Business Interruption Insurance and Policy Exceptions for the COVID-19 Pandemic

Listen & Download

The outbreak of COVID-19 led to the closing of thousands of businesses across the country. Some businesses that were closed by state and local governments are now seeking business interruption coverage as a result. There currently are two common business interruption policy forms: gross earnings and business income. Most insurers are stating that there are policy exemptions for viruses and pandemics that prevent insured businesses from receiving business interruption coverage due to COVID-19. In response, there is legislation being crafted in several states that purports to override these policy exemptions for viruses. Is this type of legislation constitutional under Article I, Section 10, Clause of the United States’ Constitution? Professor Richard Epstein, Professor of Law at New York University, discusses these issues with us in this Federalist Society teleforum. 


Prof. Richard A. Epstein, Laurence A. Tisch Professor of Law and Director, Classical Liberal Institute, New York University School of Law


This call is open to the public - please dial 888-752-3232 to access the call.

Event Transcript



Dean Reuter:  Welcome to Teleforum, a podcast of The Federalist Society's practice groups. I’m Dean Reuter, Vice President, General Counsel, and Director of Practice Groups at The Federalist Society. For exclusive access to live recordings of practice group teleforum calls, become a Federalist Society member today at



Micah Wallen:  Welcome to The Federalist Society's Teleforum conference call. This afternoon's topic is titled "Business Interruption Insurance and Policy Exceptions for the COVID-19 Pandemic." My name is Micah Wallen and I'm the Assistant Director of practice groups at The Federalist Society.


      As always, please note that all expressions of opinion are those of the expert on today's call.


      And today we are fortunate to have with us Professor Richard Epstein, a longtime participant of our teleforum calls and a Laurence A. Tisch Professor of Law and Director of the Classical Liberal Institute at New York University School of Law.


      After the professor gives his opening remarks, we will then open up the floor for an audience Q&A. Thank you for speaking with us today. Professor, the floor is yours.


Prof. Richard A. Epstein:  Thank you so much. Obviously, anything that has to do with COVID-19 is a topic which will give rise to immense concern, and I think the best way to approach this thing is to put it aside for a moment, instead of concentrating on the political dimension, and to go back and to add something about the way in which contracts of insurance ought to be worded in order to understand what things are properly included by way of coverage and what things are properly excluded by way of specific exemptions from coverage, often done by contract.


      The first point I think to say in this case is you are dealing here with contracts between two businesses: an insurance company on the one hand and a whole variety of commercial forms on the other, and that the operative principle that ought to apply in these cases is, generally speaking, one of freedom of contract.


      This does not mean contracts cannot be set aside, but it does mean that contracts can only be set aside under those circumstances where there's something by way of fraud or duress or misunderstanding that introduces them. And the basic premise for all contractual freedom is that, if you look at the utilities of the two parties to the transaction prior to the time which they enter into it and then look into them afterwards, do the subjective gains that they feel from the transaction exceed the transaction's costs that are necessary to put it together?


      Unless there is some kind of very unfortunate third-party effects—conspiracies to commit murder is an obvious example of that—generally, you want to respect that kind of tradition because you can't get yourself into the area of consumer protection in dealing with these particular [inaudible 00:02:39].


      Then, the question is why is it, generally, that insurance markets actually do arrive? And it turns out that what it has to do with is the question of variation with respect to the insured and variation, of course, with respect to the insurer.


      On the insured side, what happens is people know that they have certain kinds of expenses and certain kinds of revenues that are relatively consistent and stable and they never want to get insurance with respect to those things that are more or less fixed. In the extreme cases, you know that there's 100 percent probability that you will have a particular loss five years down the road, there is no way that you could get insurance against that because there's no uncertainty in the case.


      What you could do is you could now prepay for the loss that you're going to get paid back, and the only thing that you actually worry about is the discount rate so that the amount of money that you pay in today is going to give you, after interest and compounding, the amount of money you're going to need when that future event occurs.


      What happens is -- what you do is you use insurance to resist uncertainty with respect to things. Generally, the uncertainty has to be large enough that you prepare to incur administrative costs in order to deal with that particular problem. The reason why you do so is if it turns out that there are huge losses in a particular case that can completely wipe out a business—if you have huge gains, it's very rarely in these business kind of cases, how you like it—but essentially, since you're dealing with insurance in the domain of losses, what you say is, "A huge loss could wipe me out altogether. If I can reduce the size of the loss, that means that I can withstand the bad periods and I'm willing to pay a premium in order to get that, including the cost of administration and the like that is necessary with any kind of insurance policy."


      And so people, by and large, will therefore use it against extreme events. And the reason why business insurance is such a popular line of insurance to write is the fact it deals with exactly that kind of an uncertainty. A business which can thrive with a 5 percent loss consistently, period over period, because of natural disasters cannot survive. If they have one of 1,000-fold that time, in one period, they're all gone.


      Well, the next question that then comes is, "Well, why are there going to be exceptions from coverage under these kinds of cases?" And the answer to that question, I think, is sort of equally clear. Suppose it turns out, in the extreme case, that what you have is a common mode risk.


What the common mode risk is defined at is you have all of your policy insurers and, it turns out, that if one of them is going to be hit by a particular adverse event, the probability in the extreme case is going to be one that everybody else in that particular insured pool is going to be hit as well. The question, then, is if it turns out that the risk is universal to all the parties of the insured, what kinds of gains are you going to start to get?


      Well, the first thing that happens is you don't get the advantage that you typically get with insurance, which is that they're ten of us and we all have uncorrelated risk so that what happens to me bears no relationship to what happens to you. We can fund the loss to me in the bad period by having the taxing revenues from you in the good period.


