Business interruption ya think? A flood of coverage issues rises following Andy, Katy, Gus and Ike.
As the Insurance Advocate approaches deadline, the devastation of Hurricane Ike flashes grim reminders about preparedness, about the valor of volunteers, about the interconnectivities of life today and about the responsibility on all levels of authority to lead the way concretely past all the rhetoric in times of peril. For insurers, agents and their insureds, a performance standard is reset every time disaster strikes. Independent agents have come through with flying colors historically in their communities.
As we read estimates of Ike's toll--up to $25 billion (Deloitte Touche)--and add these to Gustav ($4.5 billion), we are halfway to 2005's $60 billion (Katrina, Wilma and Rita). And the season is not over yet.
As policyholders' trusted, professional advisors, independent agents will be called upon or will wisely take the time to reflect together with clients' on business interruption policies, to which end we present Dr. Strasavich's thoughtful work as it appeared in the CPCU Society's Risk Management Interest Group Quarterly Newsletter in Junk
The devastation of the Gulf Coast by Hurricane Katrina in August 2005 dwarfs any previous natural disaster in American history. Eight of the top 10 most costly American catastrophes in terms of insured losses have been hurricanes, with six of the top 10 occurring in just 14 months between August 2004 and October 2005. This growth in insured losses parallels recent growth in waterfront areas, with the largest population growth in Florida, Texas, and Virginia.
Among the myriad of claims arising from such disasters are business interruption claims. When first analyzing a business interruption claim, it is of paramount importance to read and understand the particular coverages within the policy. There are an infinite variety of available coverages and coverage forms, many of which are tailor-made for a particular company or business. Just a few of the prevalent coverages are:
* Civil Authority: Covers loss of business income and extra expense sustained from governmental denial of access to your property due to physical damage to third-party property.
* Business Income: Replaces income to the business that would have been earned had no loss occurred.
* Extra Expense: Pays necessary additional expenses incurred during the Period of Restoration that would not have been incurred absent physical loss or damage to the property. This often includes additional expenses to continue operating at the original location or at a temporary replacement location.
* Contingent Business Interruption: Covers loss of income incurred in the insured's business due to a property loss at the location of a key supplier or customer.
* Leader Property: Covers losses of business income stemming from damage to a third-party property that attracts business or customers to the insured's location.
Interruption by Order of Civil Authority
One common misconception of civil authority provisions is its perceived application to any action of government that causes a loss of income. This broad view is generally incorrect. Coverage under a typical civil authority provision requires physical damage to a nearby property, coupled with an action of a civil authority which prevents access to the insured's undamaged business location. The key inquiry is: Has a civil authority order "prohibited access" by requiring the business to close or suspend operations? See Southern Hospitality, Inc. v Zurich American Insurance Co., 393 F.3d 1137 (10th Cir. 2004) (FAA's order on 9/11 grounding air traffic had not prohibited access to the insured's hotels, which remained open at all times). Further, the prevention of access must be total, not partial, or a mere hindrance. See St. Paul Mercury Insurance Co. v Magnolia Lady, No. CIV. A. 297CV153BB, 1999 WL 33537191 (N.D. Miss. Nov. 4, 1999) (no coverage for casino-hotel whose business decreased 80 percent but which remained open during closure and repair of bridge); Abner, Herrman dr Brock, Inc. v Great Northern Insurance Co., 308 F. Supp. 331 (S.D.N.Y. 2004) (no coverage for Manhattan business where access was maintained though admittedly made more difficult after 9/11). It should be noted that one court has resolved a civil authority provision and the "property damage" requirement quite differently. Assurance Company of America v BBB Service Company, Inc., 593 S.E.2d 7 (Ga. Ct. App. 2003) (property damage requirement met by hurricane that did not make U.S. landfall as it caused property damage in Caribbean). Eliminating this issue, many policies will outline in a civil authority provision a requirement that the property damage that causes the civil authority order to issue must occur within a certain geographic radius from the insured's business location.
