Business Interruption Insurance Issues

Transcription

1 Business Interruption Insurance Issues by James A. McFall Return to publication table of contents

2 JAMES A. MCFALL is a shareholder in the San Diego law firm of Neil, Dymott, Perkins, Brown & Frank. In his practice, he focuses on insurance coverage, business litigation, and environmental law. Mr. McFall is an active member of DRI s Insurance Law Committee.

3 Business Interruption Insurance Issues Table of Contents I. Coverage Overview II. Post-9/11 Business Coverage Implications III. Conclusion Business Interruption Insurance Issues McFall 223

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5 Business Interruption Insurance Issues The September 11, 2001 attack upon the World Trade Center has created a myriad of property and business interruption coverage issues. The after effects of the WTC attack have brought into focus a number of coverage issues that previously had not been confronted by either the insurance industry or its customers. One of the concerns raised is what role business interruption insurance plays when terrorism causes businesses to temporarily shut down. Businesses require stability to survive and insurance is one of the bulwarks of the economy that provides that stability. One of the primary purposes of insurance is to disperse economic risk and thereby create an atmosphere of economic constancy. The physical and personal devastation of the September 11 terrorist attacks were immense. However, the economic impact stemming from 9/11 also had an immediate and tremendous effect on the United States and cannot be ignored. While much of the evidence is anecdotal, any business traveler flying in the months following the WTC attacks can testify as to the numerous seats available on any commercial aircraft in the United States. While economists will tell us that the recession actually began in the Spring of 2001, there can be little doubt that the 9/11 attacks exacerbated an already weakening economy. On September 8, 2002, nearly one year later, the Chicago Sun Times reported that it was estimated that the attacks resulted in the elimination of 1.2 million jobs nationwide. The job loss was thought to be concentrated in New York City and in industries such as air travel and tourism. According to an article in the June 2004 issue of Monthly Labor Review, within two weeks of the 9/11 attacks, over 3,300 Manhattan jobs had relocated to New Jersey, more than 80 percent of which were in the financial sector. By the end of October the number had risen to more than 17,000 jobs. However, by the end of December 2002, all but 5,200 of those jobs had returned to New York. The terrorist attack cost the Manhattan economy approximately 238,000 lost job months (or the equivalent of 59,000 jobs each month for 4 months). The loss in wages exceeded $2 billion. These figures reflect both the impact on the economy and the resilience of the economy. While Manhattan temporarily lost 12,000 jobs, those jobs did in fact return. Some of the economic upheaval caused by those temporary job losses were softened by various insurance products such as business interruption coverages. I. Coverage Overview The statistics cited above are illustrative of the dislocations that can be caused by terrorist activity. They also reflect the need for various forms of business interruption insurance that can ameliorate these dislocations. The typical business interruption policy insures for a loss of business income that results from damage or disruption to the insured premises. Traditionally, this coverage would afford a business protection in the event of damage to the insured premises (such as that caused by fire). Business interruption insurance would not repair the destroyed property; that coverage would come from the property insurance. Instead, it would insure the business for the interruption to its profit flow, thus enabling it to continue to survive while its business was interrupted during reconstruction. Many business interruption policies include extensions to the coverage that traditionally have been viewed as esoteric. Those extensions are sometimes referred to as civil authority coverage or ingress/egress coverage. The two are similar in purpose although they do have distinctive characteristics. The Insurance Services Office model extension to business interruption coverage that deals with interruption by civil authority provides: Business Interruption Insurance Issues McFall 225

6 This policy is extended to include the actual loss sustained by the Insured resulting directly from an interruption of business as covered hereunder during the length of time not to exceed two consecutive weeks, when as a direct result of damage to or destruction of property adjacent to the premises herein described by peril(s) insured against access to such described premises is specifically prohibited by order of Civil Authority. The above language is typical of the ISO version, but there are variations, which may be written less precisely and may provide coverage up to four weeks. An example of a less precise provision is: This policy is extended to insure loss sustained during the period of time when as a result of loss or damage caused by a peril insured against access to property is impaired by order or action of Civil or Military Authority. Coverage is limited to no more than four weeks for any one occurrence. The difference in language in the two provisions has profound coverage implications. One provision provides coverage for two weeks, the other four. The ISO extension is triggered only by an order of civil authority while the other extension uses the language order or action of civil authority. The ISO provision requires that access be prohibited by civil authority where the other requires that it merely be impaired. Even the property which is damaged or destroyed is different from one provision to the next. The ISO policy requires the damaged property to be adjacent to the insured property whereas the less precise provision does not have that limitation. Ingress/egress extensions in coverage are similar in purpose but are sometimes worded differently from one another, which results in differences in coverage. One ingress/egress extension might read: The insurance provided by this policy is extended to cover the actual loss sustained by the Insured during the length of time not exceeding 14 consecutive calendar days when ingress to or egress from covered locations is restricted as a direct result of actual loss or property damage from a peril covered under this policy to property in the vicinity of the covered locations to which ingress to or egress from is restricted. In no event shall this extension cover any loss which is otherwise covered under Extension 3, Interruption by Civil Authority, above. A less precise extension may read: This policy is extended to insure loss sustained during the period of time when, as a result of loss or damage not excluded in Clause 6, ingress to or egress from real or personal property is impaired. Coverage is limited to no more than four weeks for any one occurrence. Again, we see that differences in the language affect the period of coverage. One is limited to two weeks while the less precise language arguably does not contain an explicit coverage period; or if it does, it is certainly extended to four weeks. The more precise extension is triggered only when the ingress or egress from covered locations is restricted. The less precise provision only requires that the ingress or egress be impaired. Likewise, the more precise extension requires that there be damage to the property in the vicinity of the covered locations where the second extension does not specify which property must be damaged for coverage to apply. Finally, a third type of coverage that should be addressed is contingent business interruption coverage and service interruption coverage. While business interruption insurance and ingress/egress insurance extend coverage when access to the insured property is impacted, contingent business interruption coverage protects the earnings of the insured following physical loss or damage to property to the insured s suppliers and/or customers. Consider an insured that produces computers. Assume that the insured does not actually make its own silicon chips, but instead has an exclusive contract with a supplier for those chips. If that supplier suffers a fire loss at its factory, not only would the silicon chip factory suffer a business interruption, but so would the com- 226 The Future of Terrorism Risk Insurance

