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Risk Management
Losses from interruptions in utility services
Coverage will depend on the strength of your endorsements
By Donald S. Malecki, CPCU
It seems when there is a major loss or catastrophe that affects many people and some insurance changes are later introduced, some of the changes appear to have some relevance to that past major event. This may be just a coincidence, but it does raise some suspicions.
In 2003, a blackout occurred in southeastern Michigan which also affected Ohio, Pennsylvania, New York and Canada. One of those affected by the disruption of electrical service for 24 hours was a supermarket located in Detroit.
When the electrical service was restored, there was a power surge that caused damage to a computer and two compressors in the store. The insurer paid for this loss but refused to pay for alleged losses to the store’s inventory and stock totaling $109,000.
The supermarket, in the case of Four Star Brothers, Inc., D/B/A Tom Boy Supermarket v. Allied Insurance Company, No. 04-CV-73401 (U.S. Dist. Ct. E.D. MI 2006), took its insurer to court because the insurer would not pay for the entire loss.
A grocery store also affected by the same blackout in 2003 was without power for 38 hours. As a result, it lost $102,567 in stock, $7,000 in lost business income, and incurred expenses of $3,642 related to the loss of power. It, too, brought suit against its insurer in the case of Lyle Enterprises, Inc. D/B/A Larry’s Foodland v. AXA RE Property and Casualty Insurance Company, No. 04-75099 (U.S. Dist. Ct. E.D. MI 2005).
Barring only the power surge damage sustained by the supermarket in the Four Star Brothers case, neither of the two food stores collected anything from their insurers for losses sustained. It should be expected that if a business does not purchase extra coverage, and tries to argue for coverage based on any reason possible, the chances of winning are likely to be slim.
The difference, however, in the plights of both stores was that the supermarket in the Four Star Brothers case had actually purchased a Utility Services—Additional Coverage endorsement, but it still did not provide any coverage.
The reason why no coverage applied despite the purchase of a coverage endorsement is because of a misunderstanding that seems to prevail with the Utility Services coverage endorsements available from insurers writing ISO forms as well as those using independently filed forms.
To grasp a better of understanding of what the problem is, consider the standard ISO Utility Services—Direct Damage endorsement that was revised in 2007. Whether the utility services selected involve water supply, communication supply or power supply, the criteria for coverage are the following:
• Loss or damage to covered property described in the schedule of the endorsement;
• Caused by an interruption in utility service to the described premises; and
• The interruption in utility service must result from direct physical loss or damage by a covered cause of loss to the property described (i.e., water supply services, communication supply services or power supply services).
The problem here, which appears to generate most of the litigation, is with the third criterion. It is important to emphasize that the direct physical loss or damage must be to the supply service designated in the schedule of the endorsement and from a covered cause of loss.
It is not unusual in these events where there is an interruption in utility service for the named insured business to sustain damage to its goods. Both food stores in the above mentioned cases in fact sustained physical damage (spoilage) to perishable items. This is a necessary criterion, but what is often overlooked is that the power supply that is designated in the endorsement also must sustain direct physical loss or damage.
In the Four Star Brothers case, the court held that the mere cessation of “power supply services” at the Michigan utility and the fact that services to the supermarket ceased as a result did not demonstrate a direct physical loss or damage.
An unfortunate part of this case was that the supermarket had purchased a Utility Services—Additional Coverage endorsement that still did not apply and the reason, again, was with the third criterion of coverage. In the words of the court, no coverage applied under this endorsement because the supermarket could not set forth any argument or facts demonstrating how such direct physical loss or damage resulted from a covered cause of loss to the power supply.
The insurer argued that this additional coverage endorsement would apply only if the power failure were to be preceded by, and resulted from, direct physical loss or damage by a covered cause to property of one of the supermarket’s service providers.
The court offered the following example of where this endorsement would have resulted in coverage: When the utility’s property suffers direct physical loss or damage by a windstorm (covered cause of loss) and, thereafter, electrical service from the utility to the named insured’s store is interrupted due to such windstorm and the named insured’s perishable goods spoil, coverage should apply.
