MANAGING COMPLEX PROPERTY AND BUSINESS INTERRUPTION CLAIMS IN THE AFTERMATH OF SANDY

MANAGING COMPLEX PROPERTY AND BUSINESS INTERRUPTION CLAIMS IN THE AFTERMATH OF SANDY, PART I

According to the Small Business Administration, 43 percent of businesses that suffer a disaster never reopen because they did not carry sufficient business interruption insurance. This was devastating news for the areas where Sandy hit two years ago. Superstorm Sandy caused much more than property damage. A significant portion of the more than $55 billion in total economic losses this storm caused in the Northeast can be attributed to lost business, or business interruption. Flooding, power outages and transportation difficulties affected all businesses in areas struck by the storm, large and small. The New York Stock Exchange was closed for two days and the metropolitan area's mass transit system experienced closures for an entire week. Some business owners and employees were unable to access their offices, meaning they faced increased business costs operating elsewhere or were unable to conduct operations at all.

Companies in the tri-state area of New York, New Jersey and Connecticut were hit the hardest by Superstorm Sandy, with businesses in the surrounding states of Pennsylvania, Massachusetts, Maryland, Rhode Island, Virginia and others suffering financial losses and property damage as well.

The Federal Reserve of NY says that very few businesses recovered some of the losses

Very few small and midsize businesses affected by Superstorm Sandy have been able to recover some portion of their financial losses through insurance, according to a new report by the Federal Reserve Bank of New York.

Nearly one-third of smaller businesses — firms with fewer than 500 employees — in the storm-affected regions of New York, New Jersey, Pennsylvania and Connecticut that reported financial losses in the immediate aftermath of the October 2012 superstorm were uninsured when the storm made landfall, according to a supplemental report included in the New York Fed's “Fall 2013 Small Business Credit Survey,” released on Monday.

Among the businesses that had purchased property, flood or business interruption insurance, 65% said they were not able to recover any of their financial losses under those coverages. Fourteen percent said that their insurance program provided reimbursement for some of their financial losses, and only 9% said their coverages reimbursed most or all of their losses, according to the supplemental report.

Fifty-four percent of storm-affected businesses had purchased property insurance prior to Sandy, while 30% and 12% of firms were insured for business interruption losses and flood damage, respectively.

What is Business Interruption Insurance

Business interruption insurance, which also is known as business income coverage, does not cover property damage, but rather financial losses attributed to this damage or other circumstances that have affected the company's ability to do business. Business property insurance covers property that has been physically damaged by wind, flooding, fires or other such perils. Recoveries are calculated in one of two ways; either net income plus continuing expenses (net income method) or net sales minus non-continuing expenses (gross earnings method). The final amount should be the same under either method.

Other popular types of the so called time element coverages include extra expense coverage, which covers the additional costs of operating a business at the same or different location during the period of recovery, and contingent business interruption coverage, which responds to losses caused by damage to associated businesses such as key suppliers or customer

Business interruption is one of the least understood portions of property policy, and losses from Superstorm Sandy are no exception. Many insureds feel as soon as they have a loss of production, they automatically have a business interruption claim. However, there are certain thresholds that need to be reached before coverage can be triggered. For example, is the loss caused by an insured peril such as fire or explosion or sprinkler leakage?

Typical exclusions under a commercial policy are as follows:

B. EXCLUSIONS

1. We will not pay for loss or damage caused directly or indirectly by any of the following. Such loss or damage is excluded regardless of any other cause or event that contributed concurrently or in any sequence to the loss.

g. Water

(1) “Flood,” surface water, waves, tides, tidal waves, overflow of any body of water, or their spray, all whether driven by wind or not;

(2) Mudslide or mudflow;

(3) Water or sewage that backs up or overflows from a sewer, drain or sump; or

(4) Water under the ground surface pressing on, or flowing or seeping through:

(a) Foundations, walls, floors or paved surfaces;

(b) Basements, whether paved or not; or

(c) Doors, windows or other openings.

But if water, as described in (1) through (4), results in fire, explosion or sprinkler leakage, we will pay for the loss or damage caused by that fire, explosion or sprinkler leakage.

