The Calm Before the Storm Is the Time to Consider Insurance Coverage


The text of this article first appeared in the January issue of The Insurance Coverage Law Bulletin, Vol. 12, No. 12.

There were no major hurricanes in 2013. Although the season was projected to be above average in terms of activity, this was the first Atlantic hurri­cane season without a major storm event through the month of November in over a decade. See Justin Bachman, In 2013 Hurricane Season, a Remarkable Calm Before the Next Storm, Business Week (Sept. 4, 2013). Even though many of the fiercest storms — including Superstorm Sandy — occurred later in the hur­ricane season and off-season storms can persist until December, at press time, the U.S. made it through an uneventful 2013 season with no Sandy, Irene, Katrina, or similar major storm event.

Regrettably, though, it is only a matter of time before the next major storm strikes. And when they strike, these events, like other natural disasters, frequently cause widespread destruction of property, and major business interruption. Moreover, in an increasingly global economy in which virtually all organizations are part of, and dependent upon, product and service supply chains, disruptions caused by major storm events worldwide can and do cause a cascading and adverse impact on organizations throughout the supply chain.

Unfortunately, in the wake of these events, a company may be unpleasantly surprised if it does not secure prompt and complete insurance recovery for its property damage, business interruption and other losses.  A thorough understanding of a company’s insurance program, as well as an understanding of potential insurance-related issues, will help a company to efficiently maximize its insurance recovery.

The calm before the next storm is an opportune time for a company to consider the adequacy of its insurance program. Below is an overview of two common in­surance-related considerations that may assist companies to maximize insurance recoveries in the wake of the next major storm event or other natural disaster. We will discuss three more in next month’s Legal Insight.

1. Identify Potential Coverages and Seek to Amend Them As Necessary
Before a storm strikes, businesses should identify, obtain and thoroughly review all insurance instruments that potentially may provide a source of recovery. A common and obvious source of coverage for many businesses will be their first-party property insurance policies. These policies generally cover “physical loss of or damage to” insured property that results from a covered cause of loss. Insured property is often broadly defined. By way of example, in addition to the insured’s building or structure, policies typically expressly cover “business personal property” such as furniture and fixtures, machinery and equipment, stock and leased property. Policies also typically provide coverage for unscheduled “newly acquired or constructed” property and the property of third parties that is in the insured’s “care, custody or control.”

Property policies may be either “all risk” or “named peril” policies. “All risk” policies broadly cover all causes of loss that are not expressly excluded. “Named peril” policies, by comparison, cover against listed specific “perils” or causes of loss. See 10A Couch on Insurance 3D § 148:4 (2012). Irrespective of whether a business has “all risk” or “named peril” coverage, the peril of “windstorm” — which encompasses storms such as Sandy — is typically a covered peril. By way of example, the current standard-form Insurance Services Organization (ISO) “Standard Property Policy,” which is a “named peril” type of policy, covers “direct physical loss of or damage to Covered Property … caused by or resulting from any Covered Cause of Loss.” CP 00 99 10 12 (2012), § A. “Covered Causes of Loss” expressly includes “Windstorm or Hail.” Id., § A.3.d.

In addition to insuring covered property, many property policies provide so-called “time element” coverages, such as “business interruption” and “extra expense” coverages, which generally cover loss resulting from the company’s inability to conduct normal business operations because of damage to covered property. “Business Interruption” coverage reimburses the insured for its loss of earnings or revenue (and continuing operating expenses) resulting from covered property damage. By way of example, the current standard-form ISO “Business Income (and Extra Expense) Coverage Form,” which became effective in December 2012, covers the loss of net profit and operating expenses that the insured “sustain[s] due to the necessary ‘suspension’ of [the insured’s] ‘operations’ during the ‘period of restoration.’” CP 00 30 10 12 (2012), § A.1. “Suspension” includes “[t]he slowdown or cessation of [the insured’s] business activities.” Id., § F.6. The standard form further states that “the ‘suspension’ must be caused by direct physical loss of or damage to property at [covered] premises” and that “[t]he loss or damage must be caused by or result from a Covered Cause of Loss.” Id., § A.1.

A company may have business interruption coverage if a major storm damages its facility and the company suffers lost revenue while the facility is repaired or rebuilt. The standard form states that the covered “period of restoration” includes the period of time that begins “72 hours after the time of direct physical loss or damage for Business Income Coverage” and ends “the earlier of: the date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality” or “[t]he date when business is resumed at a new permanent location.” § F.3. Some policies extend the period to include additional time required to restore operations to the level that would have existed in the absence of loss or damage.

“Extra Expense” coverage generally covers the insured for certain extra expenses incurred to minimize or avoid business interruption loss and resume normal operations. For example, the current ISO standard form covers, among other things, “Extra Expense” to “[a]void or minimize the ‘suspension’ of business and to continue operations at the described premises or at replacement premises or temporary locations. … ” Id., § A.2.b.(1). The form defines “Extra Expense” as “necessary expenses” that the insured “would not have incurred if there had been no direct physical loss or damage to property caused by or resulting from a Covered Cause of Loss.” Id., § A.2.b.