The Loss Must Be Caused by Physical Damage to the Described Location from a Covered Peril
Coverage for a business interruption claim will ordinarily be found where there is physical damage to the insured's business location caused by a peril covered under the subject policy. Each of these criteria is important in analyzing a business interruption claim. First, the loss of business income must be caused by physical damage to the described location. Not all conditions interrupting business qualify as physical damage. See Keetch v Mutual of Enumclaw Insurance Co., 831 P.2d 784 (Wash. Ct. App. 1992) (volcanic ash that fell on hotel after Mount St. Helens eruption, burying hotel in six inches of ash not physical damage where hotel remained open); National Children's Expositions Corp. v Anchor Insurance Co., 279 F.2d 428 (2nd Cir. 1960) (snowstorm that caused reduced attendance at exposition did not trigger coverage where building was undamaged). After this initial hurdle is cleared, it is important to establish that the property damage at issue was caused by a covered peril. See Valley Forge Insurance Co. v Hicks, Thomas & Lilienstern, L.L.P., 174 S.W.3d 254 (Tex. Ct. App. 2004) (law firms business interruption policy containing flood exclusion afforded no coverage for closure of building due to flooding from Tropical Storm Allison). Traditional exclusions that are applicable to other coverages within the policy may also apply to the business interruption coverage. One should also examine whether the physical damage is the cause of the claimed business loss, or whether other factors are involved. Business losses caused by factors other than physical damage to property, such as poor weather, will typically not be covered under a business interruption policy. See Harry's Cadillac-Pontiac-GMC Truck Co., Inc. v Motors Insurance Corp., 486 S.E.2d 249 (N.C. Ct. App. 1997) (1993 snowstorm, not roof damage, caused business loss to a car dealership which was inaccessible for a week).
The Described Location and the Period of Restoration
The insured's business location(s) will usually be referred to as the described location (or described premises). The way the described location reads in the policy can be crucial in determining not only whether coverage is afforded for any loss, but also the period of time for which benefits are payable (referred to as the Period of Restoration). For example, is the described location listed as a particular suite or floor of a 10-story office building, or is it listed as the street address for the entire building? Assuming there is (a) physical damage to the described location caused by a covered peril, and (b) a causal relationship between the physical damage and the lost business income, the question then becomes: How long is the period of time for which business losses are covered under the policy? This time period is customarily referred to as the Period of Restoration. The Period of Restoration can be an actual period or a hypothetical period. Some policies define the Period of Restoration in terms of both an actual period and a hypothetical period. The Actual Period of Restoration is the period of time it takes the insured to actually repair or replace the damaged described location or to secure an alternate location of similar quality. The hypothetical Period of Restoration, applicable when the insured does not repair or rebuild, is the period of time ending "when the property at the described premises should be repaired, rebuilt, or replaced with reasonable speed and similar quality." Calculation of the Period of Restoration can vary significantly depending upon the description of the insureds business location contained in the policy, as insurers of tenants in the World Trade Center learned in a series of cases following 9/11. The dispute central to many of these cases was the length of the Period of Restoration, with insureds typically contending that the Period of Restoration was the amount of time to rebuild the entire World Trade Center, and insurers contending the Period of Restoration was the amount of time it took the insured to secure an alternate, suitable business location. The answer hinged largely on the description of the business premises in the policy and on the nature of the insured's operations at the business location. Generally, the more intertwined the insured's operations were with the damaged property, the broader courts tended to read the business interruption coverage. See Zurich American Insurance Co. v ABM Industries, Inc., 397 F.3d 158 (2nd Cir. 2005) (engineer and janitorial contractor at WTC complex with space on every floor held to have used entire complex); International Office Centers Corp. v Providence Washington Ins. Co., No. 3-04-CV-990 (JCH), 2005 WL 2258531 (D. Conn. Sept. 16, 2005) (Period of Restoration ends when WTC is rebuilt for exclusive provider of temporary WTC office space whose policy defined location as "One World Trade Center"); Duane Reade, Inc. v St. Paul Fire and Marine Insurance Company, 411 F.3d 384 (2nd Cir. 2005) (Period of Restoration for drugstore at WTC limited to time it takes to build reasonably equivalent store in reasonably equivalent location); Lava Trading, Inc. v Hartford Fire Insurance Co., 365 F. Supp. 434 (S.D.N.Y. 2005) (Period of Restoration in policy that defined premises as Suite 8369 of World Trade Center ends when offices should have been replaced with other space of reasonable speed and similar quality).
