A natural disaster of the magnitude of the events in Japan, combined with the added factor of nuclear contamination will invariably give rise to a variety of complex legal issues, Assessments will need to be made of how insurance policies and in particular nuclear exclusions, will respond to claims arising from the resulting loss and damage.
I. GENERAL CONSIDERATIONS
In the first instance, all affected Insureds should immediately review their insurance policies in order to check their coverage and ensure compliance with all terms and conditions to prevent falling foul of notification of loss provisions which could preclude coverage and to ensure that no potential rights or remedies are compromised.
Attention should be paid to all and any exclusions which could apply and in particular, in this instance, closely scrutinised, nuclear exclusions. Nuclear exclusions may be a feature of some policies which can result in losses be they caused directly or indirectly from nuclear radiation, not being covered.
A further general issue to consider with regard to insurance coverage, will be what has caused relevant loss. In this instance, the cause of a loss could be due to multiple events for example the earthquake, tsunami, aftershocks or radioactive contamination, some of which may or may not be covered. For example, a loss caused in part by nuclear contamination and in part by the tsunami, may not be covered due to the nuclear exclusion (this is discussed more fully at section II below). The practical considerations in determining what caused the loss will have an impact on how the insurer or reinsurer will respond to any claim.
Aggregation of losses will also need to be considered by insured, insurers and reinsurers alike. Questions will arise such as whether the losses are closely enough linked to affect the policy limits and coverage. Different methods of aggregation may include “event based” or “hours based” and is something which all parties should focus their minds on.
Insureds should obtain legal and expert advice, in order to put themselves in the best possible position to be indemnified and address any legal and coverage issues which may arise.
We set out below a discussion of specific insurance coverage issues which may arise and different coverages and types of policies that may be applicable in relation to the events in Japan.
II. NUCLEAR/RADIATION EXCLUSIONS
Typically, US and European global property insurance policies contain exclusions for nuclear radiation and radioactive contamination. The question will be how much of the loss is barred by these exclusions. A great deal of the damage and follow-on Business Interruption losses have been caused by the earthquake and/or the tsunami. Whilst the releases from the Fukushima Daiichi reactors have complicated matters, they have not been the sole cause or, in many cases, even a significant contributor to the great majority of losses.
A policyholder’s focus should be on the introductory language to the exclusions in the policy, which typically is where concurrent causes are addressed. A helpful way to look at this is to picture two partially overlapping circles, a Venn diagram. In one circle is damage by cause A, a covered cause, and in the other circle is damage by cause B, an uncovered cause. Insurance companies should pay everything in A that is not in B, and need not pay anything in B that is not in A. The debate is about the overlap, the “concurrent causes.” If the exclusion lacks an “anti-concurrent causation” clause, the damage resulting from concurrent causes should be covered. Even if the exclusion has an “anti-concurrent cause” clause, the overlap may still be covered if it maybe concluded that the damage either took place as caused by A before B arrived or would have taken place solely if A happened and B never happened.
These hypotheticals should illustrate the required analysis:
Example 1: There is earthquake cover but no flood cover, with “flood” defined to include tsunami. The earthquake knocks down the building, rendering it a total loss. Fifteen minutes later, the tsunami sweeps away the rubble. There should be full coverage.
Example 2: There is earthquake cover but no flood cover, with “flood” defined to include tsunami. The earthquake partially damages the building, the extent of damage being difficult to determine because, fifteen minutes later, the tsunami utterly destroys the building. There may be partial coverage but there will be a battle of the experts.
Example 3: There is flood coverage but no earthquake coverage. Earthquake damage is unknown and flood damage is heavy. The insurance company argues that the earthquake caused the tsunami, so the earthquake exclusion trumps the flood coverage. One could argue there is full coverage, as the flood is the efficient proximate cause.
It is arguable that insurers will seek to attribute as much damage as possible to the nuclear incident to bring such damage within the nuclear exclusion clauses. Where an insured is effectively denied coverage as a result of such exclusions, it will be necessary to consider whether they have any other avenues to recovery.
There has been much discussion regarding the potential liability of Tokyo Electric Power Co. (“TEPCO”), the owner of the Fukushima plant. The Japanese government has said that TEPCO will “take responsibility” for compensating those impacted by the nuclear catastrophe. However, under Japanese legislation, the Compensation for Nuclear Damage Act 1961, the liability of nuclear power generators is limited to well below the estimated level and value of damage caused by the disaster. Under the same legislation, where the compensation due from TEPCO falls short, the Japanese government has stated that “by law the government will step in and guarantee the claims.” However, at the current time, what this will mean for affected parties and who could benefit remains unclear.
