The earthquake in Japan is yet another example of how property and business interruption insurance may not immediately respond as corporate risk managers may expect.
As a risk manager, you did all the right things. You understood the risk of an earthquake in Japan, and you secured earthquake coverage with reasonable deductibles and sublimits. You recognized that many of your U.S. operations were dependent on suppliers or customers in Japan, and you bought contingent time element coverage. You were even careful to add other coverage extensions, such as ingress/egress, service interruption, and civil authority. You reported to your management and board that you were well covered in the event of an earthquake in Japan.
Now Comes the Loss
Japan was hit with one of the most significant earthquakes (8.9 magnitude) ever recorded. The earthquake caused a huge tsunami and caused damage to a nuclear plant—the impact of which is being felt around the world. Your operations were badly impacted. You had some damage from the earthquake; the ensuing tsunami caused further damage. Service interruptions caused by problems at the Fukushima Daiichi nuclear plant affect your plant. Many of your employees could not return to work. Your supply chain was significantly disrupted. Your plants outside of Japan have had problems receiving components made in Japan.
Impact of the Earthquake
Approximately 143,000 buildings were damaged.
Insurance payouts are expected to be between $12 billion and $42 billion.
The earthquake triggered a significant tsunami.
Numerous aftershocks occurred.
Rolling power outages resulted.
Supply chains were disrupted around the world.
So, You're Fully Covered, Right?
One would think so. But, you might pull out your policy and review the small print and consult your broker, an insurance coverage attorney, and an insurance claims accountant. They can give you a good understanding of the issues that you may face, provide some examples of precedents from other disasters, and help guide you through what may be an onerous claim process.
Some questions that you may need to address include:
If I am covered for an earthquake but not for a flood, are losses attributable to the tsunami covered since the earthquake caused the tsunami?
If the policy includes a nuclear exclusion, am I entitled to losses attributable to the service interruption caused by problems at the nuclear plant?
Am I covered for business interruption losses that I endured because of losses suffered by my suppliers?
Am I covered for business interruption losses that I endured because of losses suffered by my customers?
If I am covered for losses suffered by my suppliers and customers, how will we determine the proper period of time for such recovery?
Should the impact of the aftershocks be considered a separate occurrence under my policy?
If our business interruption loss is attributable to damage suffered by suppliers of my suppliers or customers of my customers, am I still covered?
How should losses attributable to the extended period of indemnity be claimed?
Should the impact of a peril that is not covered under my policy be treated as an "idle period" against the impact of a peril that is covered?
If losses that I suffered were partly offset by gains that I received because my competitors were impacted as well, should this offset be reflected in the claim?
Will payroll costs incurred to pay employees idled after the earthquake be recoverable as "ordinary payroll" or elsewhere in the policy?
How should deductibles and sublimits be applied to reflect all areas of coverage and all occurrences?
Understand the Facts of the Loss, and Review Your Policy
The answers to these questions are tricky and will require a better understanding of the facts surrounding the earthquake, how your operations were specifically impacted, and the specific terms of your insurance policy.
Don't wait until all the facts have evolved. If you think that you may have a claimable financial impact, begin to assess the impact immediately. Assemble a team who can help you to manage the process. Put your insurer on notice, and be mindful of deadlines. Maintain frequent communications with the insurance adjuster, and document important items in writing.
Also be careful to manage the expectation of your management team. Work to gain an "order of magnitude" of the loss as soon as possible. Then work to refine the estimate and to apply all areas of coverage. If disagreements become evident with the adjuster—whether due to coverage or quantification issues—provide your management team with a reasoned explanation of the view taken by each party.
Apply Your Loss to Various Areas of Coverage
The Japan earthquake may trigger several areas of coverage. For example, if an insured suffered direct physical damage, it may have a claim until repairs are complete and for ongoing losses during the extended period of indemnity. Losses that persist that may not be claimable after that period may be claimable under another area of coverage, such as service interruption or contingent time element.
