Business Interruption Claims for the Hospitality Industry—Is Your Hotel
Protected?
September 2010
Maximizing recovery after a catastrophic loss
requires expertise in preparing hospitality business interruption claims, combined
with a thorough understanding of the hotel's unique market and operations.
by Michael
C. Speer, CPA
Grant Thornton LLP
and Christopher Brophy, CPA
FTI Consulting, Inc.
The hospitality industry has experienced tough times in recent years. Occupancy
and average daily rates have declined in many markets across the country, and
owners and operators have scrambled to cut costs. Although there has been a
reprieve of major insured property losses—such as those experienced from Hurricanes
Katrina, Rita, Ike, and Gustav, which hit the Gulf Coast states, and Hurricanes
Frances, Jeanne, Ivan, Charlie and Wilma, which hit Florida—the risk of losses
from hurricanes, earthquakes, flooding, fire, and other perils clearly remains.
Losses from the Gulf oil spill will be extensive—with a possible time horizon
of a decade or more—and will test the mettle not only of BP and other defendants,
but of insurers as well. The recent loss suffered by the Opryland Hotel from
the flooding in Nashville further reminds owners and operators of the need to
be properly prepared and insured.
In this article, we will look at some critical aspects of hotel business
interruption coverage, some nuances that we have seen on hospitality claims,
how to address those nuances at the time of a loss, and items to consider before
a loss occurs.
What Is Business Interruption Insurance?
Business interruption insurance exists to help a business return to the financial
position it was in prior to the catastrophe that triggered the loss. Generally
speaking, most policies compensate the hotel for revenues lost during the "period
of indemnity," less expenses that do not continue during that period ("noncontinuing
expenses"), plus "extra expenses" incurred.
This seems simple enough in theory, but in fact there are numerous variables
that influence each claim, such as insurance policy limits and sublimits, terms
of the policy, nature of the loss, and specifics about the hotel and market
it serves.
Period of Indemnity
The period of indemnity is the period of time following a loss during which
the hotel can, with "due diligence and dispatch," return to the condition that
existed prior to the loss. Many hotels recognize that losses may persist even
after repairs are complete—as the property works to regain bookings and rebuild
market share—and obtain additional coverage for an "extended period of indemnity."
Situations sometimes arise that can make the period of indemnity difficult
to determine. What if the owners want to rebuild the property differently than
it existed before the loss or decide not to rebuild at all? Another example
was the impact on a hotel destroyed by the World Trade Center tragedy. What
should the period of indemnity have been for the hotel, where the time to complete
repairs was significantly affected by the investigation? Furthermore, what if
there is a shortage of labor and materials, such as after Hurricane Katrina?
These unique situations can extend the time needed to rebuild and cause disputes
regarding the loss period that is covered by the policy.
Lost Rooms Revenues
The two primary factors that influence lost rooms revenues are occupancy
percentage and average daily rate (ADR). There are a number of factors to consider
in business interruption losses regarding each of the following areas.
-
What occupancy and ADR did the hotel expect to realize during the period
of indemnity had the loss not occurred?
-
Are the projected occupancy and ADR supported by occupancy trends in
the specific market? This information may be available from authoritative
sources, such as Smith Travel Research, which tracks and reports occupancy
and ADR for a competitive set of hotels in the geographic area.
-
Can the hotel document canceled reservations "on the books," including
conferences, events, and other reservations? (If bookings prior to the loss
are higher than bookings a year ago, that may indicate that the trend would
have continued in the coming year.)
One issue facing many policyholders, and hotels are no exception, is an often
misconstrued wording in an insurance policy that addresses "loss of market."
For example, suppose that a resort hotel is on an island, and the entire island
is wiped out by a hurricane. Can an insurer contend that the hotel has no insured
loss since there was a complete loss of market (i.e., no tourists are coming
to the island any more)?
Many other factors should be considered in preparing a claim and developing
revenue projections. Consider the following examples that raise interesting
questions.
-
A hotel is stuck in a deep local recession. The hotel prepares a rolling
forecast that reflects a continued pessimistic look of the economy. Then,
suppose the hotel suffers a fire that requires 2 years to rebuild. If the
economy recovers during that time, is the insured hotel stuck with preparing
a business interruption claim based on the original forecasts?
-
A hotel is damaged by a hurricane, which also destroys the competitor's
hotel next door. Can the business interruption claim projections reflect
the uptick the hotel would have received if the hotel was not damaged while
the competitor's hotel was destroyed?
-
An island hotel is damaged by a hurricane, and the airport is also damaged,
resulting in a reduced number of flights to the island. How should the claim
reflect the losses resulting from the airport damage versus the hotel damage?
-
A hotel/casino suffers a fire that damages half of the rooms. The casino
is not damaged. Does the policy provide coverage for the loss of casino
revenue?
