Catastrophic events result in a flood of claims for insurance recovery. EQECAT, a catastrophe risk modeling software and consulting company, estimates that the loss to the insurance industry arising from the recent earthquake and tsunami in Japan will be $12-25 billion, and the World Bank estimates that damages between $14-33 billion will be covered by private insurance. While losses resulting from damage to property might be the most readily apparent, a policyholder should examine their insurance policies carefully to take advantage of the full protection offered by their insurance.
In the aftermath of a catastrophe, manufacturers and other policyholders often overlook the potential for recovery for contingent business interruption ("CBI") losses. Many property insurance policies provide this type of insurance, which protects a policyholder from an interruption in business caused by damage or destruction to the facilities of the policyholder's suppliers or the facilities of the policyholder's customers, receivers or distributors. This type of insurance compensates a policyholder for loss even if the policyholder has not suffered any direct property damage.
Manufacturers must be sensitive to changes in their supply and distribution chains in the wake of the earthquake and tsunami. Reductions in Japan's capacity to supply needed materials for manufacturing will have a world-wide impact spreading across a number of industries, including the automotive and technology industries. For example, production in the automobile industry has declined approximately 13%, with some forecasters predicting a reduction of global automobile production of up to 30%.
Hurricane Katrina provided United States policyholders with a clear example of the devastation such a catastrophe can cause, not just to property itself, but to the infrastructure vital to maintaining an efficient and profitable business. Hurricane Katrina devastated the Gulf Coast of the United States and left shipping and other industries in shambles. The destruction to shippers and suppliers of goods caused by Katrina created ripples of loss throughout domestic companies. By learning from the experiences of policyholders seeking coverage for loss arising out of Katrina, a policyholder affected by the Tohoku earthquake and tsunami can better position itself for recovery of loss caused by disruptions to their businesses. Based upon these lessons, such a policyholder can devise a clear strategy for investigating and proving CBI losses as those losses start to impact its bottom line.
Deductibles: Almost every property and business interruption policy contains a deductible, but there are at least two different ways that deductibles are structured in such policies. Some policies offer a flat-rate deductible, which leaves little room for conflict over how the deductible should be calculated. If, however, the policy offers a deductible that is calculated as a percentage of the "total insured values affected" by a loss, a dispute may arise between policyholders and insurers over the amount of the deductible, especially a CBI claim where there has been no direct physical damage to the insured's property.
Insurers may seek to maximize the deductible by arguing that a company's entire business was affected by a loss, even if only one product or product line was affected. A prudent policyholder facing this type of deductible should carefully determine how to structure and present its claim so that the deductible is minimized in relation to the covered loss. In a CBI claim arising out of Hurricane Katrina, the authors' firm successfully demonstrated that the loss was limited to only those portions of the policyholder's business dedicated to the product line that was impacted by Katrina, thereby limiting the impact of the deductible.
Total Suspension: Common policy language insures business interruption losses arising out of a "necessary interruption of business." Insurers may argue that business interruption and CBI coverage is unavailable unless a policyholder suffers a complete cessation of business activities. It behooves a policyholder to thoroughly document an interruption, even if it affects only a part of the policyholder's business, so that a claim can be adequately proved. In a CBI claim arising out of Hurricane Katrina, the authors' firm was able to establish an interruption to a portion of the policyholder's business sufficient to sustain a claim, even though many other aspects of the policyholder's business were not interrupted by Katrina.
The corollary to this principle is that a policyholder may have an obligation under its policy to resume business operations as soon as possible, using alternative means if feasible. The efforts of the policyholder to restart its business activities may be covered under other portions of its policy that provide for mitigation of loss after a covered peril. Documentation of these efforts may be critical to a policyholder's recovery of expenses associated with overcoming the business interruption. Such documentation will also help defeat any challenge by an insurer that the policyholder's ability to resume business operations demonstrates a lack of necessary interruption.
Calculating Loss: Calculating the total loss for an interruption claim is not as easy as calculating loss to real property. Most policies require that businesses calculate interruption losses in one of two ways: (1) the net reduction in gross earnings minus expenses that do not necessarily continue or (2) the net profit that is prevented from being earned plus necessary expenses that continue during the period of interruption. Establishing such a loss involves a complicated process of demonstrating how the policyholder would have performed had the event not occurred, and the nature of the market in general, potentially including the impact of the catastrophic event on that market. This may be especially difficult with new business enterprises or businesses in volatile markets. Any early assessment of loss, whether conducted by the policyholder or insurer, should make clear that the calculation of a business interruption or CBI loss is a complicated process, and it may take months, if not years, for a policyholder to realize the full impact of a catastrophe on its business.
A policyholder suffering a CBI loss faces the additional hurdle of proving damage to a third party, i.e. a supplier or distributor. After an event, a policyholder should work closely with its suppliers or distributors to establish the extent of the damage suffered by that third party. Such evidence may be difficult to obtain during the claim adjustment process in the months and years following the loss.
Loss of Market: Property and business interruption policies often contain an exclusion applying to claims for "delay or loss of market." Insurers may argue that this exclusion precludes a policyholder's loss, characterizing that loss as predicated on a change in demand or other market conditions. This exclusion, however, should not apply to preclude a business interruption or CBI claim, particularly when such a claim is based upon damage to the policyholder or the policyholder's supplier or distributor that prevents the policyholder from getting goods to its customers. In a case arising out of Hurricane Katrina, the authors' firm obtained a ruling that a loss of market exclusion did not preclude recovery for a CBI claim. Products could not be shipped because of a destroyed distribution. Moreover, while the specifics of the insurance policy's provisions will determine whether a policyholder can calculate a business loss based upon the market existing after an insured event (i.e. taking advantage of any increase in demand or in the price of a product), insurers should not be permitted reduce a loss calculation based upon the absence of demand for a product in a market affected by a catastrophe.
Insured Peril: Frequently, CBI losses are limited to damage to third parties caused by a peril of the type insured against under the policy. This provides another strong reason for policyholders to work closely with their suppliers or distributors in understanding the impact of a catastrophe on that third party's business. A policy may exclude flood coverage, but include coverage for earthquake, making it important for a policyholder to have good evidence of the cause of the damage to its supplier or distributor.
Engage Experts Early: The insurance claim adjustment process requires a dialogue between policyholder and insurer. An insurer that receives notice of a significant claim immediately will hire experts to assist in adjusting the claim. Likewise, a policyholder would be wise to enlist the assistance of experts early in this process in order to protect its interests, as losses not readily apparent may become clear over time with close scrutiny and familiarity with a policyholder's business. A policyholder should consider retaining coverage counsel early to provide advice on the scope of the losses covered by the policy in an effort to maximize coverage. Retaining experts and coverage counsel early provides the policyholder with the best chance of maximizing coverage opportunities. Proper calculation of a business interruption or CBI claim takes time, and coordination with the adjustment team and counsel often are the most important steps. These steps should be taken at the beginning of the process to maximize potential recovery.
Most companies whose business have been affected directly by the events in Japan understandably are focused on repairing damaged property and reestablishing supply chains. These companies and others that have close business relationships with companies in Japan would benefit from focusing as soon as possible on establishing the extent and scope of their insurance coverage, carefully tracking all costs being expended to rebuild the business or keep it running despite the losses caused by the earthquake, and determining how best to present an insurance claim that will maximize recovery for any losses.
Jeremy M. King and Kristi Singleton are associates in Dickstein Shapiro LLP's insurance coverage practice. They represent corporate policyholders in complex insurance disputes.