Fallout from the Japan Disaster: Causation & Aggregation Issues Under CBI & Reinsurance Policies

Transcription

1 Fallout from the Japan Disaster: Causation & Aggregation Issues Under CBI & Reinsurance Policies Darlene K. Alt Partner Providence, RI Nathan Hull Associate London James T. Killelea Associate New York, NY

2 Agenda Background of Japan Disaster Contingent Business Interruption (CBI) Insurance Causation Principles Affect of Anti-Concurrent Causation Clauses on Supply Chain Losses Damaged Property in Damaged Area: Orient-Express Hotels Case Aggregation Principles under Reinsurance Policies Event-Based Wording and Hours Clauses Application of Aggregation Principles to Japan Disaster 2

3 Background: The Disaster Unfolds March 11, magnitude earthquake Minutes later, a 33-foot tsunami traveled 6 miles inland Series of aftershocks Total economic loss: $300 billion Insured loss: $50 billion Reinsured loss: $20 billion 3

4 Background: Key Industries Disrupted Semiconductors 20% of world s total production 45.1% of global production for consumer electronics 31.5% of global production for automotive electronics Electronics 35% of the global flash memory market Automotive Shipping Energy 4

5 Contingent Business Interruption (CBI) Insurance Shortage of component parts manufactured in Japan disrupts supply chains worldwide Claims for coverage of lost profits and other expenses from supply interruptions Failure to obtain component parts Inability to ship product to consumers Business Interruption coverage (BI) v. CBI coverage 5

6 CBI Coverage: Overview Typically, added by endorsement Standard Insuring Clause: 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 the direct physical loss of or damage to dependent property at a premises described in the Schedule caused by or resulting from any Covered Cause of Loss. (ISO Form CP ) Business Income defined to include net profit (or losses) that would have been realized and the continuing normal operating expenses incurred. May include coverage for extra expenses 6

7 CBI Coverage: Causation Requirement Insured s loss caused by direct physical loss or damage to dependant property caused by a covered peril Dependant Property Contributing property Recipient property Direct v. indirect supplier Two prong causation requirement: Physical loss or damage to supplier s property caused by an insured peril; and Loss of income by insured caused by the physical damage 7

8 CBI Coverage: Potential Causes and Losses Potential Causes Earthquake Tsunami Flooding Nuclear radiation Power outages Aftershocks Typical Losses Lost profits Expenses for replacement materials Labor and relocation costs Liquidated damages Evacuation 8

9 CBI Coverage: Time and Scope Limitations Lost income insured would have earned during period of indemnity or restoration period Time necessary to rebuild, repair or replace the damaged property with "reasonable speed" or "due diligence 72 hours after damage incepts Length of indemnity period varies Specific property locations 9

10 CBI Coverage: Exclusions Common Excluded Perils Earth Movement Earthquake, including any earth sinking, rising or shifting related to such event Water Flood, surface water, waves, tides, tidal waves, overflow of any body of water, or their spray, all whether driven by wind or not Nuclear Hazard Nuclear reaction or radiation, or radioactive contamination, however caused Pollution- discharge, seepage, release or escape of pollutants 10

11 Causation Doctrines: Efficient Proximate Cause Prevailing approach in U.S. If a covered and excluded risk cause a loss, coverage exists only if the covered risk was the efficient proximate cause of the loss Definition varies widely Dominant, efficient cause that sets the other causes in motion Predominating or moving efficient cause Superior strength, influence, authority or position Primary cause Doctrine does not apply where completely independent causes simultaneously produce an indivisible loss 11

12 Application of the Efficient Proximate Cause Doctrine (EPC) Julian v. Hartford Underwriters Ins. Co., 35 Cal. 4th 747 (Cal. 2005): Rain and landslide contributed to property damage Policy contained a weather conditions exclusion Because the landslide was the EPC of the damage and it was an excluded peril (weather conditions), no coverage for the loss Western National Mutual Ins. Co. v. UND, 643 N.W.2d 4 (N. Dak. 2002): Flooding and sewage contributed to property damage Flooding exclusion in the policy Because the excluded peril (flooding) was not the EPC, coverage provided by the policy 12

13 CBI Coverage: Scope of Recovery Generally, the whole loss is recoverable as long as the covered peril is the efficient proximate cause of loss Some courts limit coverage to only those damages proximately caused by the covered peril State Farm Fire & Cas. v. Slade, 747 So.2d 293 (Ala. 1999) (coverage only allowed for damages proximately caused by lightening, a covered peril) State Farm Fire and Cas. Co. v. Rodriguez, 88 S.W.3d 313 (Tex. App. 2002) abrogated on other grounds by 267 S.W.3d 20 (Tex. 2008) (where plumbing leaks contributed to 25% of loss and were covered by policy, insured recovery limited to 25% of the loss) 13

