the policyholder’s claim for coverage and defeat a motion to dismiss. For example, a Nevada state court judge recently followed Studio 417 in denying an insurer’s motion to dismiss when the owner of Las Vegas’ Grand Bazaar open-air mall alleged certain “known facts about the coronavirus, including that it spreads through infected droplets that ‘are physical objects that attach to and cause harm to other objects’ based on its ability to ‘survive on surfaces’ and then infect other people.” JGB Vegas Retail Lessee LLC v. Starr Surplus Lines Insurance Co., No: A-20-816628 (Clark Cnty., Nev. Dist. C., Nov. 30, 2020). The policyholder further alleged that: (a) it was “highly likely that the novel coronavirus that causes COVID-19 has been present on the premises of the Grand Bazaar Shops, thus damaging the property;” and (b) “because the presence of COVID-19 at or near the Grand Bazaar Shops and [Nevada] Governor Sisolak’s March 20, 2020 Order restricting and prohibiting access to non-essential business, the Grand Bazaar Shops were forced to close and the few restaurants that remained open were severely limited in their operations, resulting in significant losses.” Citing Studio 417, the Nevada court ruled that the complaint “sufficiently allege[d] losses stemming from the direct physical loss and/or damage to property from COVID-19 to trigger Starr’s obligations under the policy.”
JGB Vegas Retail is also one of the rare cases where a policy with a virus exclusion survived a motion to dismiss. Starr’s policy contains a Pollution and Contamination Exclusion, which the court held did not unambiguously exclude coverage for the loss because the policyholder’s interpretation of the exclusion as only applying to “traditional environmental and industrial pollution and contamination” rather than a “naturally-occurring, communicable disease” appeared reasonable. This interpretation is the thing appeals are made of, so stay tuned.
Finally, the California Orange County Complex Superior Court recently bucked a statewide trend of insurer-friendly rulings and denied the insurer’s demurrer in Goodwill Industries of Orange County, CA. v. Philadelphia Indemnity Ins. Co., No: 30-2020-01169032-CU-IC-CXC (Jan. 28, 2021). The court expressed skepticism that the coronavirus could cause “direct physical loss” to property under California law, but determined that the policyholder adequately pled that the coronavirus’ ability to alter the air and attach itself to surfaces rendered both unsafe, and therefore physically altered the property within the meaning of the policy. Citing Studio 417, the court held that – at the demurrer stage at least – it could not determine as a matter of law that the complaint did not allege a “direct physical loss,” and therefore allowed the case to proceed.
The “Physical Alteration” Standard
A majority of jurisdictions currently reject the “loss of use or possession” standard championed by Studio 417, and adopt a “physical alteration” standard for determining physical loss or damage. Demonstrating the intuitive appeal of the “physical alteration” standard, a New York federal judge granted the insurer’s motion to dismiss, holding that the policyholder could not allege any physical damage or loss due to the coronavirus because “[i]t damages lungs. It doesn’t damage [physical property].” Social Life Magazine, Inc. v. Sentinel Insurance. Co. Ltd., No. 20 C 3311 (S.D.N.Y. 2020), ECF No. 25, Ex. B at 5:3-4.
Kessler Dental Associates, P.C. v. The Dentists Insurance Company, --- F.Supp.3d ----, 2020 WL 7181057 (E.D. Pa. Dec. 7, 2020) shows the uphill battle policyholders face in “physical alteration” jurisdictions. In Kessler, a Pennsylvania federal court granted the insurer’s motion to dismiss based on the policy’s virus exclusion. But the court noted that it would have granted the motion even if the policy had not contained the exclusion, holding that the policyholders failed to allege any physical loss or physical damage to the covered property. Following Third Circuit precedent relating to asbestos claims, the court stated that allegations of physical damage arising from ”sources unnoticeable to the naked eye must meet a highest threshold” and “must be present in such large quantities that it makes the structure uninhabitable.” The insured did not allege that COVID-19 was present on its premises or that the virus made its property unusable. Rather, it made the broader allegation that the virus caused direct physical loss of or damage to its business because its “business is conducted in an enclosed building, and is more susceptible to being or becoming contaminated.” This “general threat of future damage” did not rise to the level of covered physical damage or loss in the court’s eye, and Kessler Dental’s case was dismissed.
5. Proper pleading practices would be essential.
Our next prediction was that how policyholders plead their case would be nearly as important as what they allege.
This is also proving true, especially in the early stages of litigation, where two truths have emerged: First, policyholders lose if they do not (or cannot) allege that COVID-19 was actually on their premises. Second, policyholders lose if they do not allege some evidence of physical damage to, or loss of use of, their property because of the virus.
For example, in West Coast Hotel Management, LLC v. Berkshire Hathaway Guard Insurance Companies, No: 2:20-cv-05663-VAP-DFMx (C.D. Cal, Oct. 27, 2020), the court expressly rejected the reasoning of Studio 417 and dismissed the complaint without leave to amend. In doing so, the court noted that the policyholder hotels only alleged “generic statements regarding the physical nature of COVID-19 and the number of cases in California and Fresno County, but [did] not connect those allegations with any alleged physical damage on their own properties.” Because of this failure to allege “evidence of physical damage to property,” coverage was denied under both the BI and the Civil Authority coverages of the policy.
