Catastrophes like Hurricanes Harvey and Irma cause not only widespread physical damage but also leave tremendous and long-lasting area-wide economic damages in their wake. Business interruption claims are frequently the most difficult and hotly contested of insurance claims, and this is even more so in the aftermath of large-scale natural disasters. One common dispute is whether the measurement of business interruption should take into account the post-loss area-wide economic conditions. For example, in the aftermath of Hurricane Katrina, losses were exacerbated by the decline of population in the area, which magnified the business interruption losses.

Following Hurricane Katrina, some insurers inserted language in their policies that they argue reduces a policyholder’s ability to recover in certain situations. And certain insurers appear to have done this under the guise of “contract certainty” while others appear to have made changes to attempt to reduce their liability exposure without giving their policyholders an explanation of the potential restrictions in coverage the new language could bring. As always, a careful focus on policy language during placement as well as the claim process is critical to achieving the outcome that is right for you.

Under ordinary, noncatastrophic circumstances, the performance of a business prior to the catastrophe can be an accurate measurement for how that business would have performed if the damage had not occurred. But the same may not be true following a wide-impact catastrophe. For example, an influx of temporary workers could cause local economies to boom, and a shortage of available hotel rooms or apartments could cause hotel rates and rents to increase. On the other end of the spectrum, many businesses may experience a significant decrease in profits in a post-catastrophe market as temporary population shifts may result in long-lasting changes in supply and demand for commodities and services. Consequently, measuring a policyholder’s business interruption (or time element) loss is one of the most contentious issues arising from wide-impact catastrophic events.

Although policy provisions vary, as do the types of coverage available, common business interruption provisions generally include something along these lines:

In determining the amount of the Time Element loss as insured against by this policy, due consideration shall be given to experience of the business before the loss and the probable experience thereafter had no interruption of production or suspension of business operations occurred.

Two prevailing lines of authority exist for measuring a policyholder’s business interruption loss following a wide-impact catastrophe: the “economy ignored” and the “economy considered” approaches. The first approach, economy ignored, looks backward and measures the policyholder’s loss only against pre-catastrophe business levels and does not take into consideration the impact of actual post-catastrophe conditions on the economy, market or demand. Courts that apply the economy ignored approach typically do so because they are more concerned that the policyholder will reap a “windfall” from the catastrophe. The second approach, economy considered, seeks to place the policyholder in the position that it would have occupied in the actual post-catastrophe environment had it been able to continue its operations. A rationale for the economy considered approach is that it avoids giving the insurer a “windfall” because the insurer was in the best position to price and assume the risk.

To see how outcomes can differ from applying one approach over the other, consider the following brief, hypothetical examples.

  1. A grocery store in Texas is closed following Harvey, and when it resumes operations it experiences an increase in profits due to increased demand as other grocery stores in the area had not yet reopened. The grocery store claims the post-hurricane economy should be considered to calculate its business interruption claim, and thus its claim includes the additional profits it would have experienced during the period it was closed due to the decreased competition from other stores. But the insurer argues that doing so would result in a windfall to the policyholder, as opposed to putting the policyholder in the position that it would have been in had Harvey not occurred.
  2. A high-end electronics store in Florida is closed after Hurricane Irma, and experiences a drop in profits when it re-opens because the storm has resulted in a diminished market demand for high-end electronics as local residents are putting their money towards rebuilding efforts and some residents have not yet returned following the storm. The electronics store asserts that the post-hurricane economy should be ignored, and that its business interruption claim should be based on its pre-hurricane profit levels, while the insurer asserts that the post-hurricane levels should control.

As these examples demonstrate, neither test consistently benefits a policyholder or an insurer in every situation. The outcome instead relies on the unique facts in each particular circumstance. Policyholders should therefore carefully consider the impact of both tests before submitting their claim (and when renewing or purchasing coverage next time around).

Most likely because we have been fortunate not to have too many recent examples of wide-impact catastrophes, there is not an abundance of recent case law on this issue. Courts that have considered the issue have applied both the “economy ignored” and the “economy considered” approaches depending on the facts and the particular policy language. That is likely to continue as losses are measured and adjusted following Hurricanes Harvey and Irma.