      But if it turns out that we all go up together and we all go down together, then at that particular point, there's no way in which you can have that cross-subsidization in the ex-post world. So what you're doing now is you're saying to people, "What you have to do is to pay the amount that you're going to get. Everybody else is going to have to pay exactly that same amount. You put this into an insurance policy. What you're going to do is you're going to add, obviously, administrative costs, which are very difficult calculating the risk, figuring out whether the premiums are properly spent when they're paid out, and so forth."


In the end, it turns out it's just not worthwhile for people to want to do that. They're better off trying to mitigate their own loss without the administrative overhead and the oversight that's being associated with an insurance company because there's no way, in effect, that they can ask the good risk to basically subsidize the bad risk because, in these cases, everything is universal.


      When you start looking at an insurance policy, if you can't get the risk pull-in and the risk spreading out of these things, the correct strategy is to turn down the particular risk and to leave everybody on their own.


      When you start getting to the coronavirus cases, it turns out that there is the old plague about dealing with pestilence, war, and famine. And these are all very bad things, and they're generally excluded from insurance, precisely because if they hit one, they're going to hit all.


      If you start to look at this COVID case that we're facing here under these circumstances, what you find is that they drafted the policy so that the common exclusion for these kinds of risk covers squarely the coronavirus-type situation.


      Now, once you start to exclude that, of course, you're going to start to see changes in the premium. Since the policy is going to cover less, it turns out that the individuals are going to have more money on the side.


One of the things that you can do with the money that you save, at least in some cases but not in all, is that you can try to take other kinds of precautions that will mitigate the harm that comes with the occurrence of certain kinds of excluded risks so that you can take the money, in effect, and put it into loss prevention since you cannot put it into loss spreading.


      How much of that can you do with the coronavirus is actually probably pretty little because these shutdowns are going to be ordered on the basis of general natural conditions or national conditions. They're not going to be done with respect to particular stores, in most of these cases, or particular businesses.


So you have the situation that if you want to take these particular precautions, it may not allow you to open up to begin with anyhow. Although, later down the road, it may well be that you're going to be able to open up more quickly if you've done these things, and you have to make a business judgment as to whether or not you want to do that.


      When you're dealing with the current coronavirus-type situation, the basic conclusion that you have to reach is this is not a case in which you can apply the principle of contra proferentem that is often introduced—wrongly, in my view—into insurance policy.


      Contra proferentem is Latin for it simply means we construe a policy, and when it's ever ambiguous, against the party that has offered the original terms. And since the insurance company offers the terms, you tend to resolve ambiguity in favor of the customer rather than the insurance company.


I think it's, in general, a bad policy and I've always preferred the rule that you want to use ordinary meaning because you never quite know how far you're going to go off the beaten track when you impose a contra proferentem rule.


But in this case, it turns out the policies are perfectly unambiguous. Everybody understands that these things are going to be excluded. So what is requested in this case, chiefly by restauranteurs and similar type of parties, is that what you do is you basically outright override the contract under these circumstances and force the particular risk to be covered.


First dangerous sign that you see with respect to this situation is a very simple one. If you look, there is a market for getting yourself these extraordinary coronavirus-type risk, political risk, and other things, but it costs you an enormous amount in order to do so. It's offered, therefore, as an extra in some kinds of cases, which most people start to turn down.


One of the reasons that these things are very expensive is people are always afraid that it may be that the insured knows more about his own business than the insurance company does, and if they're willing to buy this kind of a policy, it means that they have an expected gain, which may turn out the fact, given the information that's private, that you have an expected loss.


So the things are essentially excluded. The number of options that are taken up to do this through contractual riders of one form or another are virtually zero. So you have this basic situation.


The question, then, is why should you give people something for nothing? Well, under these circumstances, when there's a perfectly efficient explanation as to why it is that these things happen.


Well, it turns out that what the restauranteurs start to say is, "Look, we, like every other industry, are the backbone of the American economy. We hire a huge number of workers, many of whom are marginally paid, low-income people. They've suffered enormously in this situation. If you could get us back to work, then you could get everybody back to work."


Well, I think that there is some truth to that, but what follows from that is how do you do it? The proposal that's being given with respect to the insurance companies under these situations is as follows. What they are doing is they are going to be forced to pay out claims of business interruption insurance by a set of parameters which we don't know simply because this type of coverage if not offered, but we know it's going to be a very tidy sum in the hundreds of billions of dollars, perhaps even more, as these suits start to max.


Well, all of this will sink the insurance companies if, in fact, they're required to do this because having uncompensated losses, and they will have to set aside reserves in order to deal with them. This will force them to further contract their business on virtually every line. And so, what you will do is not eliminate the insurance problem, you'll simply transfer it to all other commercial sectors which would otherwise start to be viable.


The answer that the restauranteurs give to this is they say, "Look, the insurance companies, what they should do is they should be reimbursed by the federal government for the losses that they have to incur." And this is a terrible idea.


The moment you say that we're going to reimburse for the losses that you incur, and then it turns out the insurance company is our middle man, and if every dollar they pay out in claims is a dollar they're going to get back from the federal government, it turns out they're not going to be particularly vigilant to figure out whether or not certain cases are actually valid and, if so, how those claims are to be valued.


What they'll do is they'll go back to the general public and demand the money. We've already seen how this starts to work because we've tried to give large-wave supplements and various kinds of loans to businesses at the peak of the coronavirus crisis, and what happens is the money makes people happy for a week or two or three or for a month. Then, it's all gone. The basic situation with the virus and the shutdown still remains, and so you have to go back to the well another time and get yet another set of subsidies in order to run this thing forward.


And when you try to get that set of subsidies to do [inaudible 00:12:47] what it does is it piles up the national debt. Right now, things look to be pretty good on this front. In fact, the interest rates are pretty low because it turns out that there's no private activity, but the real danger that you have is down the road there's going to be this enormous debt.


Private companies are going to try to get back into the market in order to use debt financing for their own stuff, and when they start to do that, it just turns out there's just not going to be enough available credit around if it turns out that huge amounts of payments are going to have to be made on these kinds of debts by the federal government.