In CII Carbon LLC v. National Union Fire Ins. Co. of Louisiana, Inc., the insured claimed losses attributable to direct physical damage while repairs were being made and, once repairs were completed, the insured claimed ongoing losses attributable to contingent business interruption. The insurer contended that the entire loss attributable to CII Carbon's loss of steam should fall under the contingent time element coverage. Because the contingent time element coverage was limited by the policy to $500,000, the insured could have been faced with a large uninsured loss.
The court sided with the insured and concluded that the entire loss was covered as a normal business interruption loss, which had adequate sublimits, and that the contingent business interruption loss only applied when repairs were complete to the insured's property—when the lack of steam from the supplier was the only remaining issue. Courts have generally found that the insured can use available coverage as it sees fit to maximize recovery.
Quantify Your Contingent Time Element Loss
Quantifying a contingent time element loss has its challenges. First, the insured relies on information from the supplier or customer in order to quantify the loss. For example, what was the proximate cause of the customer's or supplier's loss?
An example of wording in a contingent time element coverage is as follows:
This Policy covers the actual Time Element loss as provided by the Policy, sustained by the Insured during the Period of Liability directly resulting from the necessary Suspension of the Insured's business activities at an Insured Location if the Suspension results from direct physical loss of or damage caused by a Covered Cause of Loss to Property (of the type insurable under this Policy) to direct suppliers or direct customers of the insured …
So, the impact of your loss must be attributable to your supplier or customer, and the loss experienced by the supplier or customer must be insured under your policy. If you don't have coverage for an earthquake, business interruption losses that you suffer because your customer or supplier suffered an earthquake may not be covered. Most large companies do not have earthquake or flood insurance for all of their operations but do have coverage where those perils are known to exist. Coverage limited to those geographical areas should satisfy the requirement so that the physical damage in Japan would be covered under an American company's policy.
However, contingent time element coverage can be ambiguous in a number of respects, depending on the circumstances of the claim, and there is little guidance from the courts on how the coverage is to be applied. Some policies extend the coverage to indirect suppliers or customers, so that if a supplier of your supplier or a customer of your customer suffered a loss, you may be covered. (This is often referred to as "indirect dependent time element coverage.")
A frequent coverage issue that arises in the context of contingent time element claims is whether a company that suffered physical damage is a "supplier" or "customer" of the insured. The few court decisions on these issues generally give those terms expansive definitions benefiting the policyholder. For example, in Archer Daniel Midlands Co. v. Phoenix Assurance Co., the court held that the Army Corps of Engineers was a "supplier" of an agricultural company that paid fees to the Corps for the use of locks and other facilities on waterways for shipping produce.
Supply Chain Insurance
In addition to the standard contingent time element coverage, some insurers now offer "supply chain insurance," which provides more comprehensive coverage for losses that you suffer as a result of an interruption of your supply chain. Whereas contingent time element coverage typically requires the trigger of loss or damage to your customer or supplier of the type insured by your policy, supply chain insurance more broadly covers business interruption losses that you suffer due to that and other supply disruptions.
The Japan earthquake has resulted in a significant economic loss to companies with operations in Japan and to companies around the world that disruptions to supply chains impacted. Companies that suffered losses should promptly notify their insurers of the loss and work swiftly to prepare a preliminary estimate of the overall loss, to carefully examine their available insurance coverages, and to quantify the impact of loss in accordance with their policy and within each appropriate area of coverage. They should assemble a team to assist with the process, including their insurance broker, insurance coverage counsel, and forensic accountants with significant experience with complex claim preparation. They should also work to manage expectations of all parties and establish a plan to move forward to a timely and reasonable settlement.
Christopher M. Brophy is a managing director with FTI Consulting in the business insurance claims practice of FTI's Forensic and Litigation Consulting business segment. He writes the catastrophe risk management column for www.IRMI.com. For background and contact information for Mr. Brophy, see his full biography.
Finley T. Harckham is a senior partner in Anderson Kill & Olick's New York office. He regularly represents corporate policyholders in insurance coverage matters and has successfully litigated, arbitrated, and settled hundreds of complex coverage claims, including those involving business interruption, property loss, directors and officers liability, professional liability, and general liability claims.
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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.