As the Russia-Ukraine conflict continues into its seventh month, the consequences beyond the devastating local human impact will be felt in myriad ways by businesses around the world. Property may be destroyed, expropriated or abandoned, supply chains interrupted, and commercial activities sanctioned. Aaron Le Marquer and James Breese explain the role insurance plays in mitigating the financial consequences of war.

War risks insurance has its origins in marine insurance, and until the late-19th century, war risks were typically covered under typical ‘all risks’ marine policies. Around the turn of the century, war risks started to be identified as a heightened form of risk requiring dedicated underwriting, and exclusions were introduced requiring shipowners to purchase express coverage where necessary. In modern times, most commercial ‘all risks’ property policies will exclude losses arising from the consequences of war. Businesses whose operations may be exposed to risks arising from or related to war or political conflict must generally purchase bespoke cover in the form of political risk, political violence or terrorism policies.

For these reasons, the insurance sector’s exposure to losses flowing from the Russia-Ukraine conflict might be expected to be relatively contained. In May 2022, Swiss Re put its initial estimate of losses at £238m, while in August, Axa confirmed that it had reserved €300m so far from aviation and political risk. However, these are preliminary estimates of loss in respect of a geopolitical dispute that is still ongoing. The ultimate impact on the insurance industry may be many orders of magnitude higher, particularly in light of emerging coverage issues in the aviation and cyber spaces.

Aviation

One of the most immediate sources of significant insured loss has been the aviation sector. In March 2022, in response to the initial wave of sanctions imposed by the west in response to Russia’s invasion of Ukraine, Vladimir Putin signed a new law entitling Russian airlines to retain and operate aircraft rented from foreign lessors that were forced to sever ties with their Russian counterparties due to the sanctions.

Total estimates of the number of lost aircraft range between 400-600, with a commercial value of between $10-$13bn. Lessors are turning to their insurance policies (which tend to be a highly bespoke form of cover specific to the industry) in search of indemnification.

First out of the gates has been Aercap v AIG. In its claim against two panels of insurers led respectively by AIG and two Lloyd’s syndicates, Aercap seeks recovery of almost $3.5bn under two independent sections of its aviation policy, effectively two separate policies underwritten by different panels of insurers. Under its claim under section one of the policy, Aercap claims for wrongful deprivation of physical possession of the aircraft, which it claims amount to a total loss for insurance purposes. Aercap claims the full agreed value of the aircraft amounting to nearly $3.5bn.

The insurers’ defence to the section one claim is essentially fivefold:

1. The deprivation is not sufficiently permanent to amount to irretrievable deprivation.
2. Coverage for the lost aircraft ceased upon the termination of the relevant leases.
3. The coverage sits in excess of other recoverable insurance.
4. Any claim is excluded under insurance clause AVN48B, namely the war, hijacking and other perils exclusion clause.
5. Payment of the claim is prohibited by EU and UK sanctions.

Aercap’s alternative case, if the losses are not covered under section one, is that they are covered under section three of the policy, which provides express war risks coverage. In that case, the aggregate coverage is limited to $1.2bn. The war risks insurers are defending the claims on the basis that Aercap has failed to plead any peril within the scope of the war risks coverage. The insurers are also relying on similar “other insurance” and sanctions defences to those mounted by the section one insurers.

It appears that the Aercap proceedings will test a number of common coverage issues arising in relation to losses flowing from the Russia-Ukraine conflict. It is likely that other lessors and stakeholders in the aviation market may encounter issues unique to their policies and facts, generating the need for further litigation in this area.

Cyber

Another line of business in which insurers have been nervy about war risks is the relative newcomer of cyber. Over the past 10-15 years, insurers have fallen over themselves to write this business and establish market share in what they see as a sector of major future importance. In recent times, a hard market has seen an abrupt change in underwriting appetite, with reduced capacity and restricted terms available in the face of rapidly escalating risk.