III. PROPERTY DAMAGE
A significant number of the insurance claims arising out of Japan will be in relation to property damage. It is anticipated that the number of buildings wholly or partially destroyed will number into the hundreds of thousands.
While residential claims are likely to be covered by domestic Japanese insurers, commercial property loss will, on the whole, be insured through the international market, whether it be in the USA, UK, Bermuda or Germany.
The core coverage provided by a standard-form property insurance policy is for direct physical loss of or damage to covered property caused by or resulting from any covered cause of loss. Covered property typically includes the policyholder’s building, equipment, personal property, and stock, as well as the personal property of others. What will constitute a “covered cause of loss” will vary between policies. Of particular note is that perils such as earthquakes and tsunamis are among those risks commonly excluded from policy coverage.
The implications for coverage of damage to or total loss of property will depend on the nature of the policy. Cover can be provided by co-operative insurers and commercial insurers. Cooperative insurers in Japan, “Kyosai”, mainly provide cover for specific groups whether they be people in the same occupation or residential group. This cover will apply to the majority of household insurance in Japan. These policies do not usually exclude damage caused by earthquake or tsunami. However, property insured by commercial insurers may not cover damage caused by these perils – unless a premium has been paid to specify this by way of endorsement. If commercial insurers do provide household earthquake cover, they reinsure it 100% to the Japan Earthquake Reinsurance Corporation. The losses are shared in varying proportions between the Commercial Insurers and the Government.
The commercial property cover for earthquake and tsunami coverage is not automatically included but is usually provided by way of an endorsement. It is often reinsured into the international markets in varying proportions.
The following issues may arise for policyholders in relation to claims for Property Damage:
When is replacement cost owed? Most commercial policies pay based on full replacement cost value, although this will not always be the case. If the policyholder purchased replacement cost coverage, the insurance company should pay the full replacement cost value for destroyed property or the actual cost of repair for repaired property. In reality, insurance companies may make incremental partial payments based upon an actual cash value adjustment, with a “holdback” for the full replacement cost until the actual repairs or replacement are complete. Unfortunately, in many cases, the insurance companies may press the policyholder to effectively pay the money up front for repair or replacement and it is therefore important for policyholders to make clear and repeated requests for funding.
What constitutes replacement? Most policies cap the amount owed at either the policy limits, the hypothetical cost to replace on site, or the amount actually spent. Most policies do not limit what constitutes “replacement.” Accordingly, policyholders should be able to purchase alternative property or replace by building elsewhere. Furthermore, the policyholder should be permitted to replace by incorporating general improvements in technology; these are not “upgrades” but simply what was promised (“new for old”).
Quality of repair or replacement? There are a number of issues dealing with the quality of repair or replacement of damaged property. For instance, if the property is only damaged, and is to be repaired, to what standard must it be repaired? (Typically, the repaired property must be of the quality that existed before it was damaged). Similarly, if the property is to be replaced, with what can the insurance company replace it? (Typically, the insurance company should replace the destroyed property with new, as opposed to used, property). As most property insurance policies do not provide guidance on these issues, they are typically resolved by negotiation. As they assess the scope of their loss, policyholders should consider how best to characterise their claim, as insurance companies will attempt to challenge and limit the scope of the claim through negotiation.
Has property suffered physical loss or damage? Sometimes there is a question as to whether the insured property has suffered “physical loss or damage.” For instance, if a business is temporarily inundated with noxious fumes, has it suffered “physical loss or damage”? In general, the answer is yes: property rendered unfit for its normal use is physically damaged. This issue is important not only for any clean-up of the contaminants, but to determine whether there is a covered loss of Business Interruption (discussed below), as Business Interruption losses must stem from property damage.
Dozens of other issues can arise in relation to property damage, including exclusions, conditions, and valuation issues. It is advisable for policyholders to document their full losses from the disaster from the outset and consider inclusion of all such losses in their insurance claims.
IV. BUSINESS INTERRUPTION
Legal issues can arise for those doing business inside or outside Japan – for example Business Interruption coverage may assist not only those who directly suffer loss in Japan, for example, a factory owner, but also those indirectly affected or suffering loss due to reliance upon Japanese manufacturers, suppliers, or business partners.
Business Interruption insurance is designed to cover a policyholder for income and profits lost, and unavoidable expenses incurred, during the hypothetical Period of Restoration needed to repair or replace damaged or destroyed property used by the policyholder in its operations. As with the property damage portion of the loss, documentation of this aspect of an insurance claim is often crucial to the policyholder’s ability to secure proper compensation.
