Commentary: The Unseen Endorsement in Business Interruption

Some insurers have an underwriting trick they use to lessen their payout on business interruption insurance claims, one they don't always disclose in their policy wording.

By FINLEY HARCKHAM, a senior litigation shareholder in the New York office of Anderson Kill & Olick LP, a firm specializing insurance coverage law for policyholders

Imagine that your company had a highly successful store at the World Trade Center that was destroyed on Sept. 11, 2001, and that you breathed a big sigh of relief because everyone got out of the store in time and you had high-dollar limits of business interruption insurance. Now imagine that your insurer calculated your BI loss based upon the almost nonexistent amount of profits the store could have earned if it had continued to operate near ground zero in the aftermath of the terrorist attack, while the wreckage was still smoldering and recovery personnel, and later construction workers, controlled the site. What is more, imagine that the insurer reduced your claim further based upon the economic recession that resulted from the terrorist attacks.

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In other words, imagine that your insurer took the position that a covered BI loss must take into account every conceivable negative impact that a catastrophe would have had on your business had your premises survived, but everything around it was devastated.

This is not a hypothetical scenario: It actually happened to some policyholders, who had to endure the time and expense of lengthy coverage litigation before the court ruled, in accordance with the majority of decisions nationwide, that their business interruption losses must be calculated based upon the assumption that the policyholder had continued to do business in a world in which Sept. 11 had never happened.

This case* highlights an ongoing effort by some insurers, and some policyholders, to seek to benefit from the wider effects of a catastrophe when calculating a BI loss. In some of the early reported cases, policyholders that owned hotels in areas that were ravaged by hurricanes and other storms sought to be compensated for the profits they would have earned as a result of the increased occupancy they would have enjoyed had they been spared by the catastrophe but were left surrounded by destroyed homes, creating a strong demand for shelter among displaced persons and reconstruction workers.

Although nothing in insurance policies at the time precluded such an interpretation, the courts were mostly inclined not to give the policyholder what was perceived to be a windfall. The courts did, however, side with a few policyholders on this issue, prompting the ISO and others to change their policy forms to state that coverage would not be provided for the beneficial effects that a catastrophe would have had on the business.

So many policies now protect insurers from their downside risk on this issue but remain silent on whether the policyholder can lose some or all of its coverage.

MORE ONE-SIDED TREATMENT?

The one-sided treatment of the wider effects of a catastrophe in many insurance policies is a clear indication that insurers will continue to try to use this issue to render the business interruption coverage illusory. If they did not want to preserve that argument, they would have made clear in their policies that BI losses are not to be calculated based upon the detrimental effects of a catastrophe upon a policyholder's business.

ACTIONABLE ADVICE

What can policyholders do to avoid the possibility that an uncommunicated, purported intention of an insurer to consider the wider effects of a catastrophe could render its BI coverage illusory exposed it to massive uninsured losses?

They should instruct their brokers to try to place coverage with an insurer that will commit in writing--preferably in an endorsement to the policy itself--that BI coverage will be calculated based upon the premises that a widespread catastrophe or even localized damage to the area surrounding insured premises did not occur, and that business continued as usual under normal conditions.

Policyholders should also be careful not to make what is just a potential problem worse by asking for such clarification and then binding coverage with an insurer that declines to provide it.

This may seem to be a rather obscure issue to warrant a lot of underwriting attention, but the cost of having to litigate if confronted with this issue, and the attendant delay in receiving payment on a major BI claim, make ironing it out in advance worth the effort.

* Editor's note: The author represented the policyholder plaintiff in this case, Retail Brand Alliance, Inc. v. Factory Mutual Insurance Company, Case No. 05-CV-1031 (RJH), United States District Court, Southern District of New York.

July 1, 2011

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