So, it turns out there's no such thing as a free lunch in any of these kinds of cases. The question that you have to ask when you put in these very complicated administrative schemes is who's going to be left up holding up the bag, one, and then two, is the size of the loss going to be constant, or will it be increased because, it turns out, that you don't handle it.


In my view, what happens is if you try to play this game and placate this particular interest, others will come in and that the whole system start to groan and teeter under the case because the federal government, in the end, is going to have to hold the bag for this and for every other similar kind of loss.


So what is it that you have to do in order to handle this? It seems to me that you have to work on two particular fronts. The first one is when do we open up to begin with? And if we had done this sooner, these losses would've been smaller, and it turns out that the problem of their reallocation would've been easier to handle.


There was an enormous reluctance to do this. I thought much of it was misguided, but that's another kind of debate. I think the correct answer to those cases is to keep a very watchful eye over those people who are high-risk categories; for restaurants to make it clear how they're serving things so that they can attract customers to come in. You'd predict that there'd be changes to the menu, changes in the way in which the food is going to be served, changes in the way in which the waiters behave, an upsurge in outside business, which is generally safer than inside business, in an effort to try and get the business less interrupted that it would otherwise be so that you don't need the insurance in question.


And the second thing, it seems to me, that you have to do in order to make this particular scheme work in any kind of a coherent way is you have to worry about what kinds of liabilities are going to be imposed on these companies after it turns out that they decide to open up. That's a slightly different debate, but it's sure related to this one.


In my view, if you tried to make these determinations on a case-by-case basis, there'll never be summary judgments. There'll be all sorts of exotic cases that you can't deal with. It's going to be very difficult to resolve these via class action. It'll be very difficult to establish what the standard of care is, very difficult to figure out whether or not there's contributory negligence.


In many of the really high-risk cases, if you're running a nursing facility or some kind of facility which has been forced to remain open and take COVID-positive patients by the government, causing the losses in question, you're going to have the odd situation that trying to get indemnity from the government for the losses that you suffered are going to be absolutely impossible because of the discretionary function exception, which is located in all sorts of government arrangements, both at the federal and at the state level.


I think, in effect, that we have huge losses that are attributable to the coronavirus policy to begin with that should've been done quite differently, but that's water over the dam, under the bridge, or however you call about it. The question that you really have to ask now is, going forward, is there any way to solve this particular problem? And I think that basically creating immense cross ups for the insurances and immense liabilities under the tort system is the wrong way to go.


What happens is the insurance function doesn't work particularly well. The liability system doesn't work particularly well. What we have to do is to try to get ourselves in a sort of lawyer-free zone so that both insurance markets could resume voluntarily and, on the other side, that business openings can take place in a more orderly fashion than they are doing so now.


I've lived through some of this with connections with university, and one of the things that you discover is you've got a lot of things that you have to make, but the government takes its own sweet time in issuing the various regulations on how, when, and what you're able to reopen. The problem there: there's no incentive whatsoever on the part of public officials to make prompt and reliable decisions, and the private sector is being held hostage to that.


With that, I think I've taken my 20 minutes, if I'm not mistaken. And so, what I want to do, roughly speaking, is now take whatever questions people have. Thank you.


Micah Wallen:  Wonderful. Thank you so much, Professor. We'll now open up the floor for audience questions in a moment. Before we go to our first question, I'd also like to offer up a brief reminder to keep an eye out for the schedule of our upcoming teleforum calls. We send out emails each week announcing each call beforehand. The full list is also available on the calendar on The Federalist Society website at


Without further ado, we'll now go to our first caller.


David Emerson:  Yes, [inaudible 00:16:39] David Emerson in Berkeley. Thank you for your presentation. A question I'd like to get your reaction to is on torts and general liability policies.


Although there may not be a provision for coverage for the coronavirus for business interruption, at the same time, the insurance companies appear to be reaping windfall profits because facilities are closed. And because facilities are closed, they aren't receiving the kind of premises liability claims they would ordinarily incur.


Do you think there's a bit of horse trading or a bit of back and forth here between the windfall profits they receive there and paying out something under the business interruption policy?


Prof. Richard A. Epstein:  Well, I think, actually, that's a terrific question, and it's also come in connection with automobile insurance where it turns out that the number of accidents is way down because the driving is there.


      And I think that the situation is that you should not do horse trading, but you should understand that they are two separate situations and you deal with each of them separately. With respect to the underutilization of these particular claims, I do think that it's perfectly sensible—and I would urge the insurance companies to do this—is to say, "Look, it turns out that the volume that we anticipated was X. It turns out to be one-half X. What we're going to do is essentially to return that premium to you. Then, we're going to have to charge in the second period." In the second period, what you do is you charge for that.


      Why do you want to do them separately? Because there's absolutely no reason whatsoever to believe that people who, essentially, had a loss in premises claims made against them are going to be the people who have really high business interruption insurance. If it turns out that they should get a refund of $5,000 on the one policy and there's going to have to be a potential $500,000 windfall on the other, canceling things out doesn't make any sense at all.


      Generally speaking, you never want to lump two particular transactions together. You want to deal with them separately.


      Now, when you [inaudible 00:19:46] with the first claim, I said I thought insurance companies should start to do this on a voluntary basis. I do think that would be a very nice question of contract law to add is, given that this was also an unanticipated situation in which it had massive wealth consequences in favor of the insurance company, is there a kind of a force majeure exception that requires them, essentially, to try, in good faith, to scale back the amount of coverage that they take such that the profit they get from that business is the same as it would've been if things had gone forward in its normal way.


Which means, in effect, what they do is they have to give something back, save the administrative expenses, and give something back with respect to the claims not paid so that they get roughly the same rate of return on their investment under these circumstances as otherwise.


