Blog Post 04.03.20
Due to the spread of COVID-19, companies are facing unique challenges to their businesses, including supply chain interruptions, employee and customer safety concerns and government regulations, restrictions and shutdowns. Wide-impact catastrophes like this pandemic will cause tremendous and long-lasting economic damages. And while policyholders have procured insurance to protect themselves from such catastrophic events, business interruption claims are frequently the most difficult and hotly contested of insurance claims. Wide-impact catastrophes often heighten those challenges, given in part to the complexities of measuring business interruption claims. One common dispute is whether the measurement of business interruption should account for the post-loss economic conditions of the impacted area.
Generally, catastrophic events are limited to specific geographic areas. For example, a hurricane may impact businesses located on the coast, but leave in-land businesses untouched. The complexities of measuring a business interruption claim is likely heightened as a result of this pandemic however, given that the entire global economy is impacted, not just limited geographic regions.
Under ordinary, non-catastrophic 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, companies that rely heavily on the ability to exchange products with foreign countries might find themselves unable to transport or receive goods with that foreign country, or may find it more expensive and less effective to do so through alternative means. Similarly, an influx of temporary workers could cause local economies to boom. The inability of people and goods to move freely can cause 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 to arise from wide-impact catastrophic events.
Although policy language and provisions vary, as do the types of coverage available, common business interruption provisions generally provide:
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” approach and the “Economy Considered” approach. The Economy Ignored approach 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 apply this methodology to preclude a policyholder from getting a “windfall” as a result of a catastrophe. The Economy Considered approach, on the other hand, seeks to place the policyholder in the position that it would have occupied post-catastrophe, had it been able to continue its operations, which avoids giving an insurer a “windfall.”
To demonstrate how outcomes can differ when applying one approach over the other, consider the following brief, hypothetical examples.
As these examples demonstrate, these scenarios can play out in multiple different industries and businesses, and neither test consistently benefits a policyholder or an insurer in every situation. The outcome instead relies on the unique facts in each particular circumstance. Before submitting an insurance claim, policyholders should carefully consider the impact the different BI methodologies can have on available coverage before submitting their claim (and when renewing coverage).
Courts that have analyzed the Economy Ignored and the Economy Considered approaches have primarily done so when interpreting insurance policies in the wake of hurricanes or other catastrophic weather events.
Texas courts have followed both approaches in response to specific policy wording. In Finger Furn. Co. v. Commonwealth Ins. 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. Ins. 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 increase in business from “other income channels.”
Florida courts also have followed both approaches in connection with hurricane claims. Stamen v. Cigna Prop. & Cas. Ins. Co., 1994 U.S. Dist. LEXIS 21905, at *5 (S.D. Fla. June 13, 1994), which concerned a claim after Hurricane Andrew, 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 federal district 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 federal court came to the opposite conclusion in connection with another Hurricane Andrew claim. In American Automobile Ins. Co. v. Fisherman’s Paradise Boats Inc., 1994 WL 1720238, at *3 (S.D. Fla. Oct. 3, 1994), 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.
Courts in other jurisdictions have also taken different positions when faced with these competing approaches:
Every policyholder should read and understand their policy language before a catastrophe strikes. Policy provisions vary, and some insurers attempt to limit their exposure by including measurement provisions such as:
“Business Income” is to be determined by:
(1) The Net Income of the business before the direct physical loss or direct physical damage occurred;
(2) The 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. (emphasis added)
The economic conditions that exist after COVID-19 may result in some businesses thriving and others struggling. Whether those post-pandemic conditions will be considered in connection with valuing a business interruption claim depends on the relevant policy language and applicable law. Still, what is clear is that the economic conditions that exist after the pandemic can have a substantial impact on the value of a business interruption claim.
For more information, please reach out to your regular Pillsbury contact or the authors of this client alert.
Pillsbury’s experienced crisis management professionals are closely monitoring the global threat of COVID-19, drawing on the firm’s capabilities in supply chain management, insurance law, cybersecurity, employment law, corporate law and other areas to provide critical guidance to clients in an urgent and quickly evolving situation. For more thought leadership on this rapidly developing topic, please visit our COVID-19 (Coronavirus) Resource Center.