Business Interruption and the 2010 Hurricane Season
July 2010
As we enter the 2010 hurricane season, it
is important to prepare for disaster. As much as we want to avoid the disruption
and loss to people and businesses frequently caused by hurricanes, one cannot
ignore the very real possibility that a hurricane can hit and cause substantial
loss and damage.
by Jay M.
Levin
Policyholders should, therefore, take steps to make sure they are prepared
to get the most value from their insurance. This article will address certain
key steps and then discuss certain issues relating to business interruption
coverage.
Secure Backup Data
First and foremost, all important documents and data should be backed up
off-site in a secure and remote location. A warehouse 2 miles away from the
main facility is probably not sufficient. There are companies that provide remote
backup servers which are located in less storm-subject locations. Those locations
have their servers in secure, storm-protected facilities with backup generators
for emergency power.
Having such facilities is key not only to a business's ability to resume
operations as quickly as possible, whether at a temporary location or new permanent
location, but to having the information necessary to prove a claim. This information
should include historical costs, model numbers and suppliers of equipment, stock
inventories, and raw material inventories. It should also include the accounting
data necessary to prove a business interruption loss, and should probably even
include pending orders to prove those that are lost because of the storm.
Review Insurance Coverage
It is also important to review all property coverages. While it may be too
late to add coverages, or increase limits, in the middle of a policy term at
the beginning of hurricane season, there are still benefits to the review. First,
make sure that all locations are correctly listed on the policy and that the
stated values are correct. Many policyholders rely on annual increases of a
set percentage to determine values. In most situations, those values will end
up being too low after a few years. While a yearly appraisal is neither necessary
nor cost effective, a careful review of values should be conducted on a regular
basis with more formal and detailed consideration of the accuracy of the stated
values every few years.
Business interruption values must also be evaluated. Business interruption
coverage is not solely for lost profits; it is far broader. Even a money-losing
company can have a covered business interruption loss if it has continuing expenses
and loss of revenue. It is also worth looking at the policy language to determine
whether business interruption coverage is triggered only by a total suspension
of operations, or also by a reduction or a slowdown in operations. The latter
is clearly more favorable to the policyholder.
Two issues which frequently come up in hurricane claims are whether the insured
can take advantage of hurricane-related increases in business once the insured
reopens to prove the loss sustained during a hurricane-related shutdown and
limitations on coverage for any available extended period of indemnity. Two
cases arising out of Hurricane Katrina illustrate these issues.
In Catlin Synd., Ltd. v. Imperial Palace of Miss.,
Inc., 2008 WL 5235888 (S.D. Miss.), Imperial Palace operated a casino
in Biloxi, Mississippi. This casino was the first to reopen after Katrina and,
as a result, had a substantial post-Katrina increase in revenue compared to
its pre-Katrina revenue. Imperial Palace argued that, had it not suffered the
loss or damage, it would have had this increased revenue during the period of
time it was shut down and its post-Katrina revenue should be the measure of
damages.
The U.S. District Court for the Southern District of Mississippi rejected
this argument. The court noted that the business interruption coverage looked
to the experience of the business to determine the amount of loss. The policy
provision stated:
In determining the amount of the Time Element loss as insured against by
this policy, due consideration shall be given to the experience of the business
before the loss and the probable experience thereafter had no loss occurred.
Imperial Palace argued that the language "had no loss occurred" meant that
one looked at what would have happened had its
property not been damaged by Hurricane Katrina, even though all the other surrounding
casinos were damaged. Imperial Palace had case support from Florida, but the
insurer had more and later cases supporting its position. The court held that
the strongest and most reliable evidence of what a business would have done
absent the hurricane is what it was doing in the period of time right before
the interruption. As the court noted, had Hurricane Katrina not occurred, Imperial
Palace's competitors would have remained open.
As most business interruption claims are calculated based on the pre-loss
performance projected through the period of interruption, this holding underscores
the need to maintain backup copies of records and pending work. It is much easier
to prove a loss with complete information.
Review the Period of Indemnity
Business interruption coverage protects against economic consequences of
a loss which occur from the date of loss to the end of the "period of restoration,"
the date the damage should be repaired or replaced with due diligence and dispatch.
This period of restoration is a theoretical period, not the actual period. It
can be extended by insurer delay in resolving the property damage claim. However,
just because a business reopens does not mean that it will immediately be back
to the same revenue level it was pre-loss. Many businesses, restaurants and
stores, for example, need a certain period of time to restore the same level
of business through advertising and other marketing.
This reality is recognized by coverage for an extended period of indemnity,
which indemnifies for the economic consequences of a loss beginning on the date
the period of restoration ends and going forward for a specified period of time,
usually 30 to 90 days. Coverage for an extended period of indemnity can be purchased
for longer periods of time, frequently up to 360 days.
One looks to the same records and analysis of pre-loss performance to determine
the amount of an extended period of indemnity loss as one looks at to determine
a business interruption loss. Many insurers, however, limit extended period
of indemnity coverage with a variant of the following language:
Extended period of indemnity coverage does not apply to loss of Business
Income incurred as a result of unfavorable business conditions caused by
the impact of the Covered Cause of Loss in the area where the insured premises
are located.
Insurers dealing with major hurricanes, such as Katrina, Rita, and Ivan,
argue that the damage is so widespread that the post-restoration loss is not
due to direct physical damage to the insured premises, but to the widespread
economic impact of the hurricane on other, uninsured premises (some of the effect
of this type of exclusion can be ameliorated by contingent business interruption
or dependent properties coverage).
An example of how this language is used by insurers to reduce claim payments
can be found in Cincinnati Ins. Co. v. Washer & Refrigeration
Supply Co., Inc., 2008 WL 4600560 (S.D. Ala.). There, the policyholder
was a wholesale and retail distributor of appliance parts, appliance white goods,
and heating and air-conditioning (HVAC) equipment and supplies. It primarily
serviced the replacement market, not the new construction market. After Hurricane
Katrina, WRS's primary facility was shut down for approximately 60 days. When
WRS reopened that facility, because most of its service area was buying appliances
and HVAC equipment for new construction as opposed to replacement, it suffered
a significant loss of business.
WRS made a claim for loss during its extended period of indemnity; Cincinnati
argued that the above-quoted language precluded coverage for the reduction in
revenue because it was not due to the physical loss or damage to WRS's principal
location. Cincinnati argued that the loss was due to the change in economic
conditions caused by Hurricane Katrina.
The court found that the "overwhelming evidence indicated that WRS's slowdown
in business beyond 60 days after Katrina was caused by the impact of the storm
in the surrounding area of WRS's business." Therefore, the court held that WRS
was not entitled to coverage for its reduced revenues during its extended period
of indemnity.
Conclusion
As always, understanding the coverage available in the applicable policies
is key to understanding the potential for recovery. The best time to address
this is at renewal so that policies can be analyzed, potential disaster scenarios
thought through, and appropriate coverage obtained. Insurers will carefully
analyze business interruption claims and claims for loss during extended periods
of indemnity and will strictly enforce policy language in an effort to minimize
claim payments. The best way to combat this is by obtaining the broadest possible
coverage and by maintaining backups of all important documents so that the amount
of loss can easily be proven.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author's employer or IRMI. Expert Commentary articles
and other IRMI Online content do not purport to provide legal, accounting, or other
professional advice or opinion. If such advice is needed, consult with your attorney,
accountant, or other qualified adviser.