      I haven't read the policies, and they may have something to deal with that. I think one of the corollaries of your position is if it turns out that they basically say that "In the rare event of one of these windfalls we don't make any kind of adjustment in the particular period," then, in effect, I think you'd have to ask whether that cause is good with the usual stuff having to do with no disclosure and all the rest of it.


But I don't think that the kind of horse trading that you're talking about makes any sense. It could well be that what happens is, by virtue of the fact that these guys should pay back $1 billion dollars, we're now going to hold them responsible for $100 billion. I know which horse I would want to be on, and since that's the way in which the trade works, I don't think it ought to be undertaken, particularly as a matter of government fiat.


David Emerson:  All right. Thank you very much.


Prof. Richard A. Epstein:  Sure. Shortest presentation in history.


Micah Wallen:  Professor, I think -- I actually had a question myself. I was just wondering whether we are in this time period where there could be this second wave of the virus happening in the fall and there could be a new set of interruptions to business. Does anything in this -- does that sort of hang over this calculus at all, or anything you've discussed today? Or change how you think these policies will be approached?


Prof. Richard A. Epstein:  I don't -- that's a great question. I think the answer is there may well be something like this. My guess is if it's going to be a second wave, it will be less dramatic than the first wave for the simple reason that you'll never get a repetition of what happened in New York, no matter where you go in the country.


It's hard to know exactly how these second waves work, but if there is a second wave and it's a common mode failure, then the same logic would apply that applied to the first wave, which is that business interruption insurance now covers you a second time. Everybody's going to have to dig deeper into their reserves, but if you really decided to suspend that in the business interruption exemption, then you're going to have all the untoward consequences we talked about.


Now, the hard question is how seriously we take this. It's a very difficult question. I mean, we've seen an upturn in a bunch of states. We don't know the extent to which that's because of bad healthcare practices in the absence, or whether there's a higher level of testing, which simply reveals a higher number of cases.


It's also the case that we're not quite sure what the consequences of the virus are. If it turns out you get an increase in the number of cases of people who are in their 20s and 30s as opposed to people in their 70s and 80s, what you're looking at is a loss which is probably one-tenth the seriousness of when it hits an older population.


It's also the case that one has to think very carefully in these particular situations about the kinds of treatments that ought to be used. But a number of treatments, mainly with drugs already on the market dedicated to other purposes, which have been proposed to deal with this. The HCQ situation, hydroxychloroquine—I have managed to pronounce that after five years of trying—that some people still think that it works very effectively even if the FDA tends to differ with that. And then there's a new British drug, the doxa-something-or-other, that has come out which may have some kind of effect.


It's also the case, I think, just with standard protocols. Physicians are terrific at trying to figure out how in forward to modify practices that they learn in one case to make sure that they work better in the next case. There are obviously all sorts of bulletin boards on which you could share these information.


And so you have to ask the question: If we have a second wave, but it turns out that when it does hit the damages are going to be a lot lower, you should change the behavior. It's also the case, if you're going to have a second wave, I don't think the cost associated with the lockdown are linear in the sense that, well, if you go two months it's twice as bad as one month, another 50 percent, and so forth.


I think, in effect, that those losses are really capable of snowballing and becoming almost exponential on the business side. Businesses are now going to fail which before might've hung on. People are going to lose their skills and find it more difficult to get themselves back into the labor market. The educational losses in schools are going to be enormous as these kids are subject to real pressures and deprivation of all that's going on.


So I would be very much opposed to trying to impose the same kind of a lockdown the second time around that we did the first time around. And you want a real nightmare scenario, Micah? What's going to happen is you push this thing into the fall, we're now going to be into the regular flu season. And once we're into the regular flu season, you start seeing things. What's it attributable to? That's a serious issue right now.


That 110,000 figure—some people say it's too low, and some people say that it's too high. I tend to be in the latter group. I think what you have to do, if you're worried about this, is first take out all of the COVID forced deaths from people like Governor Cuomo in New York forcing people who are COVID positive into nursing homes where -- in New York State it's probably a death toll of over 6,000 deaths, most of which are completely unnecessary. So you have to do that.


Then, there is the question of how you treat cases that are not conclusively identified. Then, there are cases about comorbidities and so forth. And somebody could make a very respectable argument that the number is inflated because all these doubtful cases are resolved in favor of inclusion where there's a strong financial incentive to do so given that the compensation rate from the federal government for a COVID case is close to $40,000 whereas for an ordinary death case it's around $5,000, if I have my figures correct.


So we really, at this point, have no idea of what these numbers start to mean. And we have no idea of exactly when these cases get [inaudible 00:25:59] in, whether they're going to be as severe as they were the first time around. So I would think that those problems you're going to have to face when they come to it.


The experience that I have seen and the institutions that I have some familiarity with is really very simple. The government seems to think that if they tell you you can open up on June 30, you can basically make that decision on June 29.


But virtually every kind of facility that you mentioned—summer camps, daycare centers, and all the rest of that—most of the money that they spend to put their programs into place is incurred before the kids arrive on the place. They have no chance to prepare and they're not going to prepare in May if it turns out they have a 20 percent chance of opening and a 100 percent chance of losing the front-end costs, which they won't be able to recover if they don't do it.


So one of the really strong problems here is, again, with business interruption is that you get a government which is completely unresponsive in terms of the way in which it deals with things. Now you've got the huge hazards under these situations. If they think there's business insurance for people on the outside, they may be even slower and more dilatory than they turn out to be.


But you look at the New York State guidelines for universities to open up. They were supposed to be issued on June 8. It's ten days late. They don't have it. We're trying to figure out at NYU and every other university is to how to run classes in the fall. You take away ten days from that particular operation as these people diddle around with their own requirements, they're just making everybody's life harder than it has otherwise been.


