Will insurance coverage help you thaw?

While the snow has melted in the Shreveport- Bossier area, the resulting damages continue to mount. Some of these damages will be covered by insurance as a standard form insurance policy agrees to pay for direct physical loss of or damage to “covered property.” The most recent snow and ice storm caused physical damages to many homes and business closures due to those damages. Policyholders should review their respective policies to determine if coverage for those losses is available.

In addition, business interruption coverage provides for payment for actual loss of income due to “suspension” of “operations” during a period of restoration. This “suspension” must be caused by physical loss. The covered loss ends when the property could reasonably have been repaired.

So the question presents itself: Does business interruption coverage extend to the shutdowns most area businesses experienced as a result of the recent, historic winter storms, and if so, how are the damages computed?

Historically, most policies covered “namedperil policies,” that is, covering only those perils (wind/fire) identified in the policy. Most policies sold today are “all-risk” policies, the limits of which have been the subject of a fair amount of comment and commentary about courts. For both property damage and business interruption, the policy requires physical damage. Disputes typically arise when the property at issue has suffered some other condition that has rendered the property unusable or unfit for its intended purpose without destroying it completely. A direct physical loss often involves some physical alteration of the covered property. The particular provisions of the policy at issue will dictate what coverage exists. Courts from other states have found some policies include coverage for bacteria while other courts have found rust is not covered where the policy excludes “all loss or damage caused by resulting from rust.”

In a recent New Orleans case that has not yet been decided, the policyholder is making the argument that “nonaltering” physical damages are present at the insured’s business location, even if the COVID-19 contamination does not physically cause property damage. Such theories rely on older case law from other jurisdictions which have held that a release of an unsafe amount of ammonia in a facility constitutes “direct physical loss” and that property could sustain a physical loss without structural alteration.

The calculation of business interruption loss is not a straight-line simple addition. Instead, it requires policy construction and consideration of factors such as ongoing expenses, historical revenue earnings and cost of goods. Second, this formula requires a study of the policyholder’s tax returns, profits and loss statements, and audited invoices: The services of a financial analyst or certified business evaluator should be seriously considered.

Once it is determined that business interruption insurance applies to the loss, the valuation of the loss will depend on several factors including the nature of the business and its revenue stream, the necessity of the expenses incurred by the insured, and the ultimate period of recovery. Depending on the policy language, coverage for the insured’s interruption loss will then cease according to the policy’s terms when the insured’s business operations resume, whether at the same or a functionally equivalent location. Ongoing expenses and extra expenses are some of the main drivers for a business interruption loss. Ongoing, or fixed expenses, are those expenses that are incurred regardless of whether or not the insured is currently operating. Common examples include mortgages, rent and utilities. Extra expenses are the costs associated with the insured’s efforts to continue the normal operations of the business during the period of restoration to the best of their abilities. In other words, had the interruption not occurred, it is likely that the extra expenses to continue operations would also not have been incurred.

When valuing business interruption claims, one would need to consider the experience and history of the business leading up to the interruption. When damages are claimed for lost profits, a valuator must prove the lost profits with reasonable certainty based on similar business operations and comparable markets. They may not be based merely on conjecture, speculation or by simple estimation. Analysis of the business’s historical performance to determine the projected profits that might have been earned during the period of interruption will need to be undertaken. The calculation can take into account sales trends, including upward trends leading up to the date of loss. Ultimately, courts have found that the proper method for determining the loss under business interruption policies is to look at operations before the interruption took place, rather than operations after the interruption, as these are based on historical results.

Does the business have to be back to its prestorm condition before business interruption payments are discontinued? This was addressed in several Katrina cases. Generally, business interruption coverage will pay for the loss of covered business revenue only for the time of the period of restoration. If that period is extended due to extraneous factors, the carrier may deny coverage for losses during that extended period of time.

Once those issues have been addressed, the business interruption calculation requires a forensic accountant and experienced coverage counsel to follow the requirements of the policy. A typical business interruption form may state:

This policy insures against loss resulting directly from the necessary interruption of business caused by physical damage to real or personal property insured under this policy, by perils insured against, during the term of this policy.

Recovery in the event of loss hereunder shall be the actual loss sustained by the insured resulting directly from such interruption of business, but not exceeding the reduction in gross earnings less charges and expenses which do not necessarily continue during the interruption of business, for only such length of time as would be required with the exercise of due diligence and dispatch to rebuild, repair or replace such described property as had been damaged, commencing with the date of such damage and not limited by the date of expiration of this policy.

Some policies provide business interruption coverage if a civil authority, some government agency or entity, causes cessation of a business. Generally, civil authority coverage is intended to apply to situation where access to an insured’s property is prevented or prohibited by a decision or order of civil authority issued as a direct result of physical damage to other premises in close proximity of the policyholder’s property. Curfews, for instance, imposed by city officials after a riot or the closure of a bridge after a hurricane may trigger business interruption coverage. In accordance with policy language, if a civil authority prevents a policyholder from conducting business due to damage to a third party’s property, business interruption coverage may be triggered.

Ultimately, the issue of whether a particular policyholder is entitled to business interruption coverage due to a severe weather event will be dictated by the policy language. A concerned policyholder should consult knowledgeable accountants or industry professionals in order to have such questions answered.

Article by Brian A. Homza, shareholder of Cook, Yancey, King & Galloway, APLC; Robert L. Dean, CPA, managing partner of Heard, McElroy & Vestal, LLC.; and Spencer H. Lamb, CPA, representative of Business Valuation Consultants, LLC, a strategic association of Heard, McElroy & Vestal, LLC.