One word that aptly describes the devastation that is 2020 is “relentless.” The COVID-19 pandemic has caused both personal and economic suffering throughout the world for over six months. Against the backdrop of the already devastating effects of COVID-19, several regions in the United States have recently experienced powerful storms and historically large wildfires. The wildfires in the western United States and Canada have been especially catastrophic this year—burning millions of acres, forcing evacuations, damaging air quality, and creating blankets of smoke extending over much of the country. The fires have destroyed homes and businesses and will lead to hundreds or thousands of insurance claims under homeowners, commercial property, and business interruption policies.
What happens under First Party Property/Business Interruption insurance when more than one arguably covered cause of loss impacts a business at the same time?
In general terms, First Party Property/Business Interruption insurance will pay for the repair or replacement of buildings and other property damaged by a covered peril, and will also pay for business income lost during the time it takes to repair or replace that damaged property. As an example, if a fire destroys a restaurant, insurance will pay to rebuild the restaurant to its original operating condition and will pay for income not earned during the time of rebuilding. Many business interruption policies also include a feature called an Extended Period of Indemnity. This coverage will be triggered when the repair/replacement is completed and operations have resumed. The policy will then pay diminished revenue during the “ramp up” period until sales return to a “normal” state. The COVID-19 pandemic complicates these traditional scenarios in a number of ways.
What is “Normal?”
Several factors go into determining the amount of covered business interruption loss. Primary among these is a measure of the earnings or profits that would have been realized but for the business interruption. This calculation typically involves analyzing: (1) the experience of the business immediately prior to the event that causes the loss, (2) the experience of the business at the same time in prior years, and (3) the policyholder’s reasonably expected performance over the period of time in question.
But what happens when your current business experience is already drastically different than prior years or your projections? How do abnormal current economic conditions factor into valuing what would have been your normal revenues? Economic trends and conditions are key considerations when valuing a business interruption claim. Insurers may argue that recovering based on optimistic projections that would never be realized because of an economic downturn could result in an improper windfall for a policyholder. On the other hand, a policyholder rightfully would want to take advantage of unanticipated growth experienced before a loss notwithstanding modest results in prior years and conservative projections.
Several months of pandemic-reduced revenue that precede wildfire damage will undoubtedly be an issue in valuing a business interruption claim, but they should not be the whole story. Policyholders can maximize recovery by using experienced forensic accounting firms and business valuation experts to create a picture of business income that is not solely based on their experience during the COVID-19 lockdown. Indeed, policyholders can be sure the insurers will have highly qualified accountants on their side who will test all assumptions and numbers.
How Long Does a COVID-19 Ramp-Up Period Last?
Once a business damaged by a wildfire is repaired and back to normal operations, a policy’s Extended Period of Indemnity can continue insurance payments for the business’s reduced revenue until it gets back to pre-fire levels. Just as in calculating business income loss during the restoration period after a fire, COVID-19’s impact on the economy in general will shape the determination of what a “return to normal” looks like and at what point the Extended Period will end. The widespread reopening of sectors of the economy will need to be considered, as well. “Ramp-up” period revenues could quickly reach depressed pre-fire levels, and the insurer will want to cease claim payments. But increased economic activity may support prior-year revenues and projections to serve as the end point of the Extended Period coverage. These more-optimistic figures can be a reflection of what the policyholder would have earned had there been no fire loss. Again, choosing an effective and experienced accounting firm will be key in defining how long a policyholder can recover under the Extended Period.
“Loss of Market” Exclusion
Another potential pitfall to be wary of in making an insurance claim after loss from wildfire is the “Loss of Market” exclusion. These are commonly included in commercial property policies. A common formulation of this exclusion reads: “This policy does not insure against loss or damage caused directly or indirectly by loss of market.” The Loss of Market exclusion serves to prevent a policyholder from recovering for non-insurable business risks and losses that existed prior to the loss that caused an interruption. “Market” is not defined in insurance policies, and insurers could try to use that ambiguity to apply the exclusion more broadly than it should be. For instance, if a bar that had been closed for six months because of government shut-down orders is destroyed by a wildfire, an insurer might argue that there should be no recovery for business interruption because the business had lost its market prior to the fire event. This position should not be accepted by a policyholder because the risk of a government pandemic shutdown is not a normal business risk. The interrelationship between economic conditions caused by COVID-19 and a natural disaster loss raises another interesting and confusing question: What if depressed economic conditions that exist prior to a covered loss are themselves created by a potentially covered peril under the policy?
Cumulative Business Interruption Claims
Thousands of businesses have filed claims and lawsuits against their business interruption insurers seeking to recover losses caused by the COVID-19 pandemic. In courts across the country, insurers have uniformly declared that their policies do not cover business interruption from COVID-19 because COVID-19 and the SARS-CoV-2 virus do not cause “physical loss or damage.” The question of whether pandemic business interruption is covered, thus, has not been finally determined and will depend on the language of particular policies, the effectiveness of policyholder (and insurer) in framing, pursuing and making coverage arguments, and decisions by trial and appellate courts across many states.
If a business has made a claim for lost revenue caused by COVID-19, the valuation of that business interruption claim should consider the experience of the policyholder just prior to the pandemic to capture revenue that would have been earned if the pandemic had not happened. Why, then, should a subsequent claim for business interruption caused by wildfire be restricted to depressed economic conditions caused by the pandemic? It is analogous to a business experiencing two natural disasters in the same policy year. The first will cause covered business interruption loss. But should the insurer get a discount on business interruption loss caused by the second event because the first one resulted in reduced economic activity? Courts have taken different approaches on whether to consider post-event economic conditions when valuing business interruption loss (as discussed in Pillsbury’s recent client alert), but the question of how to value business interruption caused by successive events appears to be a novel one. Policyholders with current COVID-19 claims that subsequently experience loss by wildfire (or otherwise) would be well advised to consult with their coverage attorneys and forensic accountants to best explain and position their loss to maximize coverage in such an unfortunate scenario.
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