The recent devastating and tragic earthquake in Japan and flooding in the northeastern United States should serve to remind businesses of the ever-present need to consider their insurance policies as a source of some modicum of relief. In our shrinking world, with global supply chains and interdependent economies, such events have a substantial impact on the operation of businesses, including the delivery of goods and services that are vital to their financial well-being. For that reason, businesses insure themselves to cover such potential risks and losses. Multiple kinds of insurance policies and forms, many of which are basic to a first-party property insurance policy, might provide relief to defray the extraordinary costs that often attend such devastating losses. This Alert briefly discusses several types of coverage, what they generally insure, and what to look for and think about when bringing a claim that may arise in the wake of a natural disaster.
Maybe the most obvious form of coverage to review when a loss happens is for damage to property. A typical insurance policy might state:
"We will pay for direct physical loss of or damage to Covered Property at the premises described in the Declarations caused by or resulting from any Covered Cause of Loss."
There is a fair amount to unpack in this provision -- such as the meaning of "direct physical loss or damage," "Covered Property," and "Covered Cause of Loss" -- but the gist of the coverage is fairly clear. If a policyholder's factory floods or its structure is impaired, and it has to spend money rebuilding, repairing, or replacing its damaged property, a first-party property policy might provide relief. Of course, limitations and exclusions might apply, but the "property damage" component of a first-party property policy is probably the first place to look when a loss happens.
Further, there is a line of cases in which "physical damage" is found to embrace loss of use, value, or function. Typically, but not exclusively, the cases involve buildings with no visible material damage that are nevertheless rendered uninhabitable or unable to fulfill their intended functions; foods or beverages that are otherwise fit for human consumption but are rendered worthless; and power outages in which the loss of power temporarily deprives machinery of the ability to function resulting in loss. Thus, in the appropriate circumstances, "physical damage" may be equated with loss of use, function, or value, and policyholders and insurers should regard the term broadly and flexibly as common sense and the laws of various jurisdictions require.
Business interruption coverage is designed to pay the profits and unavoidable continuing expenses caused by an interruption of the policyholder's business. For example, when a policyholder's factory is damaged and operations must be suspended, and it loses the stream of income normally generated from the factory, business interruption insurance could provide coverage. A typical policy form might provide as follows:
"We will pay for the actual loss of Business Income you sustain due to the necessary suspension of your 'operations' during the 'period of restoration.' The suspension must be caused by direct physical loss of or damage to property. . . . The loss or damage must be caused by or a result from a Covered Cause of Loss."
As this provision suggests, business interruption insurance is tied to coverage for property damage -- both require "direct physical loss or damage" to property otherwise insured under the property damage component of the policy. Further, business interruption recoveries will depend on the "period of restoration," which is the hypothetical time it would take to rebuild, repair, or replace the damaged property. But this is an invaluable source of coverage when natural disasters strike, and it should be reviewed closely in light of lost profits and expenses incurred following a loss.
Extra expense coverage is the corollary to business interruption. While business interruption insurance covers a policyholder's lost profits following a loss, extra expense insures costs incurred by a policyholder to avoid or minimize business interruption losses. For example, if after a flood a policyholder is unable to use a factory, and must instead lease a replacement factory space, or construct a temporary factory while building a permanent replacement factory, such expenditures might be covered under extra expense coverage.
Contingent Business Interruption
This, along with contingent extra expense, might be the most important type of first-party property insurance in our globally linked economy. Contingent business interruption insurance covers business interruption loss arising from damage to a "dependent" or "contingent" property, meaning the property of a buyer or seller of your product -- or, for that matter, any company along the global assembly line of which your product forms a part. This insurance could prove crucial for companies with assembly or supply links to companies in Japan. Should supplies be interrupted due to property damage at a supplier's facilities, then downstream businesses that depend on those suppliers may have claims against their own policies for extra expenses and other losses resulting from the interruption. Policyholders should scrutinize their policies carefully regarding contingent business interruption coverage, because not all policies have it, and frequently such coverage is subject to different and (much) lower limits of liability.
Contingent Extra Expense
This coverage is to contingent business interruption as extra expense is to business interruption. It serves an analogous purpose, except that this insurance would cover expenditures to minimize or avoid a contingent business interruption loss. For example, if a supplier in Japan cannot timely provide a component part needed for a policyholder's product, and the policyholder must instead buy the same part at a higher cost from a different supplier, that additional cost might be insured under extra expense coverage.
Other Time-Element Coverages
Still other coverages might apply when policyholders face first-party property losses, including extended business interruption, leader property, civil or military authority, service interruption, and ingress/egress. Not all policies have these coverages, and forms can differ drastically, but these might be another source of recovery when a loss happens.
While issues of interpretation will abound related to earthquake and flood losses, clearly significant issues will involve whether a policy insures losses arising from earthquakes and/or floods. Some policies might have specific coverage for such losses, others might have specific exclusions, and still other might provide benefits but of a limited nature and with different limits of liability. Equally important, questions of causation, sequential causation, and concurrent causation surely will be at play, with insurance companies and policyholders seeking an interpretation that will maximize their respective positions.
When a loss happens, insurance questions are often put off, forgotten, ignored, or, worst of all, unnoticed. The most important first step for any policyholder is to gather and read all of its insurance policies and then, if appropriate, to notify their insurance carrier of the loss or potential loss. Coverage might be found in obscure forms, words and terms might be unclear, conditions might need to be complied with in great haste, and exclusions could limit or completely preclude any recovery. Without doing the necessary due diligence, however, a terrible loss might unnecessarily cripple a policyholder's business. The better course is to be aware, proactive, and prepared to vigorously pursue the insurance you purchased.