By Doug Wells
September 21, 2018
In the wake of Hurricane Florence and its footprint, devastating results are being experienced by communities and businesses. As a result of these catastrophes, businesses will turn to insurance carriers for recovery of covered losses. Current estimates of insurance losses related to property damage and business interruption are in the tens of billions of dollars.
The following describes various types of insurance claims expected to arise as a result of hurricanes, as well as relevant experiences and commentary.
Affected businesses will look to the first-party insurance coverage most commonly included within their commercial property policy for relief due to property damage. Some examples of physical property contemplated in this type of coverage are listed as follows:
Property insurance policies typically indemnify businesses for property damage at either Replacement Cost or Actual Cash Value. Replacement Cost is often defined as the total cost to replace insured property using new materials of like kind and quality at the same location. Actual Cash Value (ACV) is typically defined as replacement cost less depreciation. The objective of ACV is to indemnify the insured at the actual monetary value of the asset at the date of the loss. Insurance carriers will typically first consider if the option to repair the damaged asset is appropriate before replacing it.
In 2014, the Baja California Peninsula of Mexico was hit hard by Hurricane Odile. An issue that arose out of one of the insurance claims we worked on was replacement of like kind and quality of damaged furniture in a hotel. The insured wanted replacement of furniture for all rooms to maintain uniformity throughout the hotel even though not all rooms and furniture were damaged. This posed problems not only because they were seeking all new furniture, but the quality of the furniture they desired to replace with was not like kind. It is common for insureds to take the opportunity to make improvements/betterments (i.e. upgrade old vinyl countertops with granite) to their property during the rebuilding. It is critical that the costs associated with the improvements versus the cost to replace be identified and separated from the insurance recovery.
Usually included in the commercial property policy, the intent of business interruption insurance is that in the event of a covered loss, the policy would put the insured back to the same financial condition that they would have been had no loss occurred, within the limitations of the insurance coverage. Business interruption coverage typically requires that direct physical loss or damage occur to the described property where a risk of loss exists and no exclusions apply. Flood exclusions could present a challenge to insureds impacted by hurricanes because many policies do not cover flood damages.
Business Interruption is typically defined in the policy as:
A common challenge that can present itself in a business interruption claim is the potential for claimed lost sales to be recovered post-loss. We’ve worked on numerous claims over the years where an insured’s operations are down for a period of time (loss period) and production is curtailed. However, once operations resumed, they had excess capacity to fulfill the orders they were unable to during the loss period and subsequently mitigated their loss. Often, insureds will incur extra expense to mitigate their losses, as discussed below.
Business interruption coverage may also indemnify insureds for extra expense. Extra expense is typically defined as costs incurred in excess of normal operating expenses to maintain operations while the insured’s damaged property is repaired or replaced.
Examples of extra expenses typically include the following:
It should also be noted that insurance carriers will typically reimburse the insured for extra expenses incurred that mitigate business interruption exposure. For example, if the business interruption exposure is $100,000 and the cost to set up a temporary production facility is $90,000, the insurance carrier would incur the mitigation costs because it would save them $10,000.
Contingent Business Interruption
Contingent business interruption coverage is measured similarly as business interruption. The key difference is that the loss is caused by disruptions to the insured’s customers or suppliers rather than at the insured’s location of business. It is probable that contingent business interruption claims will arise out of hurricanes because of dependence on Exxon Mobil for supply by businesses in the region.
In 2011, the Pacific coast of Japan was devastated by a tsunami. One example of a contingent business interruption claim we examined was submitted by an insured located in Mexico that was dependent on a supplier of custom electronic components. The lack of supply curtailed their production and caused significant losses until an alternative became available.
Other Coverage Considerations
The following are coverages for situations where physical damage may not have occurred at the insured’s location of business but a loss may have been sustained:
It is noteworthy to consider when an insured has suffered service interruption or blocked access due to a Civil Authority or Ingress/Egress issue, the insured must prove that a loss of income was actually experienced.
Catastrophe response to events such as hurricanes is an area of expertise for Eide Bailly’s forensic accountants. Our team possesses the necessary skills and experience to assist in all forensic accounting matters relevant to the coverage areas described in this article. We strive to provide dedicated service so the claims process is more effective and easier for organizations when a catastrophe occurs.