The total disruption caused in the area impacted by the Sendai Event has resulted in the complete shutdown of some businesses, with others suffering temporary blackouts, or interruption to the water, gas or heating supplies, and, in many cases, it will be some time before they are running at full capacity again. For those in Japan who purchase cover (which is estimated to be a relatively low number), these losses caused by these events may be protected through Business Interruption insurance. Those who did purchase this cover may however find themselves in the unfortunate position of their policy excluding business interruption attributable to the earthquake or tsunami.
The following issues are typical in Business Interruption claims.
What is the rate of loss? Calculating the amount of the business income lost during the Period of Restoration can prove a difficult task. Indeed it may be some time before the true value of loss can be calculated. Unfortunately, property policies typically provide little guidance on this. This can lead to potential conflict, for example on whether examination is made of the business as a whole or a small sector of the business, and the period of past performance examined to map a trend. As a result, if the claim is large enough, the policyholder and the insurance company will likely arrive at different views as to the rate of loss. Accordingly, it may therefore be wise for the policyholder to retain a forensic accountant to assist in calculating these losses.
Can a new or unprofitable business make a Business Interruption claim? A policyholder may consider making a claim for Business Interruption loss from a new business which does not have a long track record. In general, a policyholder can recover lost income from such a business, but may be held to a higher standard of proof in establishing the profits which would have been earned. It should also be noted that Business Interruption covers both profits and unavoidable continuing expenses. Further, an unprofitable business is permitted to attempt to demonstrate that it would have become profitable during the Period of Restoration, however, the burden of proof in doing so may be high.
Can the insurance company seek credits for pent-up demand or make-up sales after the Period of Restoration? Insurance companies may attempt to demand a “credit” for the policyholder’s performance after the Period of Restoration where, for instance, the business may see pent-up demand caused by its closure result in a higher than usual turnover upon reopening. It should be kept in mind that insurance companies will not pay for additional losses that occur after the Period of Restoration and so similarly policyholders should avoid granting insurance companies “credits” for performance after the Period of Restoration ends.
What is the length of the Period of Restoration? Issues can often arise regarding the length of the Period of Restoration. As typically written, the period during which Business Interruption may be covered is the shorter of (i) the hypothetical time in which the destroyed property could be repaired, rebuilt or replaced or (ii) the actual time it takes to repair, rebuild or replace the property. A number of issues can arise surrounding the former, “hypothetical” date. For instance, does it start during the period when authorities will not let the policyholder on site due to ongoing investigation, or is it extended to account for insurance company conduct, such as refusing to advance sufficient funds to rebuild? As a rule of thumb, the extent the policyholder is not responsible for a delay, will generally serve to extend the Period of Restoration.
Can the insurance company deny recovery because of the wider effects of the catastrophe? As was seen after the attacks of 9/11 and the 2005 Hurricanes in the USA, some property insurance companies argued that Business Interruption recovery is diminished by the wider economic effects of such catastrophes. Such arguments were based on the fact that the profit component used to determine such losses is calculated by computing the net income the policyholder was earning prior to the “physical loss or damage” and the net income that the policyholder would have earned “if no direct physical loss or damage occurred.”
Sale of a business during the Period of Restoration and the assignment of the right to recover Business Interruption. Assignment of an insurance claim, rather than assignment of a policy itself may be permitted. However insurance companies may argue that the Period of Restoration ends when a policyholder sells the affected business and assigns the right to recover Business Interruption.
V. CONTINGENT BUSINESS INTERRUPTION AND EXTRA EXPENSE
Contingent Business Interruption coverage is designed to cover a policyholder for loss of income caused by damage to or destruction of property owned by others (often called “dependent property”), usually identified as “contributing,” “recipient” or “manufacturing” locations (i.e., suppliers, customers and manufacturers). Often, to be recoverable, the loss will have to arise from property damage and therefore it may not cover losses attributable to the disruption in power, heating or water supplies or indeed the imposition of any nuclear exclusion zones that interrupt production or delivery. Yet again, causation may be key to whether losses may be recoverable. Given Japan’s position as a significant supplier within the technology, automobile and other manufacturing industries, losses in relation to the disaster cannot be geographically limited to Japan - they have global commercial implications. As a result, coverage for contingent Business Interruption losses will be particularly relevant in the wake of the events in Japan
Some policies may limit coverage to named dependent properties, whilst others may cover dependent properties on a blanket basis. The property damage to the third-party property typically must be of a type that would have been covered had it happened to the policyholder’s own property. An example would be coverage purchased by a car maker to protect it if its sole supplier of a key component suffers destruction of its factory, and the car maker suffers a Business Interruption loss from its inability to complete manufacture of cars. Accordingly, a business which had a close commercial relationship with a Japanese company affected by the Sendai Event may be able to recover for losses attributable to damage to the facilities or equipment of that Japanese company.
