Business Interruption insurance claims – contentious areas
Forensic Focus - December 2016
The following Business Interruption (“BI”) insurance article has been reproduced from our 2011 Forensic Focus edition that was published following the Christchurch earthquakes.
Given the inherent complexity in BI insurance, the size and number of the claims and the scale and nature of devastation, it is inevitable that disputes and litigation will arise over BI insurance claims. The purpose of this article is to highlight some of the more contentious areas in assessing BI insurance claims.
There has been some media coverage since the Christchurch earthquake in February about depopulation not being covered by BI insurance policies. Most BI insurance policies cover the loss arising from the interruption caused by damage to the business premises - however most policies do not contemplate covering the loss arising from decline in population or demand following an earthquake. Given the extent of the financial losses suffered by some Christchurch businesses, this concept may well be tested in the New Zealand Courts in future.
The practical challenge is quantifying what the turnover would have been but for the damage to the property. Clearly there will be many cases where the claim will need to be decreased to reflect reduced demand in Christchurch following the earthquake. However, uniform adjustments to expected turnover to reflect de-population are likely to be challenged. Consider three examples:
- Population decreases (by say 10%) but the insured provides services that are in high demand following the earthquake (e.g. demolition services). All other things being equal the insured's turnover would have actually increased following the earthquake if it was able to operate, so there are unlikely to be grounds in this situation for reducing the claim due to de-population;
- Population decreases but supply is reduced by a much greater level (i.e. most competitors are unable to operate). All other things being equal the insured's turnover would have increased, but for the damage to the property, so again there are unlikely to be grounds to reduce the claim;
- Population decreases however several businesses move into the surrounding area, occupying premises that were vacant prior to the earthquake. These relocations actually increase the working population within easy walking distance of the business (for example a cafe). All other things being equal, the insured's turnover again would likely have increased following the earthquake.
In our opinion, any adjustments to turnover for “de-population” will need to be considered on a case by case basis and be supported by robust research and analysis. However, regardless of the quality of the underlying research and the robustness of the financial modelling to determine the expected turnover (i.e. what the turnover would have been, but for the damage to the property), there will never be "one" right answer. Experience and judgement will be critical.
Quantifying the financial loss for a business with a single site is comparatively straight forward. But it is much more difficult with businesses with multiple sites. Consider a situation where a retailer's CBD premises are destroyed, but another suburban store has continued to operate. It is normally necessary to determine and account for the CBD turnover that has been successfully transferred to the suburban store.
The practical challenge lies in determining how much of the CBD store's turnover has been transferred to the suburban store. The approach taken will depend on the size of the claim and the information available but in situations where the claim is very large, an intensive, granular approach to determining the level of turnover attributable to the CBD store is probably necessary.
Some landlords are delaying the repair of properties in order to maximise the period of time that rent is covered by the BI policy. The commercial logic being the landlord would prefer to have the insurer paying the "rent" rather than the tenant, particularly if the trading outlook for the tenant appears to be poor or uncertain. These actions have a multiplier effect as the tenant also looks to claim the extended loss being suffered under its own BI policy.
However there is normally a requirement for the insured to mitigate the loss being suffered. There appears, in our opinion, to be a high likelihood of litigation in circumstances where the insurer and insured party hold vastly different opinions about the extent and timing of loss mitigation strategies. This risk is probably lessened by clear communication between the insurer and insured party during the indemnity period.
Clearly there will be some businesses that will never trade again following the 22 February earthquake, despite having BI cover in place. There has been some commentary that BI policies do not provide any cover if the business does not trade again. The logic being the business has to trade again for there to be an "interruption". If this approach is applied, it is likely to generate litigation and/or create perverse incentives to trade for a short period of time at the end of the indemnity period to safeguard the BI cover.
In most businesses the three largest expense categories are rent, cost of goods sold (i.e. purchase of stock/materials) and wages.
Businesses claiming BI insurance are often not paying rent or incurring cost of goods sold during the period they are unable to trade. The largest remaining cost in most circumstances is wages (or salaries). Accordingly how these costs are managed during the indemnity period will have a significant bearing on the amount of the claim. It is therefore necessary to consider if:
- Staff should be made redundant if it appears likely to be a very long delay until the business can trade again (see the comments on mitigation);
- Annual leave balances can be run down during the indemnity period.
Ideally these issues will be avoided or resolved through good communication between the insurer and insured party. However some cases will clearly require input from specialist insurance lawyers and experienced forensic accountants to resolve.
Please contact Jason Weir if you would like to discuss this matter further.
 This article is not intended as a substitute for professional advice. No liability is accepted. The issues, and the best approach to solving them will vary depending on a variety of factors including the business, the challenges faced, the policy and the amount of money at stake. Professional advice should be sought to assist resolving issues with BI insurance claims.