By Alice Uribe

SYDNEY--Insurance Australia Group Ltd. is confident a test case looking at whether businesses in Australia are covered when their business is interrupted by an outbreak of disease will swing in the industry's favor.

Lobby group Insurance Council of Australia and ombudsman Australian Financial Complaints Authority said last week that they had agreed to file a test case in a "superior court" on the matter.

The case will likely consider the validity of some Australian insurers' small-business policies that contain exclusions in the event of a pandemic. That's because some policies still refer to the Quarantine Act of 1908, which was replaced by the Biosecurity Act in 2015.

Peter Harmer, outgoing IAG chief executive, said the insurer was "very confident" on the efficacy of its exclusions.

"We and the industry share the view that the exclusions for business interruption arising out of pandemics are still valid, but obviously if there are questions and the industry thinks that it's sensible to try and get clarity on this matter as soon as possible for ourselves and our customers," Mr. Harmer said.

"We are confident that our exclusions will hold up, but of course, where anything is going through a court there is always litigation risk, even if it's small."

Mr. Harmer said insurance policies typically have no choice but to exclude items like pandemics, war and terrorism.

"That is because those events impact many, many customers all at the same time, and there is just simply not enough capital in the industry globally to insure these events and pay out the claims," he said.

IAG, in announcing its full-year earnings for the 12 months through June on Friday, confirmed that it had set aside a 100 million Australia dollar (US$72.1 million) provision for potential Covid-19 claim costs impacts, spanning business interruption, landlords' and other insurance classes.

Analysts at Macquarie say that Australian insurers could face up to A$535 million in losses if the test case is not decided in their favor.

In the U.K., the Financial Conduct Authority have also launched a test over business interruption policy wordings, which insurers say do not cover the pandemic.

Mr. Harmer said there was the potential for a second business interruption test case, relating to a prevention of access exclusion.

"The industry's view is that pandemic exclusion applies to the entire policy, and the various coverage under that policy. The industry just wants to make sure that there is no confusion about that matter either," he said.

"We're hoping that AFCA and the ICA will collaborate again as they've done with the Biosecurity versus Quarantine Act wording to identify a test case on behalf of the industry as well." 



  Write to Alice Uribe at alice.uribe@wsj.com