And this is, of course, always the problem. The people who run government programs have no responsibility for the losses and have enormous incentives to exercise their own power in ways that aggrandize it to themselves, and everybody else has to pay the consequences.


This business insurance as a real moral avid program here is not from the insured people. My view is that the restauranteurs are doing everything humanly possible to get their situation straight. It's from the government agencies who essentially have the power to control but don't bear any of the financial responsibility associated with this.


And this goes back to the decision back in 1946. This, what turns out to be, huge exemption for the discretionary functions of government. They're not held liable for everything. So my favorite illustration on this is if the government organizes, as it did in the Dalehite case decided in 1953 in an effort to try and switch various kinds of grains overseas and the whole thing blows up and explodes, they're protected by discretionary function.


If that ultra-hazard activity were taken by a private party, there would be strict liability. And there's just no way that you can reconcile those two particular kinds of results. And we're seeing the consequences of that here. The amount of business interruption is being incased by the dithering incompetence of many people in power of which the New York State Health Department is Exhibit A.


Is there any other questions?


Micah Wallen:  Yes, I think your response actually [inaudible 00:28:59] quite a response as we now have quite a few questions lined up in the queue. So without further ado, we'll go to our next caller.


Miles Carlsen:  Yes, Professor. Miles Carlsen. Thank you for an excellent presentation. I was wondering if you have any observations on the BI test cases that are being presented through the U.K. Financial Conduct Authority and whether you have any observations on the rulings in France relative to access liability on the insurance claims presented by some of the restaurants in France. Thanks.


Prof. Richard A. Epstein:  Well, let me tell you the following thing. I'm sure I have a completely definite opinion on all of these issues, but until I know exactly what the rulings are—which I don't—I can't answer. So if you would summarize at least the first one, I'll give a shot at that and then, at this time, I'll take the second one on. I'm not afraid of giving instantaneous answers which may be wrong, but I'd like to know what it is that I'm trying to stock, and that means that you have to spend about 15 seconds explaining the cases.


Miles Carlsen:  I'll try and get it under 15 seconds. A number of the carriers have, working with the FCA, are going to basically —


Prof. Richard A. Epstein:  FCA?


Miles Carlsen:  The Financial Conduct Authority in the U.K. They're going to present basically their policy language to the high court, I'm assuming, and they're going to seek a ruling, or rulings, on whether or not their various coverages—and apparently there's going to be some disparity in the language. They're going to seek rulings on whether or not these carriers are liable for BI under the policies as drafted; not what someone would like to be but according to the language.


Prof. Richard A. Epstein:  So BI here means business interruption rather than bodily injury, right?


Miles Carlsen:  That's correct. Yes.


Prof. Richard A. Epstein:  Well, I think the answer is. I was trained as an English lawyer. My first degree is from Oxford where I studied contract. If they use ordinary meaning, then I think whatever result comes out ought to come out. If they're trying to use some more exotica theory of interpretation to skew it towards the insureds, I think it would be wrong.


Generally speaking, the underlying analysis that you would want to undertake is in variance of the country in which you undertake it. The same problem about common mode failure as being essentially uninsurable would apply as much to Britain as it does to the United States, and it's even, indeed, even closer to that. The basic principles of American insurance law derived from British law, particularly marine insurance law, which has then carried over into the United States.


And what happens is, there's a complete inverse in the way in which people want to think about it. The earlier view started in the 19th century in England was that if you presented a hull and wanted to get insurance, there was some serious asymmetry of power because the insured essentially knew what was wrong with the boat and the insurance company, even with inspections, would be at a disadvantage.


So with all the rules on doubtfulness where it's essentially in favor of the insurance company so as to force the disclosure of the risks to make a more accurate assessment of premiums.


The position today, which I think is completely incorrect, says, "Well, they're just helpless people and these insurance companies have all these market powers," so we put the policies and construe them in the opposite direction.


I think insurance has construed many large firms, but I don't see this as a monopoly industry in any way, shape, or form. There's intense competition all the way up and down, so I would say that you want to apply the same premises here that you do in the United States, and that you'll have the same consequences if you don't apply those premises and create a situation where it turns out there's going to be, essentially, the imposition of a risk for which there's no premium sufficient to cover.


You will then have to either go into bankruptcy, or to avoid it, have to set aside ever larger reserves. The more reserves you set for existing cases, the fewer discretionary resources you have to take on new risk, and so the entire insurance market for everybody else will be in a real crisis because affordability will be limited and availability at a decent price will be compromised as well.


I assume the French situation is exactly the same. I never quite know what the French are saying, notwithstanding the fact that I don't speak French and maybe before but, again, on this point, I'm a natural lawyer in the sense that I don't believe that variations in individual countries or cultures make a difference.


The other point that you do matter will count is it may be that variations in language will make a difference, but in my view, if they're on the smaller side, I think the background norm explaining why these risks are generally uninsurable, is the norm which should essentially lead you to say, "They're not going to be covered unless there's some pretty clear evidence in this particular case that you do cover it." And, generally speaking, in order to do that, I would want to see some separate premium charged in order to get above the standard kind of business rate.


It would be the same thing, for example, that you apply with respect to political risks. If you want to do business and it turns out that there's a danger that you're going to be shut down by the arbitrary actions of the Indian or the Korean or the French government and so forth, a political risk insurance, I think, is the only thing that you can do. You have to have to have very tight parameters around it before your write it, and that you are never to include a political risk component into a general coverage formula. Okay?


Miles Carlsen:  Yeah, thanks for that. Appreciate it.


Prof. Richard A. Epstein:  Thank you so much for asking the great question.


Micah Wallen:  We'll now move to our next caller.


Robert Barker:  Hi. This is Robert Barker down in Atlanta. Thanks for the conversation and thanks for picking this topic.


Isn't part of the problem here -- you state insurance is a contract law question, which it basically is, although I think the way that it's taught in law schools these days is it's kind of insurance is just another socialized arm of the government. So if there's a problem, the insurance companies can bear responsibility for it.