14 Causation Doctrines: Concurrent Causation Minority approach in U.S. Generally applies where completely independent causes simultaneously produce an indivisible loss. Loss is wholly covered as long as at least one covered peril, independently or dependently, contributed to the loss Expansive approach Favors policyholders Burden of proof varies 14

15 Anti-Concurrent Causation (ACC) Clauses Began appearing in policies in early 1980s in response to losses arising from Hurricane Camille Contracts around the causation doctrines Typical provision: We will not pay for loss or damage caused directly or indirectly by any of the following. Such loss or damage is excluded regardless of any other cause or event that contributes concurrently or in any sequence to the loss. Intended to bar coverage where an excluded peril is one of two or more causes of a loss 15

16 Enforcement of ACC Clauses Enforcement varies widely Applied in approximately 20 states Gulf Coast state courts tend to enforce ACC clauses Many courts that apply the concurrent causation doctrine enforce ACC clauses Rationale for enforcement Freedom of contract 16

17 Enforcement of ACC Clauses Non-enforcement jurisdictions California West Virginia North Dakota Washington Rationale for non-enforcement Contravenes state valued policy statutes Contrary to public policy Conflicts with reasonable expectations of insured Where multiple independent causes result in a loss, ACC clause may not apply See, e.g., Corban v. United service Auto. Ass n, 20 So.3d 601 (Miss. 2009) 17

18 Interpretation of ACC Clauses Courts split on whether ACC clauses unambiguous Courts enforcing ACC clauses generally find them unambiguous Favors insurers Tuepker v. State Farm Fire & Cas. Co., 507 F.2d 346 (5th Cir. 2007) (applying Mississippi law) If ambiguous, generally interpreted in favor of insureds In re Cameron Parish Rita Litigation, 2007 WL (W.D. La (applying Louisiana law) St. Mary s Area Water Authority v. St. Paul Fire & Marine Ins. Co. 464 F. Supp. 2d 397 (M.D. Pa. 2006) Brooklyn Bridge, Inc. v. South Carolina Ins. Co., 309 S.C. 141, 420 S.E.2d 511 (Ct. App. 1992) 18

19 CBI Claim Considerations Examine the policy, the covered and excluded perils and whether policy includes an ACC clause Analyze the interplay between covered, non-covered and excluded perils contributing to the loss Determine which state s law governs What causation doctrine applies? Does the jurisdiction enforce ACC clauses? Insurers generally have greater exposure where: Courts apply the concurrent causation doctrine Courts refuse to enforce ACC clauses Courts find ACC clauses ambiguous or inapplicable because of multiple independent causes 19

20 CBI Coverage for Japan Losses Two causes involved physical damage to supplier s property caused by an insured peril; and loss of income by insured caused by the physical damage. Japan: damage to supplier s property as well severe disruption: Damaged road and rail networks Damaged seaports Power shortages and blackouts Exclusion zones Loss of income caused by physical damage to supplier s property or one or more of the circumstances above? 20

21 CBI Coverage: English Approach to Causation English law: proximate cause of loss If two or more concurrent proximate causes, coverage for the loss caused will depend on whether one of the causes is excluded as opposed to merely uninsured. (Wayne Tank & Pump Co. v. Employers Liability Assurance Corporation CA [1973] Lloyd s Rep. Vol.2). Under US state laws, prevailing approach applies efficient proximate cause doctrine. 21

22 Damaged Property in Damaged Areas Losses caused by both damage to the supplier s property and damage to the surrounding area. Orient-Express Hotels v. Assucurazioni Generali SA [2010] EWHC 1186 (Comm). Issue: Whether luxury hotel in New Orleans was covered for loss due to interruption with the Business directly arising from Damage. Policy provided that losses were to be adjusted so that they represented the results which but for the Damage would have been obtained during the relative period after the damage. Hotel damaged by hurricanes Katrina and Rita and forced to close. During that time New Orleans was subjected to a state of emergency, a curfew and two mandatory evacuations. 22

23 Damaged Property in Damaged Areas (cont.) Damage to hotel and damage to New Orleans considered independent proximate causes of BI losses to hotel. But for test applied undamaged hotel in damaged city scenario Court found that losses would have been the same due to devastation in New Orleans and did not allow recovery under policy. 23

