Basics of Business Interruption Insurance

In the wake of the terrorist attacks on the World Trade Center and the weekly reports of new anthrax scares, businesses are evaluating what coverage would be available to them if their own business is interrupted. Insurers, in turn, are facing the prospect of new waves of claims, ranging from businesses damaged or destroyed in the World Trade Center disaster, to those that were not damaged but had to close temporarily, to companies that shut down or were interrupted when planes were grounded, to the new spectre of businesses shut down for anthrax testing, bomb scares or other threats of terrorist actions.

Business interruption insurance is usually part of a package, or an endorsement to a property policy. The terms are not uniform and can vary widely. There are some basic principles, however, common to most policies. In general, covered claims must arise from a covered cause of loss, that causes direct physical loss to property at the described premises. The covered loss must cause a necessary suspension or interruption of operation, that causes a loss of business income. Issues likely to arise in evaluating these claims include documentation of losses, the period of recovery and what perils are covered.

Suspension of Operations
For the claim to be viable, the policy usually requires a “necessary suspension” of the insured’s operations. Unfortunately, “necessary suspension” is an undefined term in the ISO policy. The majority of cases construing this language hold that a total cessation is required; a mere work slowdown or decrease in business volume will not satisfy the “suspension” requirement.

Direct Physical Loss
Business interruption coverage also typically depends upon a “direct physical loss” to covered property. “Direct physical loss” usually requires some type of physical damage to the property. This requirement can be problematic. By example, if a virus creates loss of intangible computer data, there is a question whether any direct physical loss has occurred. This issue, first raised in anticipation of Y2K shutdowns, but revived by the current threat of virus attacks, remains largely unresolved.

A few courts have addressed the issue, but with inconsistent results. Similarly, in situations involving documented anthrax contamination of business premises, there may be an issue whether a “direct physical loss” has occurred. However, one would be hard-pressed to argue that any physical damage occurs where a building is simply evacuated due to a bioterrorism hoax.

Even without a direct physical loss, however, there may be short-term coverage for a forced closure. The ISO form provides limited coverage for loss of business income caused by the action of a civil authority that prohibits access to the insured premises due to direct physical loss or damage to property other than the actual premises itself.

Described Premises
The damage need not be to property covered under the policy, if it causes interruption at the described premises. In addition, if the insured occupies only a part of a building, damage to other areas that provide access to the described premises will give rise to coverage. Thus, damage to the ground floor may be sufficient to establish a claim if an upper-level resident is denied access to its premises.

Period of Restoration
Policies typically limit recovery to the actual loss for the period of time it would take to repair or replace the building in which the business is conducted or, if no physical damage is present, the length of the required and necessary closure of the business. There is also usually a waiting period. Many policies, for instance, provide coverage only for the “period of restoration” which begins 48-72 hours after the direct physical loss suspends operation, and ends when the property is repaired with reasonable speed and similar quality, or business resumes at a new location. Short cessations—such as a bomb scare or temporary evacuation, may not be covered at all. There is also usually a maximum period of coverage—frequently 12 months, although the period of restoration is not limited by policy expiration.

Damages recoverable may include lost business income, often expressed in terms of lost profits or gross earnings less non-continuing expense. While lost income is typically proven through sales and production records, market trends may also be considered. Similarly, normal maintenance or downtime, or seasonal price fluctuations may affect the amount of loss.

Insured’s Duties
Insureds also have duties following a claim, that may be prerequisites to coverage. These include providing prompt notice of how and where the damage occurred; taking reasonable steps to protect the property from further damage; and allowing examination of physically damaged property. Businesses typically must permit the insurer access to financial books and records. The information typically requested includes profit and loss statements, production reports, inventory, invoices and purchase orders.

War Exclusion
Most business interruption policies include a war exclusion. As was widely reported, Congress encouraged insurers not to rely on the war exclusion in regard to the World Trade Center disaster, and most insurers volunteered that they would not. While the swift assurance from the industry may have relaxed some concerns, the exclusion probably would not have applied, anyway. Although there is little reported law, the limited case law suggests that “war” is limited to an act of intentional destruction by a recognized nation. Thus, while we may be in a war against terrorism, we are not at war with a recognized nation. Moreover, while other terms of business interruption policies are not uniform, the common industry forms do not include a “terrorism” exclusion.

Civil Commotion and Vandalism
While war is not covered, riot or civil commotion, including looting and vandalism—defined as “willful and malicious damage to, or destruction of, Covered Property” are frequently covered. Arguably, while it is certainly an understatement, acts of terrorism that result in property damage could be construed as vandalism.

Lost Income
Business interruption insurance is designed to protect the income which the insured business would have enjoyed had there been no interruption of the business. There is typically coverage for loss of actual earnings as well as continuing expenses, such as payroll, rent and utility bills, that continue despite the cessation of business. The extra expenses of continuing business, to avoid shutdown, such as temporary lease space, are also covered.

Topics Profit Loss Property