I guess the question that I would pose is this is not only affecting the contract between the insurance company and the insured. Because, in most cases, the insurance companies have been really clear that they don't cover terrorist losses and they don't cover pandemic losses. That's pretty well defined. And most insurance companies -- I think the Legal Sea Foods case is an exception to that because I think they actually bought pandemic coverage in early March and that's, I think, winding its way through the courts or something.


But then, there's the question of the contracts behind the insurance contracts. The contracts between the landlord and the tenant where the landlord requires the tenant to have business interruption insurance because part of the rent is based on the operations. And the landlord and tenant don't have any way of really thinking about the fact that a standard business interruption insurance policy will not cover a pandemic.


It's going to be interesting to see how those cases wind up. I think there's a lot of cases winding their way through the courts.


Prof. Richard A. Epstein:  Oh my god. This is a great problem, but again, what you have to do is whenever you want to solve these contract problems, you have to break it down. And let me take two points.


The first one you make is the social insurance point. And this was associated chiefly in the 1980s with a man named Alain Enthoven who worked at Stanford University, and he tried to do it with respect to healthcare.


The argument is that the standard contractual requirement of insurance coverages need not be satisfied. And that's a requirement which says that anybody who's in the insurance pool, regardless of who else in in that pool with them, will get a rate of return from the coverage which exceeds the premium that he pays and the private transactions cost that they have to bear in order to receive the insurance. And it turns out that if everybody has that particular type of situation, then in effect, the insurance pool will be stable even if the risks turn out to be highly heterogeneous, right.


Some big guys, some little guys, some old guys, some young guys. You can write life insurance for a 21-year-old and for an 80-year-old and put them in the same pool if you've got freedom over the coverage. And the same thing is true with respect to business insurance or interruption insurance and so forth. So that's the first kind of point.


What social insurance says is, "No, no, no, no, no." What we do is we basically require some kind of transfer from the more favorable to the less favored group. Obamacare, one of the reasons why it's had such difficulty, is when it dealt with community rating, it said that you had to have a 3:1 ratio max in the difference between the young group and the old group even though the market rate was a 5:1 difference.


I'm not going to go through the calculations now, but essentially, what it means is that 50 percent of the premium that a young person pays is going to be covering insurance for somebody else, which leads to an unraveling of the pool. The same thing happened when you tried to mandate cost coverage in the AIDS cases on individual policies in D.C. There, the ratio was 10:1 or 100:1 and so the whole pool started to disintegrate.


Social insurance can only survive if you get a government to put money in, and then you have the same problem you always did. You got to tax it from somebody else. That creates budgetary pressures and deadweight losses on the market. So you can't beat mother nature in this particular game. That's the first problem.


Second problem you ask is a completely different problem. If you have a landlord-tenant relationship that says the tenant must get business interruption insurance, and it turns out the tenant can't get that kind of insurance—let's assume this—and so what happens is the loss comes and the tenant is in breach.


Well, now the landlord has what kind of remedies? Well, they can do eviction but that, of course, is going to be stopped in some of the particular situations. They can try to sue for damages. Now, in fact, this is something -- this risk actually may be insurable in some sense because you have to understand what the difference is.


In the business interruption situation, generally speaking, you're talking about lost profits, right? And we know that that's a random variable, very hard to measure. In the rental case, what you're saying is you're only liable for the insurance on the rent. So if you could calculate an estimated probability since you could liquidate the amount of damages that occur in each particular period, it may well be liable.


But if they don't get it, the thing about this is pretty clear. You, as a landlord, can check whether or not they get the requisite kind of [inaudible 00:39:46] long before the crisis arises. And so, if you don't check for that and then thing then happens, you're faced with the risk. Well, you kind of impliedly waived that. Or you can say, "You now have an action in damages to get the rent even though they don't have the insurance," which of course, is no remedy at all because you're trying to get the protection.


Well, I don't think what you can do is to say that any screw up that starts to take place between the landlord and the tenant in these particular cases is a justification for putting huge liabilities on third parties for which they can [inaudible 00:40:17].


The old Roman [inaudible 00:40:19], which means anything that involves a third party is something which you don't have to take into account when you start to do this particular contract.


Now, there are further problems here, as you well know, because it's not clear that you need business interruption insurance. In many cases, including California, the rule seems to be that given the crisis, what we're going to do is we're going to prevent evictions, and what we're going to tell the landlord is that they can recover the extra money once the crisis is over. And the answer is, if you start looking at this in terms of standard bankruptcy procedure, this is a cram down situation.


The rule is that the amount -- if you wish to delay the payment, whether it's a mortgage interruption or a rent interruption, what you have to do is to give the party who is hurt by the delay a full and perfect equivalent to what they had. And you can't get that in these cases.


It's not as though what they're going to say is that you're going to have a lien on their personal probably if they don't pay it. So assume somebody goes for three months and then they simply walk out and leave. Well, at this particular point, where are you supposed to go? Sue them personally in order to recover this money when they don't have it anyhow?


So I would think that it would be exactly the same as with the insurance policy on BI, business interruption, which is if the government wants to basically tell the landlord that they can't collect on the rent then they have to be prepared to guarantee the particular rent, which becomes the same kind of disaster that I talked about before.


In my view, what you do is you don't do anything collectively, and then the landlord is faced with the following problem, and it's a famous problem that you have. You have a tenant in breach and you're entitled to essentially enforce the contract and throw them out. But if you do that, essentially, they're gone and you don't get the services.


So nothing is more common than in the business world to see a situation where there is a known catastrophe where the person who's entitled to the benefit says, "Look, I'm going to cut a deal with you. You can take 50 percent now and 50 percent later. Give me some kind of security." And you do it consensually. This happens all the time. Starting in the 19th century, any time you got a settlement of that particular form, what happens is they were binding regardless of the fact of whether there was or was not consideration.


