It has been impossible to view the photographs or watch the video images of the destruction from the earthquake and tsunami in Japan without feeling profoundly and ineffably sad and sympathetic. As deliberation and planning begin to replace the shock caused by these terrible events, companies that do business there already are taking action to mitigate their losses. An essential first step is to review their insurance coverages, including especially coverages protecting against consequential financial losses caused by catastrophes such as the earthquake and tsunami in Japan.
Time Element Coverage for Financial Losses
Property insurance policies cover, obviously, direct property damage caused by events such as earthquakes and tsunamis. Those same policies, however, also cover other kinds of business losses. “Time element coverage” pays for the lost profits when damaged property affects a policyholder’s day-to-day operations. The amount covered generally depends on the time it takes to resume normal business operations. Time element coverage for financial losses can arise from damage either to the policyholder's own property or to third-party property. While time element coverage comes in a variety of flavors, three kinds are quite common: (1) Business interruption coverage; (2) Extra expense coverage; and (3) Expense to reduce loss coverage. In addition, “contingent business interruption” coverage provides recovery of lost profits resulting from property damage that interrupts the business of an insured’s supplier or customer.
- Business Interruption Coverage
The purpose of business interruption coverage is the reimbursement of lost business profits -- to restore the policyholder to the financial position it was in before the property damage occurred. To recover these losses, the lost profits, at a minimum, must relate to the event that caused the policyholder’s property damage. Once the insured demonstrates covered property damage, the measure of the loss generally is the difference between expected profits during the recovery period after the event and actual profits during that period, less any unrelated losses.
Perhaps the only U.S. event in recent experience that is remotely comparable to Japan’s earthquake is Hurricane Katrina. The Fifth Circuit Court of Appeals found covered business interruption loss as a result of Hurricane Katrina in general, without requiring proof to a level of specificity that the loss stemmed solely from damage to the policyholder's property as a result of the hurricane. The insurance carrier argued that the policyholder had to prove what its likely performance would have been had Hurricane Katrina taken place but not damaged the policyholder’s property, reasoning that, even absent damage to the policyholder's property, profits would have been reduced because of the generally depressed economic conditions following the hurricane. The court disagreed, concluding instead that the loss should be calculated as if Hurricane Katrina had not struck at all. Consolidated Cos. v. Lexington Ins. Co., 616 F.3d 422 (5th Cir. 2010).
Business interruption insurance may cover not only lost profits suffered at the location of the property damage, but also the lost profits at other locations that operate in connection with the damaged location. Coverage for this interdependent business interruption loss can extend to locations that are physically distant from the damaged property if the policyholder can show that the undamaged facility operated in concert with the damaged one. An example would be a policyholder's remote facility outside of Japan that cannot receive inventory because of damage to the policyholder's manufacturing plant in Japan.
- Extra Expense Coverage
Extra expense coverage aims to cover additional costs the policyholder incurs to minimize or avoid interruption of its business. Examples of such coverage are: (1) Additional utility costs needed to resume business operations; (2) Additional costs to store business equipment; (3) Moving costs to relocate to temporary facilities; and (4) Costs expended for the temporary repair or replacement of property.
Most policies also contain a related coverage, similar to Extra Expense, typically called Expense to Reduce Loss coverage, to reimburse additional costs incurred to mitigate property damage.
- Contingent Business Interruption Coverage
Many policies protect against profits lost when a policyholder’s supplier or customer cannot conduct business because of property damage “of the type” covered under the policyholder’s policy. This coverage would provide, for example, recovery to a manufacturer of computers outside of Japan that suffers lost profits as a result of a supplier’s inability to provide required components because of damage to the supplier’s Japanese facility. Similarly, a policyholders’ profits affected by property damage to the facilities of a Japanese customer are recoverable. Covered costs also include losses incurred when a civil authority prevents access to the policyholder's facilities, or when damage to property in the vicinity of the insured property prevents ingress to, or egress from, the policyholder's facility.
Critical Policy Conditions and Deadlines
Most policies contain time limits and deadlines, some of them quite short, for putting the carrier on notice of a claim, for submitting a final proof of loss, for restoring the business or property to operation, and for filing suit if a claim is denied. Some of these deadlines require the policyholder to satisfy a condition within as little as 30 or 60 days after the loss. Failure to comply, or to substantially comply, can result in a forfeiture of coverage. The following are some important deadlines commonly included in property policies.
- Notice of Loss
Policies may require the insured to notify the insurance company "promptly," "as soon as practicable," or within a specified period after the insured becomes aware of circumstances that may lead to a claim. Providing prompt written notice of a loss is the prudent course, regardless of the notice provisions of the policy.
- Proof of Loss
Property policies often require a sworn proof of loss summarizing the amount and extent of the damage or loss. Some policies impose a specific deadline for submission, which can be as short as 60 or 90 days post-loss. If the loss is catastrophic and the deadline unreasonable, the parties often agree to extend time limits.
- Suit Limitations Clause
Some policies attempt to limit the time within which a policyholder can sue the carrier for coverage. Two years is a common deadline, which is usually much shorter than the statute of limitations that would otherwise apply. Some courts have enforced these deadlines and others have not. This clause can be a trap for the unwary.
- Repair/Replace Time Limit
Where a policy provides coverage on a “replacement cost basis” (as opposed to “actual cash value,” which typically deducts for depreciation), it may limit the period during which the policyholder must repair or replace the damaged property. Two years post-loss is a typical time limit. Where the loss is catastrophic, especially when the event results in a depletion of resources, such as labor and materials to conduct repairs, the limitation period may prove unreasonable and the parties will need to negotiate an extension.
Time element coverage is an important and valuable, but often overlooked, component of a commercial policy covering global property damage losses. While such policies may contain significant time-element deductibles, deadlines, and other limitations or exclusions, policyholders affected by the tragic events in Japan should take immediate action to obtain appropriate advice about their coverages. Policyholders exposed to financial losses in Japan should provide timely notice to their insurance carriers as a first step in preserving their rights to recover business interruption losses caused by the earthquake and tsunami there.