Canada

In this chapter of our Annual Insurance Review 2023, we look at the main developments in 2022 and expected issues in 2023 for Canada.

Key developments in 2022

2022 brought with it the economic, social, and political reverberations of the COVID-19 pandemic, impacting insurance companies and the regulation of insurance more broadly. In this chapter we recap some of  the major changes impacting the insurance industry moving into the new year. 

Business loss coverage 

We continued to see the pursuit of business interruption claims and pandemic-related insurance in 2022. 202135 Ontario Inc., et al v. Northbridge General Insurance was the first business loss coverage case related to COVID-19 to come before the Ontario Court of Appeal. The insured owned seven daycare locations which were insured for property and business losses. Due to the pandemic, all seven daycare centres were closed for three months between March and June 2020, resulting in business losses. The insured was holding a business insurance policy with their insurer that included a special endorsement to cover business losses arising from a pandemic with liability for business interruption limited to $50,000. The insurer took the position that its liability was limited to $50,000 as a global total for all of the seven locations. The insured brought an application seeking a declaration that the $50,000 limitation applied per daycare location so as to entitle them to a global total of $350,000. The Court found in favour of the insured, that the limit of liability clause, read in the context of the policy as a whole, clearly and unambiguously meant that the limit of liability was $50,000.00 per location. 

Duty to defend and the pollution exclusion 

In Kin v. Ecclesiastical, the insureds brought applications against their insurers seeking a duty to defend in an underlying action. The insured sold a property to the plaintiff in the underlying litigation. The plaintiff in  the underlying action alleged that two underground fuel storage tanks (“USTs”) were not disclosed at the time of the sale. The underlying claim specifically alleged that the USTs had leaked. The insurers denied coverage based on a pollution liability exclusion in the policies. The Ontario Superior Court of Justice concluded that the pollution exclusion applied and the insurers had no obligation to defend or indemnify the insureds in the underlying action. The Court gave effect to the clear language of the policy reading the contract as a whole. 

Social inflation and inflation more broadly  

The cost of living continues to rise with Canada’s official inflation rate seeing year over year increases throughout 2022. With supply chain issues continuing to hamper the economy, we see increased exposure on insureds in the construction industry. 
Social inflation refers to all the ways in which insurers’ claims costs rise over and above general economic inflation, including shifts in societal preferences and trends. Social inflation has a direct effect on claims-related losses and insurance costs. 

In a series of lectures done for the Lloyd’s Marketplace, Miller Thomson raises the question of how social inflation is affected by economic inflation and how economic inflation often is yet another trigger for the societal and judicial factors that affect social inflation.

Contractor Course of Construction

Miller Thomson were successful coverage counsel in a large claim involving construction of a railway embankment in Western Canada (see: Kelly Pantaluk Constuction Ltd. v. Lloyd’s Underwriters,  2022 SSKB 227). The issue was whether the “Course of Construction Wrap-Up Policy” (the ”Policy”) issued to the insured obligated Lloyd’s to defend the action. There was no dispute that the claim fell within the grant of coverage, rather that certain exclusions applied concerning own works. The Court analysed the effect of the exclusions to find that they could be properly applied in a case of this nature.

Following the three-step analysis mandated by the Supreme Court’s decision in Progressive Homes Ltd. v. Lombard General Insurance Co. of Canada, 2010 SCC 33 (CanLII), [2010] 2 SCR 245 (“Progressive Homes”), in deciding whether the duty to defend has been triggered, the court must determine:

1. whether the claims as alleged against the insured possibly fall within the duty to indemnify; 
2. whether the claims are excluded from coverage; and 
3. whether the claims fall within an exception to an applicable exclusion clause.  

The court analysed the Operations Exclusion and the Project Damage Exclusion to find both applied to exclude coverage. The issue was whether the railway company’s claim against the contractor alleged property damage to the “principal’s existing surrounding property, not forming part of the project works.” The insured contractor argued that the foundational soils beneath the embankment were surrounding property, not forming part of the project works.

The court applied the Supreme Court’s analysis of the exclusion clauses in play in Progressive Homes, one of which excluded “property damage to that particular part of your work arising out of it or any part of it.” The phrase “that particular part of your work” meant that the insured’s work could be divided into component parts. This narrowed the scope of the exclusion clause so that coverage might remain for non-defective components of the insured’s work. The insured  presented argument that a restrictive interpretation of “that particular part” should apply so as to look only at the last lift of soil on the embankment so as to allow for coverage below the last lift and restrict the exclusion to the most recent lift of soil. 