24 Lessons from Orient-Express Hotels Decision reached on basis of specific but for language in policy Insurers likely to rely on Orient-Express Hotels Important for insured and insurers to carefully check: Extent of any CBI coverage Law governing policy Applicable exclusions How losses are assessed 24

25 Aggregation Principles Under Reinsurance Policies 25

26 Reinsured Losses Ultimate potential loss for reinsurers: $20bn Resulting from: shake and fire property losses, tsunami onshore property losses, tsunami on the coast property losses, BI and CBI losses Reinsurances affected: Residential property Commercial and industrial property BI CBI Not clear to what extent property damage and BI losses caused by earthquake and tsunami will be covered. 26

27 Key Facts Relating to Aggregation Aggregation important to reinsurance policies in relation to the retention and limits of coverage 9.0 magnitude earthquake Tsunami Aftershocks Fires at industrial plants Exclusion zone Power shortages and blackouts General devastation including damage to infrastructure 27

28 Reinsurance: Aggregation Principles No general principles applicable to each and every case Turns on specific policy wording Most common types of wordings Event-based wordings Hours clauses 28

29 Event-Based Wordings Each and every loss and/or series of losses arising out of one event Sometimes occurrence used instead of event but interchangeable unless contract requires some distinction. (Kuwait Airways v. Kuwait Insurance Co. SAK [1996] 1 Lloyd s Rep 664 (QB Com CT)). arising out of one event has been interpreted as requiring: Common factor which can properly be described as an event; A test of causation must be satisfied; and The event does not have to be the proximate cause of the loss but it must not be too remote (B.F. Caudle & Others v. Alec Sharp & Others [1995] LRLR 433 CA). 29

30 Event-Based Wordings (cont.) Unities test provides that event or occurrence involves the question of degree of unity in relation to: Cause; Locality; Time; and If initiated by human action, the circumstances and purposes of the persons responsible. (Kuwait Airways v. Kuwait Insurance Co. SAK [1996] 1 Lloyd s Rep 664 (QB Com CT)). An event is something which happens at a particular time, at a particular place, in a particular way A cause is something altogether less constricted. It can be a continuing state of affairs; it can be the absence of something happening. (Axa Reinsurance (UK) plc v. Field [1996] 2 Lloyd s Rep 233 (HL)). 30

31 Hours Clauses each and every loss occurrence where loss occurrence defined as all individual losses arising out of and directly occasioned by one catastrophe. However, the duration and extent of any loss occurrence so defined shall be limited to 72 consecutive hours as regards: (a) Hurricane, typhoon, windstorm, rainstorm, hailstorm and/ or tornado (b) Earthquake, seaquake, tidal wave and/or volcanic eruption (c) Within the limits of one City, Town or Village as regards riots, civil commotions and malicious damage 31

32 Hours Clauses (cont.) (d) individual loss or losses included in any of the individual loss or losses from the perils mentioned in (a), (b) and (c) above 168 Consecutive hours as regards any loss occurrence of whatsoever nature which does not include individual loss or losses from any of the perils mentioned in (a), (b) and (c) above and no individual loss from whatever Insured peril, which occurs outside these periods or areas, shall be included in that loss occurrence The [Reinsured] may choose the date and time when any such period of consecutive hours commences and if any catastrophe is of greater duration than these periods, the [Reinsured] may divide that catastrophe into two or more loss occurrences, provided no two periods overlap and provided no period commences earlier than the date and time of the happening of the first recorded individual loss to the [Reinsured] in that catastrophe. [LPO98a]. 32

33 Hours Clauses (cont.) No English case law on meaning of hours clauses Key points to note: Losses must arise out of and be directly occasioned by one catastrophe catastrophe is not defined catastrophe and peril may be different, and the former can arise from one or more of the latter In other examples of hours clauses catastrophe is defined as a sudden violent physical operation and one and the same manifestation of an original insured peril [and certain reinsured perils] (LIRMA NP61) 33

34 Hours Clauses and the IUA IUA review in November 2009: Earthquake: sudden release of energy in the Earth s crust which creates seismic waves and shakes the land (as opposed to the ocean floor) as a result of this release of energy and can extend for miles around the epicenter. Seaquake: a sudden release of energy in the Earth s crust, which shakes the ocean floor and can extend for miles around the epicenter. Tidal wave: the swell or crest of surface ocean water created by naturally occurring tides. Tsunami (not a named peril): a series of water waves that is caused when a large volume of a body of water, such as an ocean, is rapidly displaced. This displacement can occur as a result of a seaquake, earthquake and/or volcanic eruption. 34

