Should insurers take the benefit of furlough payments received by their insured into account when providing an indemnity for business interruption losses suffered as a result of Covid-19? That is one of the preliminary issues to be decided in yet another round of Covid test cases currently before the Commercial Court.

It is an emotive but abstruse topic for those unconnected with the insurance industry. On the one hand, it concerns public policy and the extent to which government-funded support for business should reduce the liability of insurers. On the other hand, it also encompasses classic statements of the law of subrogation which date back to the 19th century.

The issue arose shortly after the first claims for Covid business interruption losses were submitted. In the course of the adjustment of those claims, it soon became apparent that most insurers were maintaining that furlough receipts represented a saving to the insured, credit for which must be given in calculating the business interruption loss.

The relevance of furlough payments to the quantification of business interruption loss is obvious. A significant element of the business expenses of an insured business is the salaries of its employees. If the insured is bound to give credit for furlough payments reimbursed by HM Revenue & Customs, then the quantification of the business interruption claim is commensurately reduced.

Insurers argued that if credit was not given by insureds for such receipts, then the insureds would be over-compensated. Policyholders argued that the purpose of the furlough scheme was not to benefit insurers, but to benefit employers and employees in a crisis by encouraging employers to keep employees in employment rather than choose to cut costs by making them redundant.

There was no legal compulsion on the government to introduce the furlough scheme, although its justification in the national interest was self-evident: it provided an important safety net at a time of economic turbulence. To that extent, it was a voluntary payment by the government.  

The question therefore arose: how should such voluntary payments be treated in the context of the indemnity provided by insurers? The answer depends upon the doctrine of subrogation.

Underlying the doctrine of subrogation is the principle of indemnity and the aim of preventing the insured from being over-compensated, by receiving payments (from insurers and others) in excess of the actual loss.

Thus, if before an insured has been paid the insurance money, he or she receives compensation which diminishes the insured loss, then the insurance money payable is reduced by that amount. Similarly, if the insurer has paid the insurance monies due, the insurer may exercise any rights or remedies of the insured arising out of the event insured against. That principle extends to claims against the insured if it emerges that the insured has compromised a right of recovery. 

Roger Franklin

Roger Franklin

Third-party liabilities

Such concepts are easily comprehended in the context of third-party liabilities which have their origins in the insured peril. The position is less clear, however, when the payments are unconnected and voluntary. In those circumstances, and in the absence of express policy wording, the position depends upon the intention of the payer. Did he or she intend that the payment should benefit the insured exclusively? If so, then the insurer cannot seek to reduce the indemnity payable by the amount of the payment by the third party.

The complicating factor in the context of furlough payments is that the intention of the government has not been entirely transparent, although there is some evidence of its views in respect of various grants provided under the Coronavirus Small Business Grant Fund and certain complementary benefits. In relation to these provisions, John Glen MP, the then economic secretary to the Treasury and City minister, stated as follows in correspondence with the Association of British Insurers dated 25 September 2020: ‘The impact of the current crisis on businesses and citizens is unprecedented, and the nature and scale of government support measures are exceptional. It is the government’s firm expectation that grant funds intended to provide emergency support to businesses at this time of crisis are not to be deducted from business interruption insurance claims. The principle of these grants is to provide emergency support and help businesses survive. The practice of making these deductions would mean that taxpayer funds are being channelled into savings for insurers, rather than supporting businesses to ride out the disruption brought on by this pandemic.’

He went on: ‘I strongly encourage those insurers who are making these deductions to follow this example, to respect the spirit of these government support schemes, and to consider the difficulties being faced by business during this time.’

Unfortunately, this exchange does not refer explicitly to furlough payments, and so the matter remains to be decided by the Commercial Court.

Some have argued that it would be anomalous if an unprecedented measure introduced by government to preserve jobs and businesses were ultimately to the financial benefit of insurers, many of whom denied liability for Covid losses until compelled to do so by the Supreme Court. Others have called for a mechanism whereby furlough receipts are deducted from the business interruption payments and returned to HMRC via tax adjustments.

In any event, the position is likely to be clarified when judgment in the test cases is handed down, which is expected this month or next.

Roger Franklin is head of insurance litigation at Edwin Coe and a committee member of the London Solicitors Litigation Association

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