Texas Law

Texas courts have followed both approaches in response to specific policy wording. In Finger Furniture Co. v. Commonwealth Insurance Co., 404 F.3d 312 (5th Cir. 2005), the Fifth Circuit held that a post-storm surge in business could not be used to reduce the insured’s claim because the policy wording mandated that due consideration be given to the experience of the business before the loss and the probable experience of the business after “had no loss occurred.” Rimkus Consulting Group Inc. v. Hartford Cas. Insurance Co., 552 F. Supp. 2d 637 (S.D. Tex. 2007) came to a different result because the policy there contained an offset provision specifically allowing consideration of an increase in business from “other income channels.”

Florida Law

Florida courts also have followed both approaches in connection with hurricane claims. For example, Stamen v. Cigna Property & Casualty Insurance Co., 1994 U.S. Dist. LEXIS 21905, at *5 (S.D. Fla. June 13, 1994), concerned a claim after Hurricane Andrew and involved a policy that provided that in calculating business interruption loss the insurer would “consider your situation before the loss and what your situation would probably have been if the loss had not occurred.” The court held that the “loss” referred to the damage to the policyholder’s property, not the hurricane, and agreed with the policyholder that the measure of its lost profits should include “the increased profits that would have resulted had the [policyholder’s] stores been open immediately after the hurricane.” Id. at *5-7. Another Florida court came to the opposite conclusion in American Automobile Insurance Co. v. Fisherman’s Paradise Boats Inc., 1994 WL 1720238, at *3 (S.D. Fla. Oct. 3, 1994), where the policy stated that business interruption loss would be determined based on likely net income “if no loss or damage occurred.” The court rejected the policyholder’s claim for profits it would have earned due to increased post-hurricane demand for its products, holding that the policy allowed “net income projections that are not itself created by the peril” and the policyholder was not entitled to “the windfall profits.” Id. at *3-4.

Approaches Taken By Other Courts

Other courts likewise have gone in both directions — some have looked only at the insured’s pre-catastrophe profits, while others have taken post-catastrophe economic conditions into account.

The Fourth and Fifth Circuits generally have employed the “economy ignored” approach. In Prudential LMI Commercial Insurance Co. v. Colleton Enterprises Inc., 976 F.2d 727 (4th Cir. 1992) (Table), the Fourth Circuit, applying South Carolina law, rejected a hotel’s claim for lost profits it would have earned following Hurricane Hugo due to an influx of repair and construction workers in the area. The policyholder had recorded losses during the two year period prior to the storm, and the court reasoned that to consider post-storm economic conditions “would be to confer a windfall upon the insured rather than merely to put it in the earnings position it would have been in had the insured peril not occurred.” Id. at *3. Likewise, in Catlin Syndicate Ltd. v. Imperial Palace of Mississippi Inc., 600 F.3d 511 (5th Cir. 2010), the Fifth Circuit, applying Mississippi law, followed its earlier decision in Finger Furniture and rejected a casino’s claim for the increased profits it would have earned had it remained open following Hurricane Katrina while other area casinos had not. Addressing the typical “had no loss occurred” business interruption policy language, the court reasoned that while the specific “loss” to the casino was distinct from the “occurrence” (the hurricane) the two concepts are intertwined under the language of the business interruption provision, and thus the court held that “only historical sales figures should be considered when determining loss, and sales figures after reopening should not be taken into account.” Id. at 515-16. The Fifth Circuit once again took the same approach in Consolidated Companies Inc. v. Lexington Insurance Co., 616 F.3d 422 (5th Cir. 2010), under Louisiana law, which involved another Katrina claim. The court noted that the “jury was not to look at the real-world opportunities for profit post-Katrina, but instead was to decide the amount of money required to place [the policyholder] ‘in the same position in which it would have been had Katrina not occurred.’” Id. at 432.

