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Insurance Coverage in the Wake of a Natural Disaster: Current Issues and Hot Topics

From the earthquake in Mexico City, to California wildfires, to Hurricanes Harvey, Irma, and Maria – to name but a few – 2017 was a year marked with an alarming number of natural disasters. When these disasters hit locations dense with business and industry, as often was the case this past year, the ripples can be felt in the insurance space as insured companies make claims seeking to recoup their losses.

However, these claims are made under unusual circumstances, creating an uptick in issues of policy interpretation that, under normal circumstances, seem straightforward. This article raises three potential "land mine" issues that may arise in the wake of the recent natural disasters. Specifically, policyholders submitting business interruption claims as a result of catastrophic events should consider the scope and potential impact of "market loss" exclusions, service interruption coverage, and the meaning of "loss sustained" in connection with heightened market costs. These are discussed in turn below.

"Loss of market" exclusions

Market conditions invariably change in the wake of catastrophic events and business interruption policies insure against the risks of adverse market changes. Business interruption coverage not only insures against an actual interruption to the policyholder's business, but also provides coverage for a decrease in demand for the policyholder's goods or services as a result of a catastrophic event. Because the purpose of business interruption coverage is to put the policyholder's business in the place it would have been absent the natural disaster, such an interpretation is consistent with the reasonable expectations of a policyholder. In other words, business interruption insurance provides coverage for the "actual loss sustained" by the insured's business as a result of a catastrophic loss and thus insures against a post-loss decrease in demand or customers.

For example, although the exact figure remains unknown, thousands of Puerto Rican residents have fled the island in the aftermath of Hurricane Maria. This mass exodus has had an adverse impact on businesses that remain on the island, decreasing the demand for goods or services as well as lowering the available customer base. Policyholders in Puerto Rico and surrounding islands can reasonably expect that their business interruption policies will provide coverage for losses arising from decreased demand or customers in the wake of Hurricane Maria.

As a result of the historic hurricane and fire season, however, insurers may adopt an aggressive interpretation of "loss of market" exclusions in an effort to limit coverage. As the name suggests, these exclusions typically preclude coverage for "loss of market" and are plainly intended to exclude coverage for losses arising from increased competition or other adverse market effects unrelated to the catastrophic event. As one court explained, "[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." i Nevertheless, insurers have asserted that the "loss of market" exclusion bars coverage for the losses to the insured's normal business by way of a decreased demand or a decreased customer base in the wake of the recent natural disasters.

To illustrate, an insurer faced with a business interruption claim may argue that the policyholder's financial loss is a result of post-catastrophe market conditions, thereby triggering the loss of market exclusion. Such an interpretation is impermissibly broad, as it significantly undercuts the scope of coverage and undermines the reasonable expectations of the insured.ii

Service interruption losses

Service interruption coverage is critical to policyholders in Puerto Rico and other Caribbean islands where physical property damage may have been limited, but public services were interrupted for weeks or months as a result of Hurricane Maria. In general, business interruption policies provide coverage for losses resulting from an interruption to public services, including water, electricity, heating and air conditioning, in the event that the service interruption lasted at least 24 hours. The interruption must be caused by damage from a covered cause (i.e., a natural disaster) to third-party property located away from the policyholder's premises. Notably, service interruption coverage typically does not require that the policyholder itself suffer direct physical property damage. As a result, this coverage is critical for policyholders who may not have suffered physical damage to their businesses, but had to cease or restrict operations as a result of a power outage or other interruption of critical services.

In light of the on-going service outages in Puerto Rico and nearby islands, insurers may assert that the policyholder's efforts to mitigate the loss of power effectively ended the service interruption, thereby limiting available coverage. However, a policyholder relying on generators to provide electricity to key operations after Hurricane Maria did not end the power outage and has not resumed normal business operations. Until the service is restored, the policyholder will continue to incur losses as a result of the outage. Nevertheless, insurers may claim that the policyholder's use of a generator "restored" service and ceased service interruption coverage. Insureds should not be punished for their efforts to mitigate their losses, however, and they should challenge any effort by the insurer to restrict service interruption coverage prior to service being resumed.