In a famous case that Judge Cooley decided in the 1880s, somebody was supposed to deliver ice to a particular plant so they could use it for keeping everything cold. It turns out it was an unreasonably warm season, and you had to go 200 miles further north to get the ice, and if you wanted the contract, you'd go into bankruptcy. And so what happens is the other guys says, "I'll tell you what. We'll make a deal, and I will compensate you for 80 percent of the additional costs that you have to pay in order to go those additional miles." And there was no consideration. They didn't get anything else back except the ice he had, and the answer is the deal was good.


That's the way you want to think about this. What they've done in California and New York is they've completely screwed up the voluntary process by putting into place the mandatory process, and they put it in for too long. It's hard to describe the level of sheer incompetence on all these private law matters that is invested in the governors in the various states. They are beyond belief ignorant of everything that should help these things work, and in their meddlesome nature, they're making every problem worse where they should be making them better.


What happens is there's no recourse against the government when it issues its dictates because of the discretionary function exception protects them, essentially, from all kinds of potential tort or takings liability.


Robert Barker:  Just a follow on those, shouldn't we be blaming the law professors for not teaching insurance law for the last 30 or 40 years?


Prof. Richard A. Epstein:  Well, I teach insurance law all the time. The answer is, look, this is a much larger question, but I'm going to take at least one minute to answer.


The single greatest tragedy in American legal education is that private law is now regarded as kind of a curiosity, and people do it because they have to not because they want to. There's no sort of systematic expertise in that. It's not only insurance law, it's also becoming contracts and torts and equities and remedies and so forth.


I spent my life, because I was trained as an English common lawyer, working on these particular fields. And, in my view, it's the lack of understanding of those fields which really leads to a kind of mindless behavior in the public law sector by people who think that every question of contract law is a question of "public policy." There was an old English judge who once said, "Public policy is an unruly horse, and he who gets on top of it should beware of being thrown for a loop."


I'll take the next question.


Robert Barker:  Thank you.


Prof Richard A. Epstein:  Sure. My pleasure. Anybody else?


Micah Wallen:  All right. We've come to the end of our question queue, so I'll offer up one more call for any questions from the audience. If you'd like to join and ask a question of Professor Epstein, just press star and then pound on your telephone keypad.


Prof. Richard A. Epstein:  And don't be reticent.


Micah Wallen:  Professor, sort of just building off my last question a bit. Something you referenced near the end is the lack of clarity we have around the numbers surrounding coronavirus with how each individual state is recording it.


It seems that we're sort of in a situation now where governments are going to be in an odd position where if they sort of backtrack and recount their statistics and they end up being much less than they appear, they'll look bad for taking the measures that they did.


Do you think that private companies or private business are going to take it on themselves to try and find out what the actual, I hate to say death count, but what's the actual mortality rate and the numbers were in these individualized areas in order to justify whatever policies they want to pursue?


Prof. Richard A. Epstein:  Micah, that is a terrific question. Let me tell you what it involves. It essentially means that if you look at the way in which these government processes work, everything is done by fiat on the basis of information which is not disclosed by individual experts whose names are not disclosed.


I don't think there has been a single public document issued in New York, Pennsylvania, New Jersey, Massachusetts, Michigan, California, and so forth that says, "The reason we are doing this is because we ran the following kinds of analysis and this is what we think."


So what happens is -- what you really want is for people to be able to bring FOIA, Freedom of Information Act, kinds of requests against the government to get this stuff. One such action was brought in California, and the response came back, quite accurately I fear, saying, "We have no documents."


If that's true, then it means that Gavin Newsom, who by and large knows very little about any of these issues based on his own practice and experience, essentially is flying blind and taking informal advice from a group of people, even his own health commission, but never committing it to paper.


What you have to do in order to understand the way in which this game works is compare this to what we normally think of as notice-and-comment proceedings under the Administrative Procedure Act with respect to major decisions that are going to be implemented through regulation. And we have this incredibly elaborate process in which people are supposed to submit these papers. The government is supposed to give out its position, and then you can criticize the position and so forth.


In many ways, it's almost too cumbersome to work, but the alternative has been don't do anything at all. So here, what you do is you have a decision, I think it's fair to say, that has been more impactful on the nature of the world and the operations of the United States than any other administrative decisions that have been taken with respect to the domestic economy, including those which have been taken in wartime where the only thing they did was to impose things like price controls and so forth.


But this is just much greater. And what's the level of process that you get? Well, people invoke an emergency statute which gives a governor the right to do things in order to protect the public for 30 days. And then they discover another emergency and another emergency and another one after that. So essentially, it's one-person autocratic rule without any public accountability whatsoever.


If you actually try to get that information, I think the answer is they won't give it to you. So, you really have to go to court in order to get it. And the difficulty with that is by the time you get through with preliminary motions, much of the danger or the benefit will pass in getting a kind of ruling.


So, what's happened is stonewalling has become, essentially, the preferred form of administration action on behalf of the governors, most of who have the effrontery to take after the hapless Donald Trump, who has done very little in this particular area to harm anything and his task force under Mr. Pence, as far as I can tell, has actually been reasonably expeditious in trying to figure out how to allocate the stuff on the federal side.


It's just a complete crackdown. There's an old maxim which says that, "In times of necessity, property rules are always suspended." And that's perfectly good when you want to make sure that a guy who's caught in the middle of the storm can clamber on the deck of somebody else, even if he damages with his ship, knowing that he's going to have to pay for the damage afterwards, but you don't have the right to exclude.


In this particular case, the necessity is being taken so much further, so much more compressively, so much more dangerously that what has happened is there is a breakdown of any and all form of public accountability. You listen to the various governors talk and it becomes perfectly clear they have no idea what they're talking about, and they won't reveal their sources. They won't subject themselves to any kind of cross-examination.