While it is true that most, if not all, commercial policies have flood exclusion provisions in the main property coverage section, most standard policies also contain additional coverages and endorsements that afford payment for business income losses despite the flood exclusion. Many Service Interruption and Equipment Breakdown and Civil Authority provisions should provide reimbursement for business income losses, regardless of the damages caused by flood.

Also, did the insured have physical loss or damage to insured property?

In the event of Physical Damage to Property of the type insured under the property policy by a peril insured under that policy which directly results in a necessary interruption of the insured’s operations, the policy will cover: The losses defined in the policy which are suffered by the insured party or parties, and which are incurred during the period of indemnity defined in the policy.

Recently, a Federal Judge in the Southern District of New York has ruled that a law firm’s claim was excluded from coverage under the policy because the law firm did not suffer “direct physical loss or damage”, such as water contamination, noxious fumes, etc. The meaning of “direct” and “physical” necessarily narrows the scope of coverage. See Newman Myers Kreines Gross Harris, P.C. v. Great Northern Ins. Co., No. 13-2177, 2014 WL 1642906 (S.D.N.Y. April 24, 2014).

If the insured did suffer “direct physical loss or damage.”, then the next question is not if the insured lost production, but did he actually lose sales from the event? For example, the insurers are going to look at total corporate sales, not just the affected area.

Many times in past storms and hurricanes, we’ve seen retail insureds that would have a loss in the affected area where the stores closed and obviously having no sales at all. However, a nearby store owned by the same company maybe is unaffected by the physical loss and experiences sales probably two times what they normally would. The insurers are going to look at that as kind of a make-up opportunity. Overall the corporate sales were flat, and the insured didn’t suffer a business interruption loss from loss of sales.

Additionally, the same thresholds need to be met for contingent business interruption. Many of the insureds, after assessing their direct damages, are now starting to look into the supply chain. If an insured potentially has contingent exposure, once again, the lack of supply coming from one of its suppliers needs to be as a result of insured peril to insure property, and then it has to cause a loss in sales for there to be coverage. Regardless if it’s a contingent business interruption claim or a direct business interruption claim, the insured should consult with your broker so they can check the policy terms and apply it to the insureds unique loss situation to see how coverage applies.

And generally the industry segments that historically have the worst losses from hurricane are retail, real estate and hospitality. This is largely due to the concentration of values in the coastal areas. However, Superstorm Sandy is unique in hitting a major financial institution center in New York. That segment should also be affected.

Looking forward, the insureds should be trying to mitigate future losses by doing:

• A business interruption exposure analysis

• Having a fully developed hurricane preparedness program

• And a business continuity program that is not only published, but also been tested and refined so it operates smoothly in the event of the next loss.

Metropolitan Risk Management Services (MRMS)

Metropolitan Risk Management Services (MRMS) is a professional service firm that specializes in outsourced risk management and advisory services. Based in the East Coast, the firm has several offices in the Northeast and Midwest, with clients throughout the United States, Canada, Europe and Latin America. While our clients are diverse businesses and organizations, each share a common approach - - a genuine desire to prevent and mitigate losses. Invariably, our clients value high quality professional advice, whether that advice is from safety consultant, engineers, attorneys, CPAs, or risk management and insurance advisors. Their goal is to obtain the best assistance available, fully recognizing the cost of identifying and confronting problems before they develop is always less expensive than addressing an issue after it is out of control.

Risk Management Services at Metropolitan

· Serve as an integral part of the business management team as an outsourced risk manager

· Overview current loss prevention and loss mitigation processes

· Provide project management services to ensure critical processes are completed in a timely manner and consistent with overall needs

· Provide an objective and independent expert evaluation of the current risk program, including a written report containing specific findings and recommendations

· Identify and assess your current and potential risk of loss

· Develop alternate (non-insurance) methods of risk financing

· Assist in strategic planning to achieve long range risk management objectives

· Develop risk management education coursework for specific needs

· Provide guidance during merger, acquisition and divestiture activities

· Provide expert witness and litigation support

METROPOLITAN ENGINEERING, CONSULTING & FORENSICS (MECF)

Providing Competent, Expert and Objective Investigative Engineering and Consulting Services

P.O. Box 520

Tenafly, NJ 07670-0520

Tel.: (973) 897-8162

Fax: (973) 810-0440