As storms Ciara, Dennis and now Ellen batter extended parts of the UK, with some areas suffering the worst floods in 200 years, insured losses have already been estimated at £200M and will continue to rise. For individuals whose homes are damaged the effects can be devastating, but effectively addressed by adequate property insurance. Businesses may face more complex insurance issues in order to recover losses arising not just from damage to property and machinery, but to the business itself, whose turnover and profits may be reduced or even eliminated in the immediate aftermath of a flood or other severe weather event. Whilst revenue may take an immediate hit, wages and other overheads must continue to be paid, and in the absence of timely and sufficient financial support, the business’s ability to continue trading may be threatened.
Business interruption cover is therefore an essential component of any business’s property insurance programme. But claims for loss of profit, which must be calculated on a hypothetical basis with many variables, are inevitably complex and drawn out, making Business Interruption claims fertile ground for disputes.
What issues do businesses and their brokers need to consider in order to make sure they are adequately covered and their claims are paid in full?
Wide Area Damage
The notorious issue of wide area damage, following the decision in Orient Express Hotels Ltd v Assicurazioni Generali SPA is a recurrent headache for any insured bringing a BI claim following a catastrophic weather event, and particularly affects those operating in the hospitality industry or other sectors relying on customer footfall. We have previously discussed the merits of the Orient Express case as part of our series “The Good the Bad & the Ugly: 100 cases every policyholder needs to know” but in summary, the claim was brought by a hotel in New Orleans, which suffered significant damage from Hurricane Katrina, leading to its closure for a period of two months. The surrounding area was also devastated by the storms, with the entire city shut down for several weeks. The court found that the hotel was prevented from recovering its business interruption losses on the basis that they were not caused not just by the damage to property, but by the damage to the wider area. Even if the hotel had not been damaged, it would have suffered the same loss of profits since New Orleans was effectively closed for several weeks due to widespread flooding.
In our view the approach taken in the Orient Express case is wrong in principle, and represents an unmerited windfall to insurers in catastrophic event circumstances: the more severe the event, the less insurers pay. However, until challenged in the higher courts, it remain a potential trap that must be addressed. Insureds and their brokers should therefore ensure that they have a clear understanding of how any business interruption coverage will respond in the event of a catastrophic weather event that will affect not just the insured property, but the area at large. It is important to ensure that the insuring and trends clauses are drafted as broadly as possible, so as to respond to losses caused by an insured peril, not just those arising directly from damage to insured property. Where possible, Denial of Access, Suppliers and Customers, and Utilities extensions (also known as contingent business interruption cover) should be incorporated – without sublimit – to ensure that loss of profits remains insured even where the business itself suffers no damage to property.
An apparently straightforward issue, but one that leads to significant reduction of BI recovery perhaps more than any other, is underinsurance. Reaching the correct value for the sum insured is not a straightforward matter, and is often misunderstood. For example, Business Interruption losses are often insured on a Gross Profit basis, but care needs to be taken to ensure that the Gross Profit declared to insurers is calculated according to the gross profit definition in the policy wording, which is likely to differ significantly from the method of calculation used by businesses in their internal or published accounts. In particular, wages are not normally included in an accountant’s gross profit figure, but should be included in the insurable Gross Grofit. However not all cover is written on a Gross Profit basis, and alternative specifications (methods of calculation) include Turnover, Gross Revenue, and Increased Costs of Working. Each of these specification categories appears in many varieties with subtle differences. A detailed understanding of the cover provided by the insuring clause and specification is therefore vital in order to calculate the correct sum insured, and the advice of insurance brokers in making sure that cover is tailor-made to the business is crucial.
Underinsurance in BI claims can arise not just from an inadequate sum insured, but from selecting an insufficient indemnity period. Businesses must ensure that they insure for an indemnity period that is long enough for the business to recover in catastrophic circumstances. This will depend on the nature of the business of the question, but will often extend beyond the standard 12-month indemnity period. Likewise, the insured should be aware that any specified waiting period i.e. the period immediately following the insured event, will act as a deductible and remain uninsured.
Delays in Payment
When a business suffers business interruption losses from a catastrophic weather event, time is of the essence in seeking insurers’ immediate engagement with the adjustment of the claim. Whilst complex business interruption claims may take many months or even years to crystallise, it is critical that interim payments are sought from insurers at the earliest stage. Without financial support at the time when they most need it, many businesses will struggle to recover. Additional losses suffered as a result of late payment may now form the basis of a damages claim under the Enterprise Act 2015. If the business is likely to suffer further loss if insurance proceeds are delayed (whether that be because the business is forced to borrow at high interest rates, or loss of growth or investment opportunity) brokers and insured should ensure that insurers are aware of this as soon as possible in the claims process. It may affect the behaviour of insurers who wish to avoid potential liability for damages in excess of policy exposure.
Whilst businesses might feel confident that they are fully covered for any BI losses suffered as a result of increasingly frequent flooding and other extreme weather events, there is a complex matrix of issues affecting the recoverability and valuation of losses under the policy, and careful attention needs to be paid to these potential pitfalls by businesses and their brokers both at the time of seeking cover and in the preparation of any claim.
Aaron Le Marquer is a partner at Fenchurch Law, a leading insurance law firm acting exclusively for policyholders against insurers. He practiced for eight years in Southeast Asia, where he acted on many contested BI claims arising out of the 2011 catastrophic Thai floods, with total value over $700m.