With much talk of the possibility of cyber warfare emanating from Russia against western supporters of Ukraine, the cyber market will have been alarmed by the decision of Superior Court of New Jersey in Merck v ACE in January 2022. In this case, the court found that the hostile/warlike action exclusion in various property policies did not prohibit coverage for the NotPetya cyberattack launched by the military arm of the Russian Federation against Ukraine. The court found that the terms of the exclusion were only intended to encompass traditional warfare and did not extend to cyber-attacks. Merck was, therefore, entitled to seek coverage of losses estimated at $1.4bn.

Upon closer examination, the Merck judgment may be of limited direct relevance to London market cyber insurers in that it was not an English law decision and related to a claim under a traditional property policy with no cyber exclusion but with a war exclusion. Nonetheless, in the present market conditions, it is unsurprising that insurers are extremely wary of covering cyber risks associated with the ongoing war in Ukraine and that the market is taking proactive steps to limit its exposure.

Taking the lead has been Lloyd’s, who, in August 2022, issued a market bulletin requiring all cyber policies to include a suitable clause excluding liability for losses arising from any state-backed cyber-attack. The circular confirms that model clauses issued by the Lloyd’s Market Association (LMA) in November will be sufficient to meet the requirements, although the LMA clauses are not mandatory. The Lloyd’s market bulletin and LMA clauses have met with some opposition from brokers and policyholders. While they recognise the legitimate desire of insurers to exclude genuine war risks from what are essentially ‘all risks’ cyber policies, they fear the proposals go too far in circumscribing the cover available under Lloyd’s cyber policies.

The difficulty lies primarily in the question of attribution. In the case of physical loss or damage to property, establishing whether war was a factual cause of the loss may be expected to be a fairly uncontroversial matter (although arguments over proximate causation are inevitable). However, in the case of a cyber-attack, investigating and establishing with certainty the factual origins and perpetrator(s) of the attack is inherently challenging and may be impossible. For this reason, the LMA clauses include a mechanism by which state-backed cyber operations are to be identified primarily on the basis of attribution by another state. Pending any such attribution, insurers are relieved from paying any loss. There are obvious problems with this approach from the policyholder’s perspective. In the present climate, it seems highly unlikely that a policyholder can expect prompt payment of any significant claim under a policy containing such a clause.

This is a challenging issue to which there is no obviously right answer. As it stands, it seems likely that the LMA cyber war clauses, if adopted wholesale by the market, have the potential to give rise to significant disputes over coverage. Litigation will inevitably ensue.

Press coverage

City AM spoke to Aaron Le Marquer as Lloyd’s issued a defence of its plans to stop providing insurance coverage for state-backed cyberattacks.

Aaron warned the terms of Lloyd’s exclusion could see insurers refuse to pay out, due to a lack of clarity around what is meant by the term ‘by or on behalf of a state’. He explained that the exclusion clause lets insurers refuse to pay out to policyholders, pending investigation, with no time limit on when an investigation should be completed.

He noted that it is often hard to determine whether hackers are state-backed or not, due to the nature of cyberattacks. “I would be very wary of paying for a policy containing any of these exclusions,” he said, as he argued policyholders may increasingly begin securing policies from insurers outside the Lloyd’s market.

Comment

Even if the conflict in Ukraine ends soon, significant direct and indirect losses flowing from the conflict will continue to manifest around the world for some time. How insurance policies respond to such losses will inevitably be subject to dispute that goes beyond merely the existence or effect of express war cover or an express war exclusion. The stage is set for hard-fought litigation that may clarify the application of policy terms in the present circumstances.

Beyond the existing disputes over aviation losses and the anticipated cyber storm, it is likely that the terms of other policies, including political risk, political violence and trade credit will also come under close scrutiny in the coming months. In the meantime, policyholders in all sectors should take time with their brokers and advisors to examine their current cover and consider whether it represents the best available in the market for their needs in order to minimise coverage disputes further down the line.

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