In addition, affected businesses outside Japan may have Contingent Extra Expense coverage, designed to pay for increased costs incurred after the disaster to minimise or avoid a Contingent Business Interruption loss for example, if components normally obtained from a Japanese supplier must now be obtained elsewhere at an increased expense. For a company pressing a Contingent Business Interruption or Contingent Extra Expense claim, the following issues may arise:
Period of Restoration? Note that, properly applied, the Period of Restoration is typically calculated in the same manner as for Business Interruption coverage. However, unlike Business Interruption coverage, the policyholder does not control whether or not the third-party business decides to mitigate its loss by using makeshift operations or relocating. Insurance companies may therefore try to shorten the Period of Restoration for Contingent Business Interruption losses on the basis that the third-party could have relocated or engaged in partial operations, however the policyholder should be entitled to its full loss incurred during the full Period of Restoration based upon what the third-party actually did.
Insurers may also seek to terminate the Period of Restoration for a Contingent Business Interruption loss if alternative suppliers or customers are located. However if the policyholder finds an alternate supplier or customer which is not equivalent to the original, the policyholder will still continue to suffer a loss, and is entitled to its profits during the entire hypothetical Period of Restoration for the third-party property, minus whatever profits it manages to earn from its dealings with the alternate supplier or customer.
Can a policyholder make a claim for loss attributable to damage to a company in the same corporate family? Insurance companies may take the position that a company cannot make a Contingent Business Interruption or Extra Expense claim if the supplier or customer is in the same corporate family, for example if the dependent property is operated by the Insured. It should be noted that many international companies maintain separate insurance programs and separately, as long as the policy at issue does not address the issue, related companies can make dependent property claims.
VI. LIFE INSURANCE AND PERSONAL ACCIDENT INSURANCE
Insurance claims may arise in relation to health issues associated with the earthquake, tsunami, or nuclear contamination. Many people suffered immediate injuries during the earthquake and tsunami, and the subsequent devastation could increase the likelihood of contracting illness. A further consideration is of course the health risks associated with exposure to radiation from the nuclear power plants.
Personal accident cover will generally cover losses relating to death, disability and hospitalisation. Whether insurance will provide cover for these risks will vary from policy to policy. Often, cover for personal injury resulting from earthquake or tsunami is only available by way of a specific endorsement to the policy. Again, health insurance policies will also commonly incorporate nuclear exclusions into policies, meaning health issues arising directly as a result of nuclear incident may not be covered. Where a policy does provide coverage for personal injury caused by any of these events, issues as to causation and aggregation will once again arise.
VII. MOTOR INSURANCE
In Japan, damage resulting from earthquakes and tsunamis is generally excluded from typical motor insurance policies. Such coverage is available only by endorsement. However, an insured is advised to check its particular policy carefully to determine whether such cover is, in fact, included.
VIII. MARINE INSURANCE
Marine damage caused as a result of the Sendai Event is likely to be significant. Losses will include damage to vessels, cargo, terminals and portside infrastructure. It is believed, not surprisingly, that many fishing vessels in the affected area have been destroyed.
A substantial proportion of Japan’s marine cargo is now written on the Institute Cargo Clauses 1/1/2009 (“ICC”). ICC can incorporate Clauses A, B, or C and coverage of damage from the Sendai Event will vary according to which form the policy incorporates. It is thought that ICC A Clauses (all risks) will typically cover earthquake-related losses. ICC B Clauses, though less robust, should cover losses reasonably attributable to the earthquake, or the resulting tsunami. ICC C Clauses, however, will probably not cover losses arising out of the earthquake.
Policies written on the old Institute Cargo Clauses 1/1/1963 are seen to be less favourable to insureds and will likely give rise to more complex issues, particularly in relation to causation.
In respect of inland transit and coastal cargo, earthquake coverage is generally excluded, unless covered by an endorsement to the policy.
IX. GLOBAL PROGRAMMES
Global companies with business entities operating in Japan, may have in place a global insurance programme operated by non-domestic insurers, which includes Difference in Conditions / Difference in Limits. Such policies should be reviewed to assess whether they provide broader coverage or higher limits than a company’s local insurance policy to cover any shortfall in coverage under the local policy.