On the other hand, other courts have considered post-damage market conditions. In Levitz Furniture Corp. v. Houston Casualty Co., 1997 U.S. Dist. LEXIS 5883 (E.D. La. Apr. 28, 1997), which involved a flood, the court held that the policy at issue “clearly and unambiguously provides coverage for earnings ‘had no interruption’ occurred, and does not exclude profit opportunities due to increased consumer demand created by the flood.” Id. at *8. Notably, the court distinguished Colleton and Fisherman’s Paradise Boats on the basis that the policy language differed — in Colleton and Fisherman’s Paradise Boats the policies stated that profits were calculated based on if no “loss” had occurred, whereas the policy in Levitz looked to the policyholder’s probable experience “had no interruption of production or suspension of business operations or services occurred.” Id. (emphasis added). In Berk-Cohen Assocs. LLC v. Landmark American Insurance Co., 2009 U.S. Dist. LEXIS 77300 (E.D. La. Aug. 27, 2009), the owner of an apartment complex sought recovery on account of an increase in occupancy rate and rental price that followed in the aftermath of Hurricane Katrina, while the insurer argued for a pre-Katrina calculation. The policy provided that in determining the amount of loss the likely income “if no physical loss or damage had occurred” was to be considered, “but not including any Net Income that would likely have been earned as a result of an increase in the volume of business due to favorable business conditions caused by the impact of the Covered Cause of Loss on customers or on other businesses.” Id. at *10 (emphasis added). The court interpreted this provision to exclude from consideration “only favorable business conditions caused by the same cause of loss for which the insured is invoking coverage under the policy,” and reasoned that this language “implies that those market conditions resulting from non-covered causes of losses are permissible.” Id. at *14-15. Because the covered cause of loss in that case was wind, but the favorable post-Katrina market conditions were the result of flood at other properties, the court held that the policyholder was entitled to the benefit of the favorable market conditions. Id. at *17. The Fifth Circuit affirmed on that point. Berk-Cohen Assocs. LLC v. Landmark Am. Insurance Co., 433 Fed. Appx. 268, 270 (5th Cir. July 20, 2011). And in Sher v. Lafayette Insurance Co., 973 So. 2d 39, 56-57 (La. Ct. App. 4th Cir. 2007), aff’d in part, rev’d in part, 988 So. 2d 186 (La. 2008), a Louisiana appellate court upheld a jury verdict that awarded a policyholder landlord the increased value of lost rental income he would have experienced after Hurricane Katrina based on the post-Katrina market.

It is important to note that the cause of the market conditions matters. For example, adverse conditions that are due to a broader economic recession may be considered, even if conditions caused by the specific damage-causing catastrophe are not. See Penford Corp. v. Nat’l Union Fire Insurance Co., 2010 U.S. Dist. LEXIS 60083 (N.D. Iowa June 17, 2010) (“Here, unfavorable market conditions, such as a recession, would have affected [the policyholder’s] earnings regardless of whether the flood ever occurred. Accordingly, they are relevant to the question of what [the policyholder’s] likely revenues would have been in the absence of the flood.”).

These cases demonstrate that, unsurprisingly, the policy language plays a critical role in determining whether the “economy ignored” or “economy considered” approach will apply. Policy provisions vary, and some insurers have attempted to address this through policy provisions such as:

[t]he likely Net Income of the business if no physical loss or no physical damage had occurred, but not including any net income that would likely have been earned as a result of an increase in the volume of business due to favorable business conditions caused by the impact of the Covered Cause of Loss on customers or on other businesses.

Another example now used by a major global property insurer is:

[t]he experience of the business before and after and the probable experience during the period of interruption. The probable experience will consider any increase or decrease in demand for the Insured’s goods or services during the period of interruption, even if such increase or decrease is from the same event that caused physical loss or damage starting the period of interruption.

To maximize coverage and avoid surprises after a loss, policyholders should consider appropriate pre- and post-loss planning and claim preparation approaches. These might include, for example, examining any changes to their policy language as well as awareness of which test courts apply in applicable jurisdictions. Additionally, because some insurers are willing to negotiate policy terms, policyholders should consider seeking better policy language when renewing coverage.

Harvey and Irma have had a significant impact on economic conditions along their paths and beyond, and that impact will continue to be felt for the foreseeable future. Post-storm economic conditions will result in some businesses thriving and others struggling. Whether those post-storm conditions will be considered in connection with valuing a business interruption claim depends on the relevant policy language and applicable law. One thing, however, is certain: post-hurricane economic conditions can have a substantial impact on the value of a business interruption claim and this issue is sure to be lead to vigorous dispute between businesses and their insurers.