COVID-19 claims: captives vs the commercial industry

A July 2020 PNAS study surveying over 5,000 American small businesses during the COVID-19 crisis revealed troubling information about the financial fragility of businesses that make up nearly half of our national economy. In this study, median firms had enough reserves to keep their businesses afloat without a cash infusion for a month at best.

The implementation of the Paycheck Protection Program (PPP), as well as Employee Retention Tax Credit (ERTC), was enough to keep some of them afloat. However, the even these massive government programmes were insufficient to prevent the permanent closures of 60 percent of businesses that were meant only to close temporarily.

How could these small businesses have protected themselves better from such an existential threat? Businesses often look to insurance for this purpose, but many who purchased business interruption (BI) insurance from the commercial market haven’t had much luck getting claims paid.

It seems that many commercial insurers are denying BI claims if those claims are related to COVID-19. And when businesses sue to force payment, the insurers respond with motions to dismiss.

All too often those motions are granted. According to the Covid Coverage Litigation Tracker, most motions to dismiss claims by insurers are granted, meaning that most businesses are effectively denied coverage for their pandemic-related losses. Moreover, the majority of these dismissals are “with prejudice”, meaning that the plaintiff is barred from filing similar claims.

The statistics are even more concerning at the federal level, where over 90 percent of claims are fully dismissed with prejudice.

Some policies purchased by insureds have virus and bacterial exclusions that prevent events such as COVID-19 and their consequences from being covered, many of them added by carriers in the early 2000s as a response to the SARS outbreak of that period.

Additionally, many BI policies require the business to suffer “direct physical loss”. A mere loss of revenue is insufficient to trigger coverage. The insurance industry has argued, and many courts have agreed, that “the inability to use a business location—in whole or in part—does not consist of physical damage or as physical loss”. According to this policy interpretation, direct or physical loss must be visible or tangible and not merely a loss of access to the property (eg, due to lockdowns).

Companies with captives, on the other hand, were able to approach the problem of BI differently. BI policies commonly issued by captive insurance companies often contain far fewer limitations and may be triggered based upon loss of income or loss of access to property rather than only physical damage to the property.

Captives owners were not forced to contest claims with commercial insurers and jump through legal hoops in a desperate attempt to get claims paid, despite already being low on funds. Captive insureds were often able to get claims approved and paid far more quickly.

This insurance meant that many such companies were able to stay in business despite forced government shutdowns, travel restrictions, contaminated employees, reputational damage, broken supply chains, contract cancellations and similar losses.

For 2020, COVID-19 related claims paid out by CIC Services-managed captives have amounted to nearly $14 million, with an extra few million currently pending. These range from just under $1,000 for some companies to more than a million for others. In many cases these claims were essential to the survival of the business. We interviewed four of our clients who had their COVID-related claims paid. Here are their stories.

In one case, a small technology company with a dozen employees was, thanks in part to captive insurance, able to keep everyone employed while its uninsured competitors were forced to downsize. Being fully staffed as the pandemic has eased placed this business in a much stronger competitive position versus their competitors that are now struggling to rehire.

According to one of its officers: “There was a lot of long-term anxiety, and a shortage of people who truly wanted to work. We were able to keep all of our employees, allow all to be secure in their paycheques (and not just because of the PPP programme), and keep all of our contractors.”

In another case a 31-year-old trucking company with about 50 employees was subjected to confusing and sometimes contradictory regulations due to its operations spanning a tri-state area. This meant it was operating in three different legal jurisdictions with three different sets of pandemic rules relating to lockdowns, quarantine, etc.

While many of its competitors were forced to borrow money to stay afloat, captive insurance allowed this business to absorb the losses without going deep into debt.

According to its owner: “In general, many trucking companies are afraid of turning to commercial insurance, because many in the commercial industry won’t insure them due to the magnitude and variety of possible risks. With a captive, we did not need to find a willing lender. We were able to create cash within our own organisation because our captive claim was quickly approved.”

In a third instance an ophthalmologist with about 150 employees was confronted by stay-at-home mandates that permitted the office to see only patients with severe conditions or those requiring emergency surgeries.

Patients in need of surgical follow-ups and routine treatment were either forced to stay at home or were too afraid to come in due to the pandemic.

The practice qualified to receive PPP, a Federal Emergency Management Agency (FEMA) loan, and a Department of Health & Human Services (HHS) grant, but none of these programmes was sufficient to cover its losses. The PPP was strictly for payroll expenses, the FEMA loan must eventually be repaid, and the HHS grant was strictly for COVID-19 related expenses such as equipment and masks, not COVID-19 related losses in revenue, which were substantial.

The practice had a captive insurance programme that stepped in to cover much of the lost revenue and other extraordinary expenses. Without the captive, the business would have suffered $600,000 in irrecoverable losses. The captive supported the business when governmental programmes covered only some of the overhead.

While many of his peers are still fighting with commercial carriers over claims, this ophthalmologist was able to receive much needed capital from captive insurance claims almost a year ago.

Says the owner of the practice: “Commercial insurance companies are in the business solely to make money off their clients. Captives are in the business solely to assist their parent corporations in surviving any catastrophes. Without the parent company, the captive cannot exist.

“A symbiotic relationship exists between a captive and its parent company that doesn’t exist between the parent company and a commercial insurer. It’s in the best interest for commercial insurers not to pay out claims, but it’s in the best interest for captives to pay out claims. If you want timely pandemic coverage at all, it has to be through a captive.”

In a final example, a captive insurance programme was essential in helping a dental practice survive COVID-19. Approaching spring break in 2020, the company was on track for a record-breaking year. Then, like many others, it was blindsided by the pandemic. With the stay-at-home mandate, they were forced to prioritise only emergency patients, and for over a month, saw only about one patient a week.

Even by the end of April 2020, they were still seeing only around 15 to 20 percent of their typical patient load.

Government programmes helped cover some of the payroll but did not offset the loss of revenue or profits. The business quickly filed claims under its relevant captive insurance policies, and by May 2020 those claims were adjusted and approved, and the business received $200,000 in covered claims.

According to the practice owner: “Within a few months, we were able to keep the business running in the same fashion it had been before the shutdown. The captive protected the business from devastating financial loss. We didn’t have to worry about how to pay for extra equipment or taking on additional bills. Because of the captive, we didn’t have to think about where cuts needed to be made.”