The question became whether the railway Claim contemplated that the contractor’s work on the embankment could be subdivided into component parts and whether the claim alleges that only the final layer of soil was defective as opposed to there being “ongoing warning signs” of a predictable embankment failure.

Mr. Justice Layh distinguished this case from the facts of Progressive Homes: he found that successive and repetitive works of an identical nature cannot be separated into component parts.  

His Lordship also addressed the contractor’s argument that it was not performing operations “at the time of the damage” (as the damage had occurred at night when work had shut down). He agreed with Lloyd’s position  that construing the exclusion clause so narrowly that it only applies when the insured is touching the property would read it out of the policy. The fact that the contractor was not actively performing works when the embankment failed does not make the exclusion inapplicable.

Next, his Lordship considered KPCL’s argument that, since the railway claim against the contractor alleged wrongdoing by various consultants, the contractor was entitled to a defence for damages arising from their failures. However, the court noted that the railway pleading noted the insured was the general contractor for the project, responsible “for all aspects of construction, project management, safety, traffic management, testing and commissioning …” The judge observed that clause 8(c)(i) excludes from coverage “operations... performed by or on behalf of the Insured”. The words “on behalf of” also distinguish the present case from Progressive Homes.

Continuing the three-step analysis, his Lordship then turned to the contractor’s reliance on Endorsement 22 to determine whether it creates an exception to the Operations Exclusion. This turns on whether the railway Claim alleged damage to the railway’s “existing surrounding property, not forming part of the project works.”  The Contractor argued that the “foundational soils” were not part of the project works, while Lloyd’s responded that “the foundation soils were an integral part of the embankment, with which his Lordship agreed.  First, the foundation soils are an integral part of the embankment.  Second, monitoring the stability of the foundation soils was part of the contractor’s scope of work, as alleged in the railway’s Claim.  

Justice Layh was alive to a possible objection that he was reading Endorsement 22 to narrowly.  He noted that the endorsement could apply if, for example, the collapse had damaged nearby equipment  which was not used for construction on the project.

Summing up, Justice Layh addressed briefly the distinction we had raised between wrap-up policies and builders all risk policies.  He noted that the substance of the policy, not its label, is determinative and he had not relied on the distinction to reach his decision, which was that Lloyd’s did not have a duty to defend KPCL and awarded Lloyd’s costs.

Note: The above case is now on appeal to the Saskatchewan Court of Appeal.

The risk environment, increasing interests rates and regulatory responses 

The Canadian Office of the Superintendent for Financial Institutions (OSFI) published its Annual Risk Outlook for Fiscal Year 2022-23. In the latter half of 2022, OSFI observed a material shift in its risk environment. Higher inflation and monetary policy tightening has triggered a material rise in interest rates. Rising costs of debt, given a relatively robust level of private sector indebtedness altered OSFI’s analysis of its risk environment for 2022-23. OSFI noted that further rate hikes and a house price correction could lead to increased borrower defaults, credit losses and a broader housing-led softening of the economy.  

OSFI recently issued an advisory that applies to all Canadian mortgage insurance companies. It implements administrative interpretations to the Mortgage Insurer Capital Adequacy Test (MICAT) with respect to the determination of requirements for variable mortgages and adjustable-rate mortgages. The amortization of these loans could temporarily extend until the payment amount is set to align with the original amortization period. OSFI will continue to assess whether mortgage underwriting standards are well-adapted and sufficient. 

What to look out for in 2023 

 We expect to see the continued economic and social fallout of the COVID-19 pandemic to impact the claims environment and insurance industry at large.  Coupled with this we will see continued inflationary pressures on the real estate and other fields that rely upon real estate with potential downward effect on values, which will influence many other markets.

With respect to business loss coverage, we will continue to see more claims and applications addressed by Canadian appellate courts. We expect that there will be further litigation in the business loss space in the context of class actions that are starting to crystalize. 

We foresee that the economic uncertainty going into the new year will continue to shape regulatory responses to increased risks related to private sector indebtedness and mortgage underwriting. 

Written by Mark R. Frederick & Vanessa De Sousa.

Download our full Annual Insurance Review 2023 for more insights.