It is beyond dispute that manufacturing and sales have gone global. Almost without exception, companies of almost any size that manufacture or sell goods and products rely on foreign suppliers for all or part of the raw materials or parts they need to complete their own manufacturing process or the goods and products they sell. As the Fukushima reactor failure showed, localized disasters can affect a worldwide supply chain and force the shutdown of factories on the other side of the globe. It is, therefore, incumbent on risk managers to give serious thought to insurance coverage for supply chain failures.
The most common insurance product available to protect manufacturers and producers in this type of situation is contingent business income (CBI) coverage, also known as dependent properties coverage. This coverage is specifically designed to protect policyholders against economic loss caused by damage to property owned by others, including upstream suppliers and downstream customers. There are substantial variations in the scope of CBI coverage depending on whether an Insurance Services Office, Inc., or manuscript form is used and what types of coverage are selected. One of the key issues that should be addressed when purchasing CBI coverage is whether the policyholder must identify the specific locations for which this coverage will be provided. As will be seen from the Millennium Inorganic v. National Union case, failure to consider this issue can be very significant.
Recent Instructive Case Law
In Millennium Inorganic Chems. Ltd. v. National Union Fire Ins. Co., 893 F. Supp. 2d 715 (D. Md. 2012), Millennium was a leading global producer of titanium dioxide, a white pigment used in manufacturing a wide range of products. Millennium was insured under a global business insurance program, which contained up to an aggregate limit of $450 million per occurrence and included both business interruption coverage and CBI coverage. The CBI limits were $25 million per occurrence for named locations and $10 million for unnamed locations. It covered "contributing properties," but the policies did not define that term. The contributing properties were identified only with the words "direct only," and the policy required that the contributing properties be "direct suppliers of materials" to Millennium locations. None of these terms was defined.
Millennium required an uninterrupted supply of natural gas for operations at its Bunbury plant. In June 2008, there were two major producers of natural gas for consumption in Western Australia, where the Bunbury plant was located. Apache was one of those producers and operated a natural gas production facility on Varanus Island. The gas produced by Apache and the other producers was injected into a natural gas pipeline jointly owned by various other entities that was operated as a regulated, common-carrier pipeline, charging users for transporting gas from the inlet points to various outlet points. The pipeline company neither sold gas to end users nor purchased gas itself for resale. All the gas from the various producers was intermingled in the pipeline so it was impossible to identify or separate the gas produced by one company from the gas produced by another company. Various "aggregators" bought the gas from the producers and sold it to the end users.
Millennium purchased its gas from Alinta, which in turn purchased it from Apache and other producers. Alinta took title to the gas at the moment it passed through a meter at the inlet point in the pipeline but never took physical possession of the gas. Millennium purchased the gas from Alinta and took possession at or immediately downstream of certain outlet points on the pipeline without connecting to low-pressure gas distribution networks used by other end users.
On June 3, 2008, an explosion on Varanus Island forced the complete cessation of Apache's natural gas production. This interrupted Millennium's supply and forced Millennium to close its Bunbury plant.
Millennium made a claim for CBI coverage. Both parties agreed that the CBI coverage applied only to "direct contributing properties." Both agreed that the Apache property was not specifically identified in the policy and that the maximum available policy limits were $10 million. The insurers, however, argued that the CBI coverage applied only to direct suppliers of materials to the insured's locations, while Millennium argued that that limitation applied only to named contributing properties, not to unnamed contributing properties. As noted above, none of the relevant phrases was defined in the policies. The insurers contended that Apache was neither a direct contributing property nor a direct supplier because Millennium had no direct relationship with Apache. Instead, Millennium's relationship was with Alinta, the aggregator, and Alinta was Millennium's direct supplier. According to the insurers, Apache was, at most, an indirect supplier. Millennium countered that Apache was the direct supplier of natural gas because Alinta was merely an aggregator, not a gas producer or gas transporter. Alinta only traded gas by purchasing it in large quantities, selling the gas to the end users, and managing the transportation of the gas through the pipeline to the end users. It never actually "possessed" the gas.
The Maryland District Court analyzed both the factual idiosyncrasies of natural gas production and distribution in Western Australia and the surprisingly limited number of cases dealing with CBI coverage. The court ultimately determined that Apache was a direct supplier of natural gas to Millennium. While the court held that the policy was not clear and could be read to support the opposing positions of both Millennium and the insurers, the court noted that in case of ambiguity and, as in this case, the failure of extrinsic evidence to show an agreement by the parties as to the meaning of the terms at issue, the ambiguity must be construed in favor of the policyholder.
While Millennium certainly gave some thought to the consequences of a supply chain disruption, as evidenced by its purchase of CBI coverage, it is also clear that insufficient thought was given to the CBI coverage. The fact that there were separate limits for named locations and unnamed locations, but no locations were named, implies that the coverage form was provided simply to fill a need without anyone actually reviewing it and considering how it might apply. After all, why have two levels of coverage where one is incapable of being used?
It is easy to second-guess the care with which Millennium bought its coverage, particularly in light of more than 4 years of litigation over the applicability of Millennium's CBI coverage; however, property insurance renewals must be subject to detailed analysis. When this author reviews and analyzes policies for renewal, the different coverages are carefully compared to the policyholder's risk profile. Particularly for CBI and other time element coverages, the business must be reviewed, key suppliers and alternative suppliers identified, and an analysis made of what happens if a key supplier has a major loss. Some of the key questions to ask include the following:
How long would it take for the key supplier to get up and running, depending on the nature of the supplier's loss?
If there is only one supplier, what are the long-term effects to the policyholder's market share if the policyholder is closed down for 6 months to a year because of the loss suffered by the policyholder's supplier?
Are alternative suppliers available?
How long would it take them to be able to meet the policyholder's needs?
On the customer side, the policyholder must identify its key customers and analyze the effects of a key customer's loss and inability to purchase the policyholder's goods or products on the policyholder's business.
Part of the process of obtaining time element coverage, and particularly CBI coverage, is understanding the policyholder's supplier and customer chains. Absent that understanding, the risk of coverage gaps or inadequately drafted policies is substantial. Coverage gaps lead to uninsured losses and inadequately drafted policies, such as the one in Millennium Inorganics. That, in turn, leads to time-consuming and expensive coverage litigation. Both can be minimized or avoided if enough care is taken to carefully review and analyze the policyholder's risk profile and the proposed policy language at the front end.
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