In the wake of Hurricanes Harvey and Irma, policyholders can expect insurers to put forward strong objections to some of the most consequential claims asserted by insureds.

Takeaways

• In construing policy language on BI claims after wide-impact events, courts typically try to avoid a “windfall” result for either side.
• Policy language matters and can drive varying results depending on how courts construe policy language.
• Policyholders ought to pay careful heed to controlling legal precedents regarding BI in wide-impact situations.

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 upon shipping and rail systems might find themselves unable to transport or receive goods, or may find it more expensive and less effective to do so through alternative means, such as trucking. Similarly, an influx of temporary workers could cause local economies to boom. Resulting population shifts 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 provisions vary, as do the types of coverage available, common business interruption provisions generally include something along the lines of:

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” and the “Economy Considered” approaches. 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 do so because they are more concerned that the policyholder will reap a “windfall” from the catastrophe. The Economy Considered approach, on the other hand, 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, which avoids giving an insurer a “windfall.”

As a demonstration of how outcomes can differ from applying one approach over the other, consider the following brief, hypothetical examples.

1. A limited service hotel located on the Gulf Coast had been operating at a 50 percent occupancy rate for the three years prior to Hurricanes Harvey and Irma striking the area and destroying the hotel. The hotel claims the post-hurricane economy should be considered to calculate its business interruption claim, and that the influx of temporary workers would have caused it to operate at a 100 percent occupancy rate. But the insurer argues 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 Hurricanes Harvey and Irma not occurred, that is, a 50 percent occupancy rate.
2. For the three years prior to Hurricanes Harvey and Irma, a full-service hotel attached to a convention center had an 85 percent occupancy rate. But unlike the hotel in the prior example, this hotel was inland, so the hurricane caused only minor damage to the hotel and the surrounding area. The convention center, however, suffered massive damage that required it to close for at least 12 months. As a result, after the hurricanes, the hotel’s occupancy sank to 15 percent. The hotel asserts that the post-hurricane economy should be ignored, and that its business interruption claim should be based on its pre-hurricane occupancy levels, while the insurer posits that the post-hurricane levels should control.

As these examples demonstrate, neither test consistently benefits a policyholder or an insurer in every situation. The outcome instead relies on the unique facts in each particular circumstance. Policyholders should therefore carefully consider the impact of both tests before submitting their claim (and when renewing coverage next time around).

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. 

Every policyholder should also 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).

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 they can better anticipate possible arguments against their claim. Additionally, because insurers are frequently willing to negotiate policy terms and conditions, policyholders should consider negotiating for better coverage when renewing coverage.