35 Hours Clauses and the IUA (cont.) IUA: with regard to tsunamis, it might be worth noting that if a seaquake, earthquake and/or volcanic eruption set in motion an uninterrupted chain of events leading to a tsunami, the catastrophe would already be catered for by the clause. If losses resulting from tsunami not considered as directly occasioned by earthquake then losses will be subject to a 168 hour (7 day) time limit, rather than a 72 hour time limit Aftershocks from earthquakes and seaquakes could be expected to be part of same catastrophe as original earthquake or seaquake 35

36 Aggregation Issues (Event-Based Wordings) Ultimately depends on particular wording of the policy Issues: Do earthquake and tsunami constitute the same event? Do the aftershocks constitute the same event as the original earthquake? Can losses from power shortages/blackouts relate back to the earthquake or tsunami? Can losses from exclusion zones relate back to the earthquake or tsunami? 36

37 Aggregation Issues (Hours Clauses) Issues for Hours Clauses: Which losses were directly occasioned by one catastrophe? Japan earthquake an earthquake or a seaquake or both? Japan earthquake and tsunami one catastrophe? Aftershocks within the original earthquake? 37

38 Aggregation under Reinsurance Policies in the U.S. Reinsurance law is still developing No reported U.S. case law interpreting what constitutes an event or cause for reinsurance purposes U.S. authorities have not formulated a single test However, usually a cause oriented analysis Courts tend to focus on meaning of key terms: series of accidents, arising out of one occurrence, common origin, etc. Resolution of aggregation issues turns on language of reinsurance contract and applicability of Follow the Fortunes 38

39 Definition of Series in Context of Aggregation Common sense construction Travelers Casualty and Surety Co. v. Certain Underwriters at Lloyd s (N.Y. 2001) Reinsurers refused to follow cedent s treatment of payments made as a result of contamination at multiple pollution sites over many years as one loss Court upheld reinsurers position based on following contract language: Loss was defined as all loss arising out of any one disaster and/or casualty Disaster and/or casualty was defined as: All loss resulting from a series of accidents, occurrences and/or causative incidents having a common origin and/or traceable to the same act, omission, error and/or mistake shall be considered to have resulted from a single accident, occurrence and/or causative incident 39

40 Definition of Series (cont.) Travelers Casualty and Surety Co. v. Certain Underwriters at Lloyd s (N.Y. 2001) (cont d) Interpreted Series to mean a group of usually three or more things or events standing or succeeding in order and having a like relationship to each other: a spatial or temporal succession of persons or things Court found environmental losses could not be aggregated because the acts of pollution occurred over 100 years and were disbursed geographically from New Jersey to Oregon Found that a series of accidents could be properly aggregated if they have a spatial or temporal relationship to one another and a common origin 40

41 Arising out of One Accident in Context of Aggregation Hartford Accident and Indemnity Co. v. Ace American Reinsurance Co. (Conn. Super. Dec. 2005), reversed, (Conn. Dec. 2007) Contract provided Reinsurers would be liable for losses, above a particular threshold and below a specified limit incurred by the cedent under its policies by reason of any one accident Definition of any one accident included a common cause provision which provided for the aggregation of multiple losses arising out of products manufactured, made, handled, distributed or sold by the insured as any one accident to the extent such losses arose from a common cause Lower court declined to permit aggregation of 17,500 asbestos claims under common cause language Connecticut Supreme Court reversed the lower court noting that clause was uniquely broad and had never been construed by an other court. However, common cause language was ambiguous as to whether it allowed aggregation of losses that arose out of same pattern of events or contained spatial and temporal limitations that precluded the aggregation of claims incurred at hundreds of different locations over decades 41

42 Aggregation Issues Arising Out of Japan Disaster (U.S. Law) Expect similar issues to those facing reinsurance industry in UK Issues: Will earthquake, tsunami, fires and ensuing aftershocks be considered a series of accidents constituting one loss? Will the earthquake that initially struck Japan be considered the common cause of all other losses associated with the disaster to allow such losses to be aggregated as one accident? Will courts construe the language of the applicable policy defining occurrence or Event as ambiguous, thereby preventing a ruling on whether aggregation principles can be applied in the first place? 42

43 Contact Us: Darlene K. Alt Partner Providence, RI Nathan Hull Associate London +44 (0) James T. Killelea Associate New York, NY