Mary Beth Forshaw and Bryce L. Friedman – December 11, 2012
In the weeks since Sandy struck the east coast of the United States, estimates of property damage, business interruption expenses and other related losses have exceeded $70 billion, with insured losses estimated to be in the $25 billion range. As hundreds of thousands of homeowners, businesses and other entities turn to their insurers for reimbursement of hurricane-related losses, several key coverage issues are likely to arise.
Business Interruption Coverage
Widespread power outages, transportation closures and evacuations resulted in enormous revenue losses to insured businesses. Whether such losses are covered under business interruption provisions will depend primarily on the particular cause and nature of the loss as well as the applicable policy language.
A critical inquiry in this context will be whether the interruption of business activities was caused by physical damage to the insured’s property or by some other factor, such as damage to neighboring or nearby property, government action (e.g., evacuation), or other intangible factors (e.g., loss of electricity, decrease in tourism appeal). Where there has been no physical property damage, insurers may have a valid basis for denying coverage for business interruption losses. See, e.g., Pentair, Inc. v. American Guar. & Liab. Ins. Co., 400 F.3d 613 (8th Cir. 2005) (loss of power in factories, resulting in failure to manufacture products does not constitute a “direct physical loss”); Roundabout Theatre Co. v. Continental Casualty Co., 302 A.D.2d 1, 751 N.Y.S.2d 4 (1st Dep’t 2002) (no coverage under business interruption policy where street closure forced theater to cancel performances); Ramada Inn Ramogreen, Inc. v. Travelers Indem. Co. of Am., 835 F.2d 812 (11th Cir. 1988) (no coverage for income loss caused by decrease in hotel room occupancy after loss of restaurant where hotel was not physically damaged and did not suspend operations); Keetch v. Mutual of Enumclaw Ins. Co., 66 Wash. App. 208, 831 P.2d 784 (Wash. Ct. App. 1992) (no coverage where motel suffered loss of business after volcano eruption; decline in “physical attractiveness” of property was insufficient physical damage since motel was able to stay open).
Additionally, business interruption coverage may be unavailable if a policyholder is unable to establish a causal connection between the damage to property (or other covered event) and the loss in business revenue. See Arthur Andersen LLP v. Federal Ins. Co., 416 N.J. Super. 334, 3 A.3d 1279 (N.J. App. Div. 2010) (post-September 11 losses not covered under business interruption provision where policyholder failed to allege causation between property damage and its subsequent loss in revenue) (see November 2010 Alert); United Airlines, Inc. v. Insurance Co. of the State of Pennsylvania, 385 F. Supp.2d 343 (S.D.N.Y. 2005) (rejecting coverage for $1.2 billion in business interruption coverage after World Trade Center attack because amount of recovery sought, based on total shutdown of U.S. aviation system, bore no relation to the actual property damage suffered by the policyholder at its World Trade Center ticket counter), aff’d, 439 F.3d 128 (2d Cir. 2006); Dickie Brennan & Co., Inc. v. Lexington Ins. Co., 636 F.3d 683 (5th Cir. 2011) (no business interruption coverage for losses incurred as a result of evacuation because policyholder failed to establish a causal link between “damage to property other than at the described premises” and the issuance of the evacuation order, as required by the policy).
Business interruption coverage disputes may also focus on the proper method of calculating covered losses. Litigation in this context has centered on whether business interruption loss should be calculated based only on a policyholder’s preinterruption sales figures, or whether post-interruption sales figures should be considered as well. The method of loss calculation takes on heightened importance in situations in which a policyholder experiences dramatically increased sales revenues following a catastrophe due to the elimination of its competitors. See Catlin Syndicate Ltd. v. Imperial Palace of Mississippi, 600 F.3d 511 (5th Cir. 2010) (policyholder’s recovery could be based only on its lower, pre-hurricane sales, rather than on post-hurricane sales that reflected elimination of policyholder’s competitors) (see May 2010 Alert);Consolidated Cos., Inc. v. Lexington Ins. Co., 616 F.3d 422 (5th Cir. 2010) (business interruption losses should be based on the policyholder’s historical sales figures, not on a scenario in which a disaster struck but did not damage the policyholder’s facility); Finger Furniture Co. v. Commonwealth Ins. Co., 404 F.3d 312 (5th Cir. 2005) (“The strongest and most reliable evidence of what a business would have done had catastrophe not occurred is what it had been doing in the period just before the interruption.”). Some policies may include explicit policy language precluding the consideration of post-catastrophe sales spikes in calculating business interruption losses. The calculation of business interruption coverage may also be contested where a policyholder is unable to restart business in its prior location. See Retail Brand Alliance, Inc. v. Factory Mutual Ins. Co., 489 F. Supp.2d 326 (S.D.N.Y. 2007) (in wake of the September 11th attack, business interruption coverage extends only until policyholder builds “reasonably equivalent stores in a reasonably equivalent location,” not for the hypothetical time frame it would take to rebuild in a new “World Trade Center” complex; extending business interruption coverage until a business is restored to its prior “profit-earning potential” would be “nonsensical”).
Questions of Causation: Wind vs. Flood Damage
In order to obtain property insurance under an all risk or named perils policy, policyholders typically bear the burden of establishing that the loss was caused by a covered risk. In the storm-damage context, proof of causation may present several difficulties for policyholders. Damage may be caused by a combination of covered and uncovered risks, or may result from a sequence of events, only some of which are within the scope of policy coverage. Additionally, the cause of damage may be difficult or impossible to ascertain where properties have become inaccessible for inspection due to evacuation orders or other practical obstacles. Although the latter issue has already been addressed by several states (by way of executive orders or initiatives that relax the standards for inspection, proof of loss and other policy requirements), the legal issue of causation may nonetheless arise in numerous post-Sandy coverage disputes.