7 puter manufacturer until it was able to locate an alternate source for chips. Contingent business interruption insurance provides protection in these instances. Purchasers of contingent business interruption coverage may also buy service interruption coverage. Most contingent business interruption policies contain an exclusion for suppliers of water or power. This gap is filled by service interruption coverage. Contingent business interruption insurance is becoming more significant in our modern economy. In an effort to streamline costs, businesses have transitioned into relying upon just in time inventory systems. As a result, any interruption in supplies can result in a corresponding interruption in production. Businesses usually do not have raw materials or component parts stockpiled in sufficient numbers to allow for any extensive interruption in supply. A contingent business interruption coverage might read 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 dependent property at a premises described in the schedule caused by or resulting from covered cause of loss. II. Post-9/11 Business Coverage Implications As mentioned above, the economic ramifications stemming from the September 11 attacks encompassed far more than the collapse of the WTC towers. Immediately after the attacks, Mayor Giuliani of New York ordered the evacuation of the area surrounding the WTC complex. This evacuated area became known as the frozen zone. In addition to the evacuations in lower Manhattan all primary tunnels and bridges leading in and out of Manhattan were closed by the City of New York or by the New York/New Jersey Port Authority. Light rail and ferry service from New Jersey to Manhattan were also suspended and highways leading to Manhattan were closed. For the two days following 9/11 access to lower Manhattan was effectively prohibited; in the area immediately around the WTC complex the impact continued to last for weeks. Similarly, the Federal Aviation Administration ordered a national ground stop, effectively grounding all civilian aircraft for two days. Reagan National Airport continued to be closed until October 4, These actions impacted many businesses that were not directly attacked or in the area of attack on 9/11. An already ailing domestic airline industry was particularly hard hit by the immediate groundings of flights and subsequent closures of airports as well as the lingering reluctance of consumers to fly commercially. It has been estimated that the resulting drop in passenger flights led the airline industry to lay off more than 100,000 employees. As a result of the restrictions imposed upon flights, U.S. Airways cut over 11,000 jobs. A year later U.S. Airways had called back no more than 1,900 employees. U.S. Airway is a poignant example since Reagan National was and continues to be a major hub for the airline. The airline was already reeling from the effects of deregulation, an aging fleet, and high fuel costs when hit by the effects of the attacks in New York and Washington. The dislocations caused by the terrorist activity helped to drive the airline into bankruptcy in 2002 and again in While not all of U.S. Airways tribulations can be attributed to the 9/11 bombings, there can be little doubt that the airline s difficulties were intensified by the attacks. The tribulations of the airline industry are a microcosm for the problems suffered by the tourism industry throughout the United States. Just as airlines experienced a decrease in ridership, hotels throughout the nation experienced a corresponding decrease in travelers. The decrease in hotel occupancy was followed by a decrease in patronage of ancillary business such as restaurants, cabs, tour companies, etc. The United States General Accounting Office reported that for the year 2001 alone the economy of the New York-New Jersey metropolitan area sustained $27 billion in lost income while metropolitan areas throughout the United Stated sustained losses approximating $191 billion. Business Interruption Insurance Issues McFall 227