Computation of Loss of Business Income
Even when coverage is found, a business interruption policy does not replace business income. More properly stated, such policies replace the profits of a business. If a business has lost money for an extensive period of time before the loss, it may be unable to recover under a business interruption policy. Aside from the necessary causal relationship between the physical damage to the insured's business location and the business loss, courts will consider the preinterruption performance of a business in determining the profits or income that a business would have had (if any) during the Period of Restoration. In Dictiomatic, Inc. v United States Fidelity & Guaranty Company, 958 F. Supp. 594 (S.D. Fla. 1997), a business claimed a loss of business income after Hurricane Andrew. The court determined that the insured failed to prove that but for the suspension of operations, it sustained an actual loss of business income that was caused solely by the hurricane and not by other factors. The insured could recover only to the extent that it actually lost sales or business during the periods when the business premises and business property were not functioning, and could not put the insured in a better position than it would have occupied without the interruption. In American Medical Imaging Corp. v St. Paul Fire and Marine Insurance Co., 949 F.2d 690 (3rd Cir. 1991), an ultrasound testing provider had a location sustain smoke and water damage from an adjacent fire, and immediately rented space in a temporary location. The temporary location had fewer telephone lines. To demonstrate a loss of income during its relocation, the insured showed business projections for the year in question and the accuracy of such projections in the past. In business interruption claims after a hurricane, some insureds contend that they would have reaped a business windfall in the post-storm environment but for the physical damage sustained by their business. This has been dubbed by some The Island Theory as it theorizes profits of a business that is open while its competitors are all closed. Should post-storm business conditions be considered in computing lost business income under the policy? More specifically, in post-Katrina New Orleans, is a loss of business income the result of physical damage, or the result of a decreased population? A couple of courts have considered these issues. In Prudential LMI Commercial Insurance Co. v Colleton Enterprises, Inc., 976 F.2d 727 (4th Cir. 1992), a hotel damaged by Hurricane Hugo claimed that had it not been damaged, it would have seen a significant increase in business from claims people, repair workers, etc. The hotel, however, had lost $350,000 in the 32 months before the storm. The Court held that the insured should be placed in the position it would have occupied had no hurricane (not damage) occurred, and to do otherwise would be to confer a windfall on the insured. See also American Automobile Insurance Co. v Fishermen's Paradise Boats, Inc., No. 932349CIVGRAHAM, 1994 WL 1720238 (S.D. Fla. Oct. 3, 1994) (dramatically increased demand for boats after Hurricane Andrew did not justify upward increase in business income for business interruption claim).
As with claims handling in other areas of insurance, it is of paramount importance to read and understand the provisions contained in a business interruption insurance policy. The details of the policy can influence tremendously the described location, the Period of Restoration, and the computation of business income. As increased hurricane activity is projected over the next decade or longer and as insurers continue to wade through business claims resulting from the storms of 2004 and 2005, proper and uniform handling of business interruption issues will benefit insurers and insureds alike.
Michael D. Strasavich, J.D., is a partner with Burr & Forman LLP in Mobile, Ala. A native of Dallas, Texas, he is a graduate of Spring Hill College and the University of Alabama law school from which he earned magna cum laude honors in 1995. Since that time, he has maintained an active practice in the areas of insurance law, commercial litigation, and employee benefits law: He maintains active membership in national and state defense organizations and has spoken on several occasions to bar and industry groups on hurricane-related insurance Issues.
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|Author:||Strasavich, Michael D.|
|Article Type:||Cover story|
|Date:||Sep 22, 2008|
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