The Meaning of "Loss Sustained" in Business Interruption Policies

Such large-scale disasters also create unique issues regarding the calculation of the "loss" and an insured's recovery of the same. Insurance policies which purportedly cover business interruption losses resulting from a hurricane or other disaster often include the phrase "due consideration shall be given to the experience of the business before the period of recovery and the probable experience thereafter had no loss occurred," or some iteration thereof, when discussing loss valuation. The meaning of the phrase "had no loss occurred" has been the topic of dispute in the wake of past disasters, and courts have not yet reached a consensus.

There are typically two competing interpretations at play. The first interpretation is that the term "loss" means the financial impact that the disaster imparted on the policyholder in light of the disaster itself and its unique impact on the policyholder and other businesses. The second interpretation corrects for the disaster's impact by effectively reading the phrase "had no loss occurred" to mean "had no disaster occurred."

These interpretations and their implications are illustrated by the divided 4th Circuit Court of Appeals in Prudential LMI Commercial v. Colleton Enterprises, Inc.iii In Prudential, a motel owner's property was damaged by Hurricane Hugo after posting losses in excess of $350,000 for the preceding 32 months.iv Nonetheless, the owner sought recovery of over $190,000 in net lost earnings from its insurer, arguing that the motel would have realized this amount if it had been able to operate and accommodate the increased demand for motel rooms that Hurricane Hugo had caused, effectively seeking application of the first interpretation above.v The majority disagreed, employing the second interpretation and holding that the term "loss" should be construed as likely earnings had no hurricane The dissent agreed with the owner, however, finding that the term "had no loss occurred" is more logically construed to implicate the loss of the policyholder only, and not all losses of everyone affected by the hurricane.vii

Courts employing reasoning similar to the Prudential majority seem to be most concerned with the opportunity afforded to policyholders to take advantage of an effective windfall in the wake of devastation. For instance, in Catlin Syndicate Ltd. v. Imperial Palace of Mississippi, Inc.viii, Hurricane Katrina had damaged a casino which, upon a prompt reopening, significantly increased its revenue because several competitors remained closed for further repairs.ix The Catlin court rejected the policyholder's calculation of an $80 million loss, finding that "only historical sales figures should be considered when determining loss, and sales figures after reopening should not be taken into account."x

Conversely, courts that apply the first interpretation have taken a more literal approach to the term "loss" and seem to recognize the realities of the policyholder's business in the wake of such a catastrophic event, even if those realities call for increased coverage. For instance, in Levitz Furniture Corp. v. Houston Cas. Co.xi, flood water had damaged the insured's furniture store and inventory, forcing it to temporarily close.xii However, upon its reopening, the insured experienced stronger than usual sales as others impacted by the flood sought to replace their own damaged furniture.xii The court ultimately found that the insured's claim for earnings "may include sales attributable to the increased consumer demand caused by the . . . flood," effectively applying the first interpretation and the dissent approach in Prudential.xiv And while the underlying motivation behind courts that utilize the second interpretation may be to avoid windfalls to the insured, courts applying the first interpretation have also done so at the insistence of the insurer who would like to take advantage of decreased earnings following a natural disaster.x

  1. Duane Reade, Inc. v. St. Paul Fire & Marine Ins. Co., 279 F. Supp. 2d 235 (S.D.N.Y. 2003); aff'd as modified, 411 F.3d 384, 398-399 (2d Cir. 2005).
  2. Doyd Motors, Inc. v. Employers Ins. of Wausau, 880 F.2d 270, 274 (10th Cir. 1989).
  3. 976 F.2d 727 (4th Cir. 1992).
  4. Id. at *1.
  5. Id.
  6. Id. at *3.
  7. Id. at *4-5 (Hall, J., dissenting).
  8. 600 F.3d 511 (5th Cir. 2010).
  9. Id. at 512.
  10. Id. at 516; see also Consol. Companies, Inc. v. Lexington Ins. Co., 616 F.3d 422 (5th Cir. 2010) (applying the first interpretation to limit insured recovery).
  11. No. CIV. A. 96-1790, 1997 WL 218256 (E.D. La. Apr. 28, 1997).
  12. Id. at *1.
  13. Id.
  14. Id. at *4.
  15. See, e.g., Penford Corp. v. National Union Fire Ins. Co. of Pittsburgh, Pa., No. 09-CV-13-LRR, 2010 WL 2509985 (N.D. Iowa June 17, 2010) (applying the first interpretation to limit recovery of the insured in the wake of a post-flood recession).