8 Not surprisingly, some businesses sought to recoup their losses through insurance claims. Many of these businesses were located far from the actual sites of the terrorists attacks. In 730 Bienville Partners, Ltd. v. Assurance Co. of America, 67 Fed.Appx. 248, 2003 U.S.App.LEXIS 8570 (5th Cir.), the facts indicate that a hotel owner made a claim under its commercial property policy for lost revenues at two of its New Orleans hotels. The insured argued that as a result of the FAA national ground stop and airport closures, many of its intended guests were unable to reach its hotels. The company sought to recoup under the civil authority extension. The federal district court in New Orleans found no coverage as a matter of law. It reasoned that while the FAA closure of the airport may have prevented guests from getting to New Orleans and to the insured s hotels, the FAA had not prohibited access to the hotels. This decision was affirmed by the Fifth Circuit. In 730 Bienville, the policy required that the loss of business income be caused by an action by civil authority that prohibited access to the insured s premises. That condition had not been met since no civil authority had barred access to the insured s hotels. A federal case in Chicago involved efforts by the city to recoup losses incurred at O Hare Airport, Meigs Field, and Midway Airport as a result of the FAA national ground stop. The court, in City of Chicago v. Factory Mutual Insurance Co., 2004 U.S.Dist.LEXIS 4266 (N.D.Ill.), granted the insurance companies summary judgment, finding that although ingress to and egress from the airport was prevented by the FAA s order, and that the damage was indirectly caused by terrorist-inflicted damage, this claim was excluded by the policy. The court found that the damage was indirect and remote, since the damage was to the WTC, not an airport in Chicago. The court, in essence, found a territorial limitation in the ingress/egress extension. In Southern Hospitality, Inc. v. Zurich American Insurance Co., 393 F.3d 1137 (10th Cir. 2004), an insured argued that the FAA closures had hindered access to its hotels and therefore, fell within the policy coverages. The case was notable because of counsel s argument regarding the definition of prohibit. The court found that in order for coverage to be triggered the order had to at least hinder access to the plaintiff s property and under the facts of this case the requirement had not been met. A recent decision by the federal court in New York City also refused to apply coverage or at least to the degree that insured was seeking. In Abner, Herrman & Brock Inc. v. Great Northern Insurance Co., 308 F.Supp.2d 331 (S.D.N.Y. 2004), an investment firm doing business in Manhattan sought coverage under the policy s civil authority provision for business income losses after September 11. The insured claimed that while its property incurred no physical damage as a result of the 9/11 attack, its loss of business income was covered because traffic restrictions imposed by civil authority in lower Manhattan barred access to his property for three days. The company was also seeking reimbursement for lost income for a much longer period of time when normal operating procedures were hampered by restraints imposed by traffic restrictions. The carrier argued that the insured was entitled to be reimbursed for the three days when access was prohibited by civil authorities, but for the time after that there was no coverage because access to the insured s property was not actually prohibited but simply made more difficult. The court found that the civil authority provision only covered business income lost during the time that access to the insured s premises was actually prohibited by civil authority, but not for the time when access was merely hampered. The cases in this area involve somewhat dissimilar policy language and varying facts, but they reflect a pattern on the part of the courts not to find coverage under the civil authority extension unless the civil order actually or specifically prohibits access to the insured s property. In County of Clark v. Factory Mutual Insurance Co., No. CV JD-RJJ (D.Nev. 2004), the insured made a claim under the ingress/egress provisions for losses sustained during the FAA airport closures following the September 11 attacks. The court denied the insured s motion for summary judgment in part because it concluded there was no certainty that the FAA order was a direct result of the physical damage to the WTC. While the court s reasoning may seem counterintui- 228 The Future of Terrorism Risk Insurance

9 tive, the issue seems to be whether the airport closures were in response to the attack on the WTC complex or because the FAA was fearful of additional terrorist attacks. In Assurance Co. of America v. BBB Service Co., 265 Ga.App. 35, 593 S.E.2d 7 (2003), the insurer made a similar argument and was able to have an appellate court reverse a summary judgment. While that case did not involve WTC attacks, it stemmed from an order issued by a county declaring a state of local emergency as a result of hurricane Floyd. The carrier argued that the evacuation order was issued due to the threat of damage to property, not due to actual property damage. These discussions are noteworthy in light of US Airways, Inc. v. Commonwealth Insurance Co., 65 Va.Cir. 238, 2004 Va.Cir.LEXIS 121, in which the airline sought coverage under the civil authority extension. The language in the U.S. Airways policy was very similar to that at issue in the BBB Service Co. case. The carrier argued that the orders were not issued as a result of physical damage to Reagan National Airport, and therefore coverage was not triggered. The trial court disagreed and found that the policy did not require actual damage or loss of property to invoke coverage. The court found: It is clear from the evidence that an order by a Civil Authority or Military Authority was issued as a direct result of damage or loss to U.S. Airways property. Prior to the U.S. Airways decision, no court had ever concluded that the civil authority extension did not require some physical damage for coverage to be triggered. III. Conclusion The litigation that ensued after September 11, 2001 over previously obscure extensions of coverage, illustrates the importance of certainty in the insurance market. The vast majority of business interruption claims were not the subjects of litigation. For the tenants of the World Trade Center, issues involving ingress/ egress were moot. Business interruption coverage and its ancillary extensions of coverage, when properly utilized, can help to minimize some of the economic dislocations caused by terrorist attack, and thereby lessen the impact of the same. The Terrorism Risk Insurance Act of 2002 enables the insurance industry to continue to offer these coverages despite the underwriting uncertainty posed by terrorism risk. Return to publication table of contents Business Interruption Insurance Issues McFall 229

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