Companies may also have so-called “contingent business interruption” (CBI) coverage. In contrast to “business interruption” insurance, which generally responds when there is damage to an insured’s own property or operations, CBI generally responds to cover an insured for losses, including lost earnings or revenue, when there is damage to the property or operations of an insured’s supplier, customer or other business partner or entity that the insured relies upon to conduct its own business operations.

For example, an ISO standard industry “Business Income Form Dependent Properties — Broad Form” endorsement states that the insurer will pay the insured’s loss of business income due to a “necessary ‘suspension’” of operations that is “caused by direct physical loss of or damage to ‘dependent property.’” See CP 15 08 04 02 (2001), § A. “Dependent property” is defined to include “property operated by others” that the insured depends on, among other things, to “[d]eliver materials or services to [the insured],” “[a]ccept [the insured’s] products or services,” or “[m]anufacture products for delivery to [the insured’s] customers.” Id., § E.1.(a., b., and c.). CBI coverage can be extremely valuable, since supply chain disruption can cause significant losses, particularly in view of an increasingly dependent global economy. As one recent commentator has noted:

Recent catastrophes such as the Japanese tsunami, Thailand floods, Superstorm Sandy and Icelandic volcanic ash clouds have brought to light the risks inherent with the modern global supply chain. Modern supply chains have proven cost effective and efficient alternatives to traditional business operating models, but they also increase business exposure to systemic risk. A disruption to a key customer, supplier, or even a supplier of a supplier, can cause a ripple effect with profound consequences for manufacturers, customers, other suppliers in the chain and even entire industries.

Advisen White Paper, The Vulnerability of Global Supply Chains: The Importance of Resiliency in the Face of Systemic Risk, at 2 (Sept. 2013).

In addition to CBI, an insured may have service interruption coverage. By way of illustration, the current standard ISO “Utility Services — Time Element” endorsement provides coverage for “loss of Business Income or Extra Expense … caused by the interruption of service to the described premises.” BP 04 57 07 02, § A. The interruption of service includes “Water Supply Services,” “Communication Supply Services,” and “Power Supply Services,” each as defined. Id., § B.

Property policies often include additional coverages, including “civil authority” coverage, which generally covers loss resulting from an “action” or “order” of a civil authority that prevents or impairs access to the insured’s premises (e.g., evacuation and mass transit closure orders), “ingress/egress” coverage, which generally covers loss resulting from the prevention of access to the insured’s premises (e.g., resulting from closures of bridges, tunnels and roads), and expenses that the insured incurs to remove debris on the insured’s property following an insured event. Importantly, many property insurance policies require insureds to mitigate their loss, and also will pay for mitigation expenses. For example, the ISO “Standard Property Policy” states that the insured must “[t]ake all reasonable steps to protect the Covered Property from further damage” and “keep a record of … expenses necessary to protect the Covered Property, for consideration in the settlement of the claim.” CP 00 99 10 12 (2012), § G.3.a.(4).

It is important to review all potentially applicable policies carefully to identify potential avenues of coverage and potential gaps in coverage. In addition, when attempting to identify potentially relevant types of coverage, it is important to remember that the insurance instruments containing potential coverage may take a variety of different forms, and come under a variety of different (sometimes non-obvious) names, and are not limited to property coverages, but may include, for example, pollution and marine policies and liability policies. See generally Key Insurance Coverage Considerations in the Wake of Superstorm Sandy, Vol. 11, No. 12, The Insurance Coverage Law Bulletin (January 2013, In addition, an insured also may have purchased flood insurance coverage through the National Flood Insurance Program, which is administered by the Federal Emergency Relief Agency.

2. Recognize Potential Exclusions — and Their Limitations
As with any type of insurance, commercial property policies contain a wide array of exclusions that may limit coverage and insurers often respond to claims by asserting that various exclusions in the policy may apply to bar or curtail coverage. Whether any exclusion applies will depend upon the specific exclusionary language in the policy, the particular facts surrounding the loss or damage at issue, and applicable law. Some exclusions to look out for in the context of a major storm event include the following:

In the context of a major storm event, a company should keep in mind that property policies typically cover a variety of naturally occurring weather conditions, but may exclude flood and water damage. By way of example, the current ISO standard form policy contains a “water” exclusion that excludes loss or damage caused by “[f]lood, surface water, waves (including tidal wave and tsunami), tides, tidal water, overflow of any body of water, or spray from any of these, all whether or not driven by wind (including storm surge).” CP 00 99 10 12 (2012), § B.1.g.(1). Likewise, an “all risk” specimen form may state, for example, that the policy “does not insure against loss, damage or expense caused by or resulting from … Flood, as defined herein, unless endorsed hereon.” See, e.g., AIG Specimen Form 59983 (3/94), at 4. “Flood” is defined as “waves, tide or tidal waves and the rising (including the overflowing or breaking of boundaries) of lakes, ponds, reservoirs, rivers, harbors, streams or similar bodies of water, the unusual and rapid accumulation or runoff of surface waters from any source, all whether driven by wind or not.…” Id. at 6.