-
A hotel is adjacent to an independently owned casino that suffers a fire,
and the hotel is undamaged. The casino owner decides to rebuild the casino
twice the size of the old, and it will take much longer to rebuild. Assuming
the hotel has contingent business interruption coverage (that covers an
interruption of business due to damage or destruction of the casino), how
will the loss be measured? (On the one hand, the hotel will lose revenues
while the casino is being rebuilt—including the additional time required
to expand the size—but on the other hand, the hotel may benefit by having
a larger casino when it does reopen.)
-
The risk manager for a large Real Estate Investment Trust that owns hundreds
of hotels operated under the same brand receives notice from the General
Manager of one location that the property has significant bedbug infestation.
The property is closed for 3 months for cleanup and repairs, and other hotels
suffer losses due to the negative publicity for the brand. Does the insurance
policy respond to these losses? If so, how are they measured?
Other Lost Revenues
Ancillary revenues including food and beverage, conferences, retail, golf,
spa, and other revenues can constitute a significant portion of a hotel's revenue
stream. When an interruption of business occurs at a hotel, any or all of these
sources of revenues are also typically interrupted in addition to room revenue.
It is important to analyze each revenue stream and consider how much revenue
would have been generated based on seasonality, market conditions, groups, and
other factors related to the specific hotel had the loss not occurred.
Ownership Issues
A challenging situation can arise when several owners share in one policy.
Suppose a large hotel operator has two properties in Chicago, but the properties
have two different owners. One property has a fire. The other property realizes
higher occupancy as it picks up some of the business from the first property.
How should the loss be measured? Is the insurable loss at the damaged property
reduced by the "make-up" of business at the other property?
Another issue can arise when a hotel has a contractual arrangement, as is
often the case, with a management company, asset manager, and/or hotel "brand,
" any of which may receive fees from the hotel that are in some manner tied
to revenues or profits. In such instance, would the contractual party be entitled
to any of the business interruption proceeds, and, if so, how could this best
be addressed in the business interruption claim? Typically, the various parties
protect their rights to recovery by having all parties listed as "named insureds"
on the policy.
Ordinary Payroll
Ordinary payroll coverage is a common endorsement in many policies that provides
coverage if a policyholder wants to retain key hourly employees who are idled
after an incident and unnecessary to continuing operations. Suppose a hotel
loses one-half of its rooms in a fire, but still needs to retain certain hourly
employees (e.g., front desk staff, accountants, bell stand, restaurant staff,
etc.) If the hotel has only 30 days of ordinary payroll coverage, is the labor
inefficiency covered during the first 30 days? After the first 30 days?
Extra Expenses
Most policies typically allow a hotel to claim extra expenses incurred during
the period of indemnity that are necessary to carry on operations and/or minimize
the amount of the loss. Consider the situation where, after a major fire closes
a hotel for a period of 6 months, management wants to spend $100,000 to have
a "grand reopening" to demonstrate to the world that the property is back and
is better than ever. Further, the hotel expects that this will improve its occupancy
in the immediate months after reopening. Should these costs be covered under
the hotel's insurance policy?
Conclusion
Business Interruption claims are complex for several reasons. First, they
involve predicting the future. For a hotel, what would the occupancy rate, ADR,
and cost structure have been had there been no incident? Second, they also involve
important and often disputed coverage issues—how does the hotel prepare the
claim so that it is in accordance with the terms of the policy?
Hotel owners and operators are well served to address these critical issues
in advance. A well-thought out risk strategy that includes input from the hotel's
risk manager, insurance broker, a forensic accountant specializing in insurance
claims, and a respected insurance coverage attorney can make a significant difference
at a time when the coverage is most needed.
Michael C. Speer, CPA,
is an Expert Commentator for the IRMI.com
business
interruption series, which provides articles on practical and topical ideas
on how a risk manager or insurance professional can better understand the business
interruption claims process and the challenges faced with such claims. Mr. Speer
has over 30 years of experience in public accounting and consulting firms. He
is a member of the Disputes, Valuations, and Investigations practice of LECG
and on the leadership team of the firm's business interruption and fidelity
claims support group. He also provides general forensic accounting and litigation
support services. For contact information, see
Mr. Speer's full biography on IRMI.com.
He can be reached at .
Christopher M. Brophy, CPA,
is a managing director with FTI Consulting in
the firm's
Property Insurance Claims Group. He has worked on hundreds of property
damage and business interruption claims, including claims caused
by the 1993 World Trade Center bombing; the September 11, 2001,
World Trade Center attacks; numerous hurricanes; several contingent
business interruption losses; and many individual losses resulting
from fires and explosions. He has extensive expertise with losses
in the hospitality, manufacturing, chemical, financial services,
hospital, telecommunications, technology, and nonprofit industries.
Mr. Brophy is also a Certified Fraud Examiner and has assisted clients
with forensic investigations, contract disputes, fidelity claims,
and FEMA claims. He can be reached at .
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