Property insurance policies with business interruption coverage and case law require close inspection to determine the proper method for measuring business interruption claims following wide-area impact catastrophes.
Quantifying a policyholder’s business interruption loss is a contentious issue in the wake of large scale disasters.
The methodology for calculating business interruption losses varies by jurisdiction and can depend on specific policy language.

The recent winter storms that impacted the vast majority of Texas crippled businesses, snarled supply chains and damaged utilities. Many businesses in the region and across the United States also suffered longer-lasting economic damage as the physical damage is repaired and operations restored. Those businesses will rightly want and need to recover payouts under their property and business interruption insurance policies to help offset their losses.

A common dispute that often arises following such disasters is whether the measurement of business interruption should account for the post-loss economic conditions of the impacted area. 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 disaster had not occurred.

But the same may not be true following a wide-area impact catastrophe. For example, resulting population shifts—such as an influx of temporary workers or an exodus of residents—can cause long-lasting changes in supply and demand for commodities and services. Construction supplies might be in higher demand than before the catastrophe as rebuilding efforts begin. A business that is able to reopen quickly might boom if none of its competitors are similarly able to reopen. Consequently, measuring a policyholder’s business interruption loss is likely to be one of the more contentious issues to arise from wide-area impact catastrophic events like the winter storms in Texas.

Two 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 Economy Ignored approach looks backward and measures the policyholder’s loss only against pre-catastrophe business levels; it does not consider the impact of actual post-catastrophe conditions on the economy, market, or demand. Consider, for example, a full-service hotel attached to a convention center that had an 85 percent occupancy rate before the winter storm. The convention center suffered massive damage from frozen pipes that required it to close for at least one year. As a result, after the storm, the hotel’s occupancy sank to 15 percent. The hotel asserts that its business interruption claim should be based on its pre-storm occupancy levels and that the post-storm economy should be ignored, while the insurer posits the opposite; i.e., post-storm levels should control.

In contrast, the Economy Considered approach, 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 instead of having had to shut down because of the disaster. Consider the same convention center and hotel. If the carrier construes its policy as allowing the Economy Considered measurement, the probable loss of business due to the convention center’s closure could be argued to limit the hotel’s recovery to what it would earn at a 15 percent occupancy. But the reverse could also be true. If the hotel had been operating at an 85 percent occupancy rate for the three years prior to the storm, but the influx of temporary workers would have caused it to operate at a 100 percent occupancy rate if it had been able to open, the hotel could claim full occupancy rates under the Economy Considered approach. Of course, the insurer would argue 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 the storm not occurred, that is, an 85 percent occupancy rate.

Neither test consistently benefits a policyholder or an insurer in all situations. Instead, the outcome relies on the unique facts of each circumstance and which method is used might be based on the particular policy language as well as the law of the particular jurisdiction.

Although policy provisions vary, common business interruption provisions generally include language like:

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 loss occurred.

Following Hurricane Katrina, some insurers inserted language in their policies that they argue reduces a policyholder’s ability to recover in certain situations. These insurers attempt to limit their exposure by including measurement provisions like:

“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 last provision is obviously designed to be one-sided in the insurer’s favor. Policyholders and brokers alike should watch out for provisions like this and seek to negotiate, at a minimum, a more balanced approach moving forward.

Knowing the case law that applies in your jurisdiction is also important. Note that even if your operations in Texas were impacted, Texas law may not necessarily apply to your claim, particularly if your headquarters or primary operations are located elsewhere. Because the relevant law can be critical to evaluation of this issue, you should consult with experienced coverage counsel if there is any question of what jurisdiction’s law may apply to your policy.

Limited recent case law in this area exists, but 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 policyholder’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.” The court in Rimkus Consulting Group Inc. v. Hartford Casualty 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 increase in business from “other income channels.” A federal court in Texas recently re-affirmed this dichotomy of outcomes depending on policy language in connection with a Hurricane Harvey claim. Alley Theatre v. Hanover Insurance Co., 2020 WL 1650659 (S.D. Tex. Mar. 26, 2020).

In another Fifth Circuit case, Catlin Syndicate Ltd. v. Imperial Palace of Mississippi Inc., 600 F.3d 511 (5th Cir. 2010), this time applying Mississippi law, the court rejected a casino’s claim seeking recovery of 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.”

Courts across the country have found similarly and differently.

  • 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 only allowed “net income projections that are not itself created by the peril” and the policyholder was not entitled to “the windfall profits.”
  • On the other hand, 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.”

Policyholders should therefore carefully review their existing policy language and the impact of both tests before submitting their claim (and when renewing coverage next time around). Moreover, to maximize coverage, policyholders should adopt appropriate pre- and post-loss planning and claims-handling approaches. These might include, for example, determining which test courts apply in the jurisdictions in which they operate and researching what position their insurers have previously taken so that they can better anticipate possible arguments limiting their claim payout. Additionally, policyholders should consider negotiating for better and more appropriate coverage in future policies.

Post-winter storm economic conditions may 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. But one thing is certain: post-storm economic conditions can have a substantial impact on the value of a business interruption claim.

These and any accompanying materials are not legal advice, are not a complete summary of the subject matter, and are subject to the terms of use found at: https://www.pillsburylaw.com/en/terms-of-use.html. We recommend that you obtain separate legal advice.