As the above language illustrates, even if a policy contains an exclusion, there may be coverage under an endorsement to the policy — or under a different insurance instrument. By way of illustration, the ISO “Flood Coverage Endorsement” expressly adds “flood” as an additional Covered Cause of Loss:

The following is added to the Coverage Causes Of Loss:

Flood, meaning a general and temporary condition of partial or complete inundation of normally dry land areas due to:

  1. The overflow of inland or tidal waters;
  2. The unusual or rapid accumulation or runoff of surface waters from any source; or
  3. Mudslides or mudflows which are caused by flooding as defined in C.2. above. For the purpose of this Covered Cause Of Loss, a mudslide or mudflow involves a river of liquid and flowing mud on the surface of normally dry land areas as when earth is carried by a current of water and deposited along the path of the current.

All flooding in a continuous or protracted event will constitute a single flood.

CP 10 65 10 00 (1999).

In addition, companies should not assume that a flood exclusion applies whenever a claim involves water. While damages occurring from a tidal surge and overflowing waterways may be excluded under certain circumstances, rain that washes away land and otherwise compromises infrastructure may not be excluded.

Service Interruption
Property insurance policies may exclude coverage for damage caused by interruption of services, such as electricity or natural gas. For example, the current standard ISO form excludes loss or damage caused by:

The failure of power, communication, water or other utility service supplied to the described premises, however caused, if the failure:

  1. Originates away from the described premises; or
  2. Originates at the described premises, but only if such failure involves equipment used to supply the utility service to the described premises from a source away from the described premises;

Failure of any utility service includes lack of sufficient capacity and reduction in supply.

Loss or damage caused by a surge of power is also excluded, if the surge would not have occurred but for an event causing a failure of power.

CP 00 99 10 12 (2012), § B.1.e.

However, the standard form further provides that “if the failure or surge of power, or the failure of communication, water or other utility service, results in a Covered Cause of Loss, [the insurer] will pay for the loss or damage caused by that Covered Cause of Loss.” Id.

Law or Ordinance
Insurers have argued in some cases, albeit with limited success, that even if an initial event (a hurricane or storm, for example) is covered, losses from enforcement of laws or ordinances are not covered under an “ordinance or law” exclusion. For example, the current standard ISO form excludes loss or damage caused by:

The enforcement of or compliance with any ordinance or law:

  1. Regulating the construction, use or repair of any property; or
  2. Requiring the tearing down of any property, including the cost of removing its debris.

This exclusion, Ordinance Or Law, applies whether the loss results from:

  1. An ordinance or law that is enforced even if the property has not been damaged; or
  2. The increased costs incurred to comply with an ordinance or law in the course of construction, repair, renovation, remodeling or demolition of property, or removal of its debris, following a physical loss to that property.

Id., § B.1.a.

Property policies may contain pollution exclusions, which insurers may argue bar losses resulting from, for example, water contamination arising from a hurricane or storm. Standard-form property policies (both named-risk and all-risk) often purport to exclude losses caused by “pollutants.” By way of example, one ISO standard form states that the insurer will “not pay for loss or damage caused by or resulting from” the “discharge, dispersal, seepage, migration, release or escape of ‘pollutants.’” CP 10 30 10 91 (1991), § B.2.l. “Pollutant” may be defined, for example, as “any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste.” BP 00 01 06 89 (1989), § H.3. Not all policies exclude pollution-related loss, and pollution-related coverage may be expressly afforded in the policy, by endorsement, by separate policy, or through a global “master” policy or umbrella coverage.

Loss of Market
Some property policies contain an exclusion for “loss of market.” By way of example, a typical loss of market exclusion may state that

“[t]his Policy does not insure against loss caused by or resulting from… [d]elay, loss of market or use, indirect or consequential loss or loss directly attributable to legal proceedings, except general average and salvage charges. …” See also Fireman’s Fund Ins. Co. v. Community Coffee Co., L.L.C., 2007 WL 1076790, at *1 (E.D.La. Apr. 9, 2007) (considering a policy exclusion for “loss of market or for loss, damage, deterioration, or expenses arising from delay, whether caused by a peril insured against or otherwise, or from inherent vice or nature of the good insured”). In a catastrophic loss situation that leaves widespread devastation, as was the case with Superstorm Sandy, insurers sometimes rely on this exclusion in attempt to reduce the actual business interruption loss the insured suffers by a decline in the “market” after the loss, e.g., a decline in the customer base because of damage to local homes and businesses.

The exclusion should apply, however, only when an insured makes a claim for loss resulting from a change in market conditions that are not the result of a covered peril. This was the conclusion of the Southern District of New York in DuaneReade, Inc. v. St. Paul Fire & Marine Ins. Co., 279 F.Supp.2d 235 (S.D.N.Y. 2003), which rejected an insurer’s reliance on the exclusion in the wake of the 2001 World Trade Center terrorist attacks. The court concluded that “[t]he loss of market exclusion relates to losses resulting from economic changes occasioned by, e.g., competition, shifts in demand, or the like; it does not bar recovery for loss of ordinary business caused by a physical destruction or other covered peril.” Id. at 240.

This discussion concludes in Part Two in next month’s Legal Insight.