When a loss is caused by both covered and excluded perils, most courts apply the efficient proximate cause doctrine, which holds that there is coverage only if the covered peril is the predominant cause of the loss or damage. In coverage litigation arising out of hurricanerelated damage, this analysis frequently gives rise to a wind vs. water debate. The attribution of loss to wind vs. water is critical given that most property policies cover wind-related damage but exclude losses arising from flooding. The wind vs. flood analysis may also be decisive in determining whether claims are covered by private insurance as opposed to the National Flood Insurance Program, where applicable.
Resolution of causation issues may implicate interpretation of policy provisions relating to “ensuing loss” and/or “anti-concurrent causation.” Ensuing loss clauses, which act as exceptions to property insurance exclusions, may operate to provide coverage when as a result of an excluded peril, a covered peril arises and causes damage. However, in order for the ensuing loss clause to apply, there must be a distinct, new, covered peril. In addition, courts may be unlikely to find coverage pursuant to an ensuing loss clause where the damage at issue is otherwise expressly excluded by a particular policy provision. See Fiess v. State Farm Lloyds, 202 S.W.3d 744 (Tex. 2006). Storm-related damage may also be outside the scope of coverage pursuant to an ‘‘anti-concurrent causation clause.’’ Courts have enforced clearly worded anti-concurrent provisions to bar coverage when an excluded peril (such as water) and a covered peril (such as wind) combine to damage personal property. See Leonard v. Nationwide Mutual Ins. Co., 499 F.3d 419 (5th Cir. 2007), cert. denied, 128 S. Ct. 1873 (2008); South Carolina Farm Bureau Mutual Ins. Co. v. Durham, 380 S.C. 506, 671 S.E.2d 610 (S.C. 2009); ARM Properties Mgmt. Grp. v. RSUI Indem. Co., 2010 WL 4386787 (5th Cir. Nov. 5, 2010).
Water Damage Exclusions
Water damage exclusions, common in many property policies, may give rise to coverage litigation where heavy rains, other moving water sources or accumulated areas of water are the primary cause of property damage. Although specific policy language will ultimately dictate courts’ decisions in this context, insurance coverage litigation arising out of Hurricane Katrina provides support for insurers seeking to deny coverage on the basis of water damage exclusions under a variety of circumstances. See In re Katrina Canal Breaches Litig., 495 F.3d 191 (5th Cir. 2007) (rejecting distinction between natural and non-natural causes in applying a flood exclusion and holding that losses caused by the flooding of breached levees were excluded); Sher v. Lafayette Ins. Co., 988 So.2d 186 (La. 2008) (flood exclusion unambiguously excludes damage caused by water that flowed through levees); Corban v. United Servs. Auto. Ass’n, 20 So.3d 601 (Miss. Oct. 8, 2009) (rejecting insured’s argument that the water damage exclusion should not apply because the damage at issue was caused by ‘‘storm surge,” which was not specifically listed in exclusion).
Replacement Costs and Actual Cash Value
As business and property owners begin the repair and rebuilding process, policyholders and insurers may disagree as to the proper method of calculating property valuations. Property policies may allow a policyholder to obtain reimbursement for replacement costs (often defined as the cost to replace destroyed property with property of ‘‘like kind and quality’’) and/or actual cash value (“ACV”) (often held to be the depreciated value of the destroyed property). In ascertaining the replacement cost or ACV of an insured property, questions may arise as to the relevance of certain economic factors. For example, policyholders may seek inflated replacement cost assessments where post-hurricane regulations impose more costly building requirements. Such arguments have been rejected by courts in analogous contexts. See SR Int’l Bus. Ins. Co., Ltd. v. World Trade Center Props., LLC, 2006 WL 3073220 (S.D.N.Y. Oct. 31, 2006), opinion clarified by, 2007 WL 519245 (S.D.N.Y. Feb. 16, 2007) (holding that replacement cost recovery is limited to the amount it would cost to rebuild the World Trade Center ‘‘precisely’’ as it existed on September 11, 2001 and rejecting policyholder’s contention that replacement costs include the additional expenses necessary to adapt the new structure’s design to the ‘‘changed legal, physical, and political environment of post-9/11 New York”); SR Int’l Bus. Ins. Co., Ltd. v. World Trade Center Props., LLC, 445 F. Supp.2d 320 (S.D.N.Y. 2006) (‘‘Hypothetical replacement cost is an estimate of the costs of reproducing the destroyed property as it stood at the time of loss, not a calculation of the projected cost of the actual replacement property.’’).
Reinsurance Coverage
Although primary insurers are likely to bear the brunt of Sandy’s insurable losses, hundreds of millions of dollars of reinsurance proceeds may also be at stake. As claims against primary insurers settle or enter litigation, disputes between ceding insurers and reinsurers may follow. Given Sandy’s unusually long duration (more than 72 hours) and extensive geographic reach (more than 1,000 miles), reinsurance disputes may turn on whether the storm constituted a single occurrence or multiple occurrences under reinsurance policies. Similarly, a critical issue may relate to interpretation of an “hours” clause, which limits the duration of an occurrence to a fixed number of hours. These and other reinsurance disputes will all likely implicate “follow the settlements” and/or “follow the fortunes” provisions, which limit a reinsurer’s ability to challenge a primary insurer’s reasonable, good faith settlement and litigation decisions.
In months and years to come, the widespread destruction caused by Sandy may give rise to a host of other coverage issues, including interpretation of sue and labor clauses, notice provisions and various policy-specific exclusions. We will continue to keep you updated on significant developments in this context.
Navigating the insurance implications of Superstorm Sandy – Lexology.