Business Interruption Coverage

Business Interruption Coverage

   By David B. Smith, Insurance/Risk Management Consultant, Farella Braun + Martel LLP.

The recent earthquake in Eureka, California (as well as the devastating events in Haiti), reminded me of the financial challenges and complexities faced by businesses large and small following a catastrophe.  While the Eureka situation is in no way comparable to the devastation in Haiti, businesses there will be facing challenges and potentially lengthy shut-downs.  One tool for dealing with the financial loss of such an involuntary shutdown is business interruption insurance.  However, that comes with its own set of challenges.

Insureds face difficulties determining limits for both earthquake insurance and business interruption insurance.  Generally speaking, limits for both should be based around Probable Maximum Loss (PML) calculations instead of Maximum Possible Loss (or Maximum Foreseeable Loss).  This is different to the normal valuation techniques for property insurance.  A good broker is worth his or her weight in gold for this.

Additionally, it is important that you buy the right property coverages.  Business interruption coverage is only triggered if there is a covered property loss.  If you don't have earthquake coverage, you won't have business interruption coverage if your business is closed because of earthquake damage.  Business interruption coverage is not available as a "stand alone" coverage, only as part of one of the business property policies that are offered.

A good broker, who fully understands the complexities of business interruption insurance, is essential when purchasing the coverage.  Make sure your broker does.  If you're unlucky enough to need to make a claim, it's even more essential to get expert help.

It's important to remember that business interruption insurance covers financial loss.  That leaves you, the insured, to prove how much loss you suffered.  Insureds and insurers frequently have disputes about the value of buildings and machines and all sorts of other physical property.  However, trying to calculate the amount of money your business would have earned had the loss not occurred is open to much more disagreement, and is clearly an arena ripe for conflict.  On top of that, many losses involve the loss of the very financial records the insured needs to prove the claim.  This is just another reason that a well thought-out risk management program, including offsite duplication of financial records, should be in place.

Business interruption losses spawn more disputes (though not so many lawsuits) than most other coverages, simply because it is so hard to prove the value of the loss.  Insurers vigorously challenge insureds' estimates of what profits would have been earned.  Add outside distractions such as recession or disasters, and disputes are bound to ensue.  (For example, an insured who owned a hotel in New Orleans that was badly damaged by hurricane Katrina was told that because there was no tourism in the area following the disaster that he would not have had any business anyway, and therefore he had suffered no business interruption loss.)

For these reasons, any insured suffering a business interruption loss should, very early on in the process, hire both insurance coverage counsel and accountants who specialize in business interruption losses.  Counsel can stay hidden in the background to start with (so as to not appear over aggressive or defensive), but you can be absolutely sure that the insurer will hire its own accountants who specialize in minimizing covered business interruption losses.  If the insured doesn't have his or her own accountants and advisors, there is the risk (some would say certainty) that the carrier will run financial rings around him.  Carriers deal with these issues every day, whereas the insured hopes he or she never has to.  Therefore it's important to get these consultants in quickly, so that they're not battling from behind when they do get involved.

It is completely understandable that insureds facing potentially catastrophic loss would be reluctant to spend money on lawyers and accountants at that time.  However, it is completely false economy not to do so.

David B. Smith is an Insurance and Risk Management consultant with the firm of Farella Braun+Martel.

See Farella Braun + Martel's, Farella's Policyholder Perspective blog at http://www.farellacoveragelaw.com/2010/05/federal-court-rejects-insurers-discretion-in-terminating-the-duty-to-reimburse-defense-costs-under-a.html.