6. Precedent will spread far slower than the virus itself.
We cautioned that it will take years before we have any judicial precedent for these claims. It’s still too early to tell which courts will adopt the “loss of use” or the “physical alteration” standards to define the meaning of physical loss or damage. But those cases which survived the early stages will take months to litigate, and then years to work their way through the appellate system. Even as higher courts issue their rulings, we expect to see inconsistent rulings within jurisdictions and, ultimately, a split in authority among the states. This is exacerbated by the fact that Multidistrict Litigation, which has the potential of expediting resolution, has largely been denied until recently, when an Illinois federal judge allowed a host of restaurants, bars, and theaters to pursue their claims against one insurer, Society Insurance Co. in Multidistrict Litigation. See, Re: Society Insurance Co. Business Interruption Protection Insurance Litigation, MDL No. 2964 (N.D.Ill. 2021). So while the coronavirus itself spread extremely quickly around the world, the spread of judicial precedent will take far longer to reach every state.
7. Good accounting will be better than the best stimulus check.
We also cautioned about the need to keep detailed records of all losses related to the pandemic. Accounting for BI claims is often the second battlefront in commercial property disputes, and we predicted that – if coverage exists – policyholders must be prepared for heavy accounting and auditing of their losses. Good accounting is also necessary to inform policyholders whether the cost of pursuing their claim will be more expensive than the claim itself.
One area where we’re already seeing insurers attack the actual value of policyholders’ claims relates to the “period of restoration” as defined in sundry ways by all commercial property policies. This is an objectively measurable period of time in which the policyholder could reasonably rebuild or repair the damaged property. The period of restoration includes a “waiting period” after the loss (usually 72 hours) before coverage begins, and then extends through the time needed to repair or replace the property. With COVID-19, sometimes a deep clean after potential contamination is all that is needed, so the period of restoration will rarely extend past the policy’s defined “waiting period.” Combined with the policies’ typical per-occurrence deductibles, it’s possible that, even if coverage is owed, the cost of preparing claims and suing carriers will exceed any possible recovery. At least one insurer already raised the issue (Blue Springs Dental Care LLC v. Owners Insurance Co., No. 20-CV-00383-SRB), but the challenge won’t be addressed until coverage is resolved.
8. Don’t count on the government to bail you out.
Finally, we noted that coverage might be propped-up through federal or state legislation. For example, in the early days of the pandemic states introduced legislation that would retroactively eliminate virus exclusions from all commercial property policies, or would create presumptions of physical damage or loss when COVID-19 was present on covered property. These ambitious measures would require extraordinarily broad (and potentially unconstitutional) governmental overreach, and most bills either stalled out or were withdrawn. But Washington State took another stab at the problem, and introduced legislation that would codify state court rulings which adopt the “loss of use” standard, creating law that “an insurance policy, which requires ‘direct physical loss of or damage to property’ to trigger coverage, shall be satisfied based on the ‘deprivation of such property and the loss of the ability to use such property’.” The law would be retroactive to February 29, 2020, thereby giving a glimmer of hope for legislative help on the coverage front. It’s still too early to know if the bill will become law, but it’s not uncommon for states to codify common law, so this approach just might work.
Using Our New Normal to Shape a Better Tomorrow
So now what? Policyholders suffered, and continue to suffer substantial losses, even as we ease into reduced coronavirus restrictions. But before jumping into a lawsuit, policyholders should ask themselves the following questions:
· Have I already filed my claim?
If not, you should. There is no penalty for requesting coverage, but you might forfeit coverage if you fail to do so promptly. Insurers are now very experienced with COVID-19 claims, and most have a standardized investigation process that will ask you several questions before the insurer issues its coverage position. These questions (information about potential or confirmed contamination, steps taken to remediate/prevent, affected premises, etc.) will also inform your decision about how vigorously you want to pursue coverage. We recommend involving coverage counsel to tender and respond to the investigation: the insurer will deny coverage, and coverage counsel will help you protect and maximize your claim if you pursue it in court.
· Does my policy contain a Virus Exclusion?
Most do. They don’t automatically eliminate coverage, but well-worded virus exclusions (like ISO form CP 01 40 07 06) severely handicap your chances of getting past the pleading stage of a lawsuit.
· Do I really want to sue?
Again, your insurer will deny your claim, so you will have to sue if you’re serious about recovering. This is a long and potentially expensive process, with results varying from state-to-state and no guarantee of victory. We also don’t expect insurers to negotiate any settlements until the legal landscape is more defined, so it’s entirely possible that you will spend more on legal and investigative fees than you can recover, even if you beat the odds and prevail in court.
· Can I allege the presence of COVID-19 on my property?
The litigation momentum is currently in the insurers’ favor, but one bright line between victory and defeat is a properly pled complaint, which alleges both the presence of COVID-19 and loss of or damage to the property as a result. At a bare minimum, you need to be able to allege that the virus was probably on your property, and your chances of surviving the early litigation challenges turns on your ability to demonstrate the existence and scope of contamination at your premises. If you can’t allege that COVID-19 was actually on your property, we don’t recommend filing a lawsuit.
The only thing the future promises is a slow, patchwork resolution of coverage for your COVID-19 losses. We will continue to monitor developments as the current cases move through the courts, as well as any legislative progress that could buttress your policyholder rights. In the meantime, continue to maintain solid financial and historical records, tender your claim if you have not done so already, and reach out to coverage counsel to weigh your options.
Footnote 1: The first coronavirus coverage case filed, Cajun Conti LLC et al v. Certain Underwriters at Lloyd’s, London, et al., survived early dispositive motions and went to trial. However, on February 10, 2021, New Orleans Parish Judge Paulette R. Irons denied the policyholder’s motion for declaratory judgment and entered judgment in favor of the insurer, albeit without a written order. We expect the policyholders to appeal.