Superstorm Sandy made landfall along the coast of southern New Jersey on October 29, 2012. More than eight million people lost power during the storm. As of Sunday, November 11, 2012, approximately 150,000 customers in New York and New Jersey still remained without power. That number does not include properties that were too damaged by the storm to have power safely turned back on. Some people affected by the storm still have only limited access to their properties following mandatory evacuation orders and other restrictions imposed by public authorities.
As power is restored and access is granted to those areas hardest hit by the storm, affected businesses are taking stock of their losses. Some projections have business interruption (BI) losses accounting for more than a third of the total insured losses in Sandy’s aftermath. Similar to the Japanese earthquake and tsunami, 9/11, and Hurricanes Katrina and Rita in 2005, the sheer number of BI claims is likely to lead to an uptick in coverage litigation brought by businesses with basic BI coverage facing uninsured or underinsured losses and, possibly, errors and omissions claims against agents and brokers. Understanding the parameters of BI coverage is critical to managing policyholders’ expectations.
Business Interruption Coverage
BI coverage is meant to indemnify the insured against losses resulting from the inability to continue normal business operations. The coverage typically reimburses the policyholder for profits he would have earned but for the interruption of his business. There is generally a time element associated with any business interruption claim. Generally, reduction in earnings, less expenses not incurred during a reasonable “restoration period” are covered. A reasonable restoration period is measured by the time it should take a diligent policyholder to restore the property, but in no event to exceed a specified period of time.
Typically, there is a physical loss or damage requirement before BI coverage is triggered. The loss or damage must be to the insured property and caused by a covered peril. Named-peril policies will specify a list of covered perils such as fire, hail, lightning, windstorm, explosion and vandalism. An all-risk policy will cover all direct causes of loss unless specifically excluded from coverage. Identifying whether there has been physical damage to insured property caused by a covered peril is the first step in determining coverage. Although wind losses are covered, most homeowners and commercial policies specifically exclude flood unless added by endorsement. Separate flood insurance is available to home and business owners through the National Flood Insurance Program monitored by FEMA.
The physical damage must be causally related to suspension of business operations. A decline in the volume of business due to Sandy that is not related to physical damage will likely not trigger coverage, except as discussed below.
Determining the reasonable restoration period following business interruption is essential to calculating the loss. Generally, coverage is only extended to the point where the damaged property is repaired or to the date when normal business operations resume, whichever occurs first. Factual issues often arise as to when repairs could have been completed or business could have been resumed. Calculating lost income is the policyholder’s burden to prove and involves more than mere speculation. Most often a business’s pre-loss history of sales, earnings and expenses is the measure. Issues will arise where a business has been in a pre-loss downturn or has not accumulated a significant history. Failure to maintain proper records or underreporting of income by insureds also raise issues that need to be addressed.
Extended Business Income Coverage
The impact of Sandy generated massive losses to businesses that are not characterized as physical loss or damage to the insured building or property and, therefore, may not be covered by basic BI coverage. An example may be where a West Coast business is unable to operate because of supply chain disruptions from the East Coast. BI coverage can typically be extended to cover some of the types of anticipated losses via extra expense coverage, contingent business interruption (CBI), utility service and civil authority coverage.
Extra expense coverage can be part of basic BI coverage or separate. Extra expense coverage reimburses the insured for expenses in excess of the normal operating expenses during the period of restoration. This type of coverage is particularly critical to service-oriented industries such as medical, legal and credit, which cannot sustain a period of suspended operations. Depending on the policy, relocation costs incurred, such as leasing new space and equipment and restoration of damaged equipment, may be covered. Costs incurred in establishing the BI loss may also be covered.
Contingent Business Interruption
Sandy’s impact on airports, rail lines, ports, power stations and other infrastructure will lead to significant supply chain disruptions. If BI coverage is extended to provide for CBI insurance, coverage may apply to business interruption losses resulting from physical damage caused by a covered peril to real or personal property of third parties in the policyholder’s supply chain (i.e., distributors, suppliers, receivers). For a discussion of CBI coverage and supply chain disruption losses in the aftermath of Sandy, see “Sandy’s Supply Chain Disruptions.”
Sandy’s power outages in Manhattan involved flooded underground lines and a transformer fire at a substation during the storm, while power outages in other parts of the city as well as New York, Connecticut and other affected states were primarily due to downed overhead power lines. Utility service interruption coverage provides coverage for losses incurred due to physical damage to the property that supplies the utility, such as electric, gas and water. There is typically a time component to the coverage requiring that the service outage would last a minimum amount of time – usually 24 to 72 hours. As with basic BI coverage, the service interruption must generally result from a covered peril. Some policies exclude coverage for damage to overhead power lines.
An untold number of businesses may have sustained losses in Sandy’s aftermath due to their inability to access their locations by order of a civil authority. Standard homeowners and commercial property policies may exclude coverage for acts of civil authorities, although each policy must be reviewed in that regard. For coverage to extend to losses resulting from the actions of civil authorities, there generally must be physical damage caused by a covered peril to the area where the business is located. The action of the civil authority must be mandatory, as opposed to a suggestion, recommendation or request, and must completely restrict access to the property. Employees’ inability to get to work due to localized road closures or transportation disruptions would not be covered. For a discussion of the potential increase in cyber loss risks posed by employees working remotely, see “Avoiding Cyber Loss in Sandy’s Wake.”
The devastation of Superstorm Sandy will no doubt cause a plethora of BI claims in the Northeast and possibly throughout the rest of the United States due to contingent coverages. Understanding the limits of basic BI coverage is critical to preventing coverage and errors and omissions litigation based on the issues identified above and possibly the unmet expectations of policyholders.