Justice Roberts, at least in the short run, made it pretty clear that, "God, this is so complicated. I'm not going to have any part of this." So this sole judicial situation has been essentially through passivity to ratify the situation. And you wonder why we're in such trouble under these circumstances?


Well, the answer is when you violate standard rules of due process, standard rules of procedure for getting and organizing the administrative information in the state, when you completely upend private arrangements by government arrangements that have many unintended consequences and many direct, intended consequences that are perverse, that's why you get this kind of situation. The quicker that we can unravel ourselves from this thing, the better it's going to be.


But if you try and put on top of this business interruption insurance and rent suspensions and wealth transfers and special unemployment benefits and so forth, you'll prolong the agony and, sooner or later, as Margaret Thatcher used to say, "You'll run out of other people's money."


Is there another question?


Micah Wallen:  All right. There is not so I'll toss it back to you for any closing remarks you wanted to add before we end today.


Prof. Richard A. Epstein:  Sure. I'd just make one thing to my passive audience—I always like to take questions—is that what happens is the following maxim that applies. What happens is whenever you have a situation under crisis, the question is what kinds of rules do you start to follow? And there's one set of principles that says that what you do is you suspend every kind of rule in order to deal with the immediate emergency. And there's certain kinds of cases for which that is certainly the direct approach.


To give you kind of an illustration, Congress has the power to declare war. It turns out that Congress is in recess and their enemy fighter planes 100 miles away from the border, the President can marshal the air resistance without going to Congress to start to deal with it.


But if it turns out afterwards then, soon or later, the longer the process goes on, the more you want by way of political participation and regular methods in order to deal with the incipient threat.


One of the areas in which this was extremely controversial, and it's a very, very hard question, was the War Powers Act, which, essentially, sort of bound the President. He vetoed it and it was passed over his veto. The question is, can you basically change the relationship between the executive branch and the Congress going forward by actions in which the President has no say whatsoever?


And I think there's a strong argument to say well, probably not; maybe no. But in this case, it's not war. It's not enemy. It's not secret. And so what you need to do is to read it as follows. If you look at the original statutes, virtually all of them start to say the governor gets 30 days. But what's he supposed to do in those 30 days? First of all, manage the crisis. But the second thing is, he should immediately start to bring into advance other political branches of government, including the legislature and its committees, so as to form a more coherent policy based upon [inaudible 00:52:55] democratic situation.


If, in fact, he's allowed to declare successive emergencies arising out of a common event, it means the 30-day limitation is nugatory, and it turns out that all the political branches are shut out of the process. If you're doing something like that and you don't get multiple voices in there, you're not going to get intelligent cross examine and criticism of what's going on. Cuomo could ignore anybody in New York state. Governor Pritzker could ignore anybody here. They just trot out some kind of an expert and say there's a terrible peril.


Now, the other thing that goes wrong—and I'll just end on this note—is what they do is they tend to rely on garbage models. The Imperial College model was a notable failure. Neil Ferguson had done many similar predictions in which there were no interventions and he was always off by a factor of five or ten, and the original models were completely wrong. And everybody starts to act on those models. They never realize that if you just know that there is going to be a crisis out there, people will respond to it before the government gets a chance to do so.


So you can't have a model in which this thing grows up slowly in a [inaudible 00:54:03] and then two months into it, all of a sudden you get this huge spurt. Their model essentially had, on July 5, there would be 10 million active cases in the United States unless we did something. And then they flattened the curve by saying, "Oh, we'll get it down to 5 million active cases and a little bit earlier." Wrong on both counts. Because they underestimated the reaction.


I also think—other people disagree—that there's another serious issue about the coevolution of a virus. Generally speaking, if you look at AIDS or syphilis or any other disease, it may be quick, it may be long, but there's going to be coevolution. So I think, as I mentioned earlier, that if you have a second wave of the virus, in my view, it's likely to be less damaging than the first one.


And then, you combine that with better treatments and so forth, it's fine. It would be a complete disaster to follow Mr. Fauci's proposal. He knows nothing, as far as I can tell, about actually the social design of these systems to say that we can't do anything until we get a vaccine. That day may never come. Just as with flu season, sometimes they work and sometimes they don't work.


What you have to do is to, essentially, get this system back into operation by having a more responsive political system which understands and appreciates the need for private ordering and then what you have to do is to give private parties, when they're given a responsibility, to figure out how to satisfy their market conditions.


You go on the Upper West Side where there's a large number of old, vulnerable people and you say, "Come into the bar anytime you want and have a drink," nobody's going to show up. So there got to be all sorts of separations. And localized knowledge as to what kind of establishment is catering to what kind of clientele will do a lot better than this sort of single, monolithic approach that has been taken by the governors.


On this issue, being a Hayekian is extremely important. Decentralized authority harnesses private information that no governments should have. Decentralized authority gives you people with incentives that really matter whereas government controls, mañana is always too soon. We could take our own sweet time.


We, essentially, are seeing the great failure of the large progressive administrative expertise model going forward as opposed to the decentralized incentives of the model on the other side.


And business interruption insurance. You see the same fight playing out over and over again. Now the question is can we force the government to subsidize the losses without consequences to the parties on whom the taxes are going to be imposed and the way in which their conduct is going to be altered.


This is not a happy topic, but I have come to the end of my time, so I will be silent and, at least for the while, hold my peace. Thank you all for listening.


Micah Wallen:. On behalf of The Federalist Society, I'd like to thank Professor Epstein for the benefit of his valuable time and expertise today. We welcome listener feedback by email at [email protected]. Thank you all for joining us. We are adjourned.




Dean Reuter:  Thank you for listening to this episode of Teleforum, a podcast of The Federalist Society’s practice groups. For more information about The Federalist Society, the practice groups, and to become a Federalist Society member, please visit our website at