The Aftermath of Catastrophes: Valuing Business Interruption Insurance Losses

• Publication year: 2013

The Aftermath of Catastrophes: Valuing Business Interruption Insurance Losses

Christopher French

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THE AFTERMATH OF CATASTROPHES: VALUING BUSINESS INTERRUPTION INSURANCE LOSSES

Christopher C. French^*

Abstract

With the onslaught of tornadoes, hurricanes, and floods in recent years, business interruption losses have been staggering. Many businesses do not survive such catastrophes. Even business owners that purchased business interruption insurance, which is intended to ensure that a business's revenue stream continues during an interruption in its operations, often find that their insurers have dramatically different views regarding the amount of the losses that should be reimbursed. The reason for this disparity in views is that the loss valuation provisions in business interruption insurance policies provide very little guidance regarding how business interruption losses should be calculated. Thus, disputes regarding the valuation of business interruption losses frequently arise and courts and juries are forced to resolve such disputes with widely varying, inconsistent, and unpredictable results. This lack of predictability has placed a burden on the legal system because far more business interruption cases are tried than are necessary.

This Article analyzes the origins and purpose of business interruption insurance, as well as the courts' inconsistent interpretations of the standard form business interruption loss valuation provisions. The Article then offers an interpretation of the existing loss valuation provisions under the rules of policy interpretation and considers whether the result would be different if

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the language were analyzed from a product liability perspective in light of the fact that policies are non-negotiated contracts of adhesion sold on a take-it-or-leave-it basis. The Article concludes with an analysis of the public policy considerations related to the payment of business interruption insurance losses and proposes alternative loss valuation formulas to be used in the future that should provide for consistent, fair and predictable loss valuations and payment of claims without litigation.

Table of Contents

Introduction.................................................................................463

I. Relevant Policy Language....................................................469

A. The Origins of Business Interruption Insurance................469
B. The Policy Language Regarding the Valuation of Business Interruption Losses..............................................470

II. Courts' Interpretation and Application of the Policy Language Regarding the Valuation of Business Interruption Losses...............................................................472

A. Courts That Have Interpreted the Loss Valuation Language to Allow for Consideration of Only Historical Financial Data...................................................................473
B. Courts That Have Interpreted the Loss Valuation Language to Allow for the Consideration of Local Economic Conditions Post-Catastrophe............................477
C. Courts' Inconsistent Holdings Regarding the Application of the Loss Valuation Language.....................481
D. Courts' Confusion Regarding the Evidentiary Standard Under Which Business Interruption Losses Must be Proven................................................................................486

III. Principles of Insurance Policy Interpretation Relevant to Valuing Business Interruption Losses.......490

A. The Doctrine of Contra Proferentem.................................490
B. The "Reasonable Expectations" Doctrine.........................493
C. Construction of the Policy as a Whole..............................496

IV. How Business Interruption Losses Should be Valued .. .496

A. The Problems with the Existing Framework......................497

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1. Business Interruption Loss Valuations are Inherently Speculative so They Cannot be Proven with "Reasonable Certainty".......................................497
2. Using Only the Policyholder's Historical Financial Information to Value Business Interruption Losses Ignores Some of the Valuation Policy Language.........499
3. Consideration of the Post-Catastrophe Economic Conditions Can Lead to Unfair Results and Factual Disputes That Must be Tried........................................502

B. How Business Interruption Losses Should be Valued Under the Existing Policy Language..................................504

1. Applying the Rules of Policy Interpretation to Loss Valuation Language.....................................................505
2. Analyzing the Loss Valuation Policy Language as a "Defective Product".....................................................508

C. Proposed Loss Valuation Formulas That are Based Upon the Original Purpose of Business Interruption Insurance and Which Provide Consistent, Predictable Results and the Efficient Resolution of Claims..................510

1. A Stated Daily Loss Value Set Forth in the Policy or Only the Policyholder's Prior Three Years of Historical Earnings and Expenses Should be Used When Valuing Business Interruption Losses................511
2. Public Policy Considerations.......................................515

Conclusion....................................................................................519

Introduction

Business interruption losses caused by natural and unnatural disasters are enormous. For example, the business interruption losses associated with the 9/11 terrorist attack have been estimated to exceed $10 billion.¹ Hurricane Katrina caused more than $45 billion in damage.² The governors of New York and New Jersey estimated that Hurricane Sandy caused more than $60 billion in damages.³

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Many businesses impacted by such disasters never recover. Indeed, the United States Department of Labor has estimated that 40% of businesses never reopen after experiencing a disaster.⁴ Of those that do, at least 25% fail within two years.⁵

Now imagine a business owner in an area that was just struck by a flood, tornado, or hurricane. The business was damaged such that operations had to be suspended. Lucky for the business owner, however, he was able to resume operations in a few weeks or months after repairs were made. Even better, he had the foresight to purchase business interruption insurance, which is intended to place the business owner in the position he would have occupied if the catastrophe had not occurred.⁶

Yet, when the business owner submits a business interruption claim to the insurer, the insurer denies coverage for the claim or offers a paltry sum and advises the business owner that there would have been little or no demand for the business's services or products during the time period its operations were being restored because the area near the business was wiped out by the disaster. Thus, the insurer tells the business owner that the business did not actually suffer a business interruption loss because very few customers or clients would have patronized the business following the disaster even if the business had not been impacted. At best, the insurer tells the owner, what little business he might have had would not have covered the business's fixed costs such as rent and payroll.⁷ Consequently, the insurance policy purchased to cover business interruption losses provides little or no recovery because the business's projected earnings during the period of interruption would not have exceeded its continuing fixed costs.⁸

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Unfortunately, this is not a fictional scenario. It is all too real and it is regularly experienced by many business owners throughout America. There are countless business owners in New Jersey and New York that are currently going through such an experience right now in the wake of Hurricane Sandy.

Insurers take such a position due to the nebulous wording of the loss valuation provisions buried in lengthy, complex, standard form business interruption insurance policies that insurers draft and then sell on a take-it-or-leave-it basis.⁹ The loss valuation language often is worded as follows:

In determining the amount of gross earnings covered hereunder for the purposes of ascertaining the amount of loss sustained, due consideration shall be given to the experience of the business before the date of the damage or destruction and to the probable experience thereafter had no loss occurred.¹⁰

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Insurers rely upon the above italicized language when they attempt to support the argument that business interruption losses are negligible or non-existent in situations where the area surrounding a business has been destroyed by a catastrophe such that the demand for the impacted business's services or products has been greatly reduced or eliminated.¹¹ Other times, if the catastrophe results in increased demand for the policyholder's services or products, then the insurers argue only the pre-catastrophe sales and expenses of the policyholder should be used to value the loss.¹²

Some courts have accepted the argument that the economic conditions post-catastrophe should be considered when valuing business interruption losses.¹³ Other courts have not.¹⁴ Courts also have disagreed regarding which elements of a business interruption loss are recoverable.¹⁵ In addition, some courts have required the policyholder to prove the amount of any business interruption loss to a "reasonable degree of certainty" even though such calculations are, by necessity, only projections regarding what the policyholder would have earned in the hypothetical world in which the catastrophe did not occur.¹⁶ All of these inconsistencies and problems reflected in the courts' decisions flow from the nebulous valuation language that is contained in business interruption policies.

In this Article, the author contends that if the existing policy language continues to be used, then the ambiguities in it should be...