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.
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.
Source: IRMI - by Jay M. Levin