Potential troublesome area for insureds
Candidates for the purchase of the Utility Services—Direct Damage endorsement need to understand that covered property does not include electronic data, including destruction and corruption. The definition of electronic data appears in the respective coverage forms, rather than this endorsement.
In addition, when coverage is desired for either communication supply services and/or power supply services, the insured has the option of including or not including overhead transmission lines.
It is important to get some understanding from the insurer what is meant by transmission lines. Are these the lines, for example, that are used to transmit power over long distances, typically those that are seen traversing the high towers throughout the U.S.? How do these differ from overhead power lines one sees on poles around town and from public streets to buildings? Or are they the same?
The answers to these questions are important not only for purposes of selecting the proper coverage but also in getting a better understanding of the utility services exclusion found in the basic, broad and special causes of loss form discussed subsequently.
If the price variance is not too much, it probably would be a good idea for an insured to purchase coverage that includes overhead transmission lines. The reason is that if a loss occurs where overhead transmission lines are not included, the insurer may deny coverage. The added cost, in other words, may eliminate many of the problems that go into disputing coverage with an insurer.
Potential troublesome area for insurers
Reference to “physical loss or damage” in property policies is becoming a problem for insurers. To the extent courts hold this description to be ambiguous, it is resulting in coverage where, possibly, coverage is not intended. The case of Wakefern Food Corporation et al. v. Liberty Mutual Fire Insurance Company, No. A-2010-07T3 (Sup.Ct. N.J. App. Div. 2009) might be a perfect example of what the nature of the problem is.
This is a complicated case, but to the point, the circumstances giving rise to a dispute were the same as the 2003 blackout that affected the food stores in the preceding cases. This case, however, affected a group of supermarkets that suffered spoilage of perishables and loss of business.
Having paid $5.5 million in premium for insurance covering (among other things) damage due to the loss of electric power, the named insureds turned to their insurer for payment of their losses. The insurer, however, denied coverage contending that its policy applied only in the case of “physical damage” to off-premises electrical plant and equipment. Also, although the power grid was physically incapable of supplying power for four days, it suffered no physical damage and, therefore, no coverage applied.
As it turned out, the court held that reference to “physical damage” was not defined and therefore was ambiguous. One case is not particularly a problem in many instances. In this case, however, the court cited eight cases where “physical damage” was not restricted to physical destruction or harm. It, instead, could also include loss of functionality. When a court finds support for its conclusions with as many cases as eight, it will get the attention of insurers.
In time, it should come as no surprise, in fact, if insurers begin to define any reference to “physical loss or damage” in their property policies. If they do not, they should expect some payout where they do not believe losses should be paid.
Causes of loss forms
A separate article having to do with the utility service exclusion addressed in the basic, broad and special causes loss forms would probably be justified. What simplifies matters is that the exclusion is identical in all three forms.
Briefly, however, the 2007 edition of these forms now excludes loss or damage caused by a power surge, if the surge would not have occurred but for an event that caused the power failure. Remember the covered power surge sustained by the supermarket in the Four Star Brothers case discussed earlier? The insurer paid for that loss. Any future loss of that kind would not be covered if any of the ISO causes of loss forms are used.
One other important point is that no coverage applies if failure of power originates at the described premises, if the failure involves equipment used to supply service to the described premises from someplace away from the described premises.
Make sure to ask the insurance company what reference to “equipment” means. A generator or a transformer definitely would be examples of equipment. But what about overhead transmission lines? Producers should find out precisely what equipment means so that proper coverage can be put into place. To wait until something happens, does not make good risk management sense.
Finally, when an insured is receptive to purchasing Utility Services—Direct Damage CP 04 17, a time element coverage that also should be considered is Utility Services—Time Element CP 15 45. This endorsement is not triggered unless there is a covered direct loss. What it can do for the insured, however, is to extend the appropriate business income and/or extra expense coverage form to apply to (1) a suspension of operations at the described premises, (2) caused by an interruption in utility service to that premises, and (3) with the interruption in utility service resulting from direct physical loss or damage by a covered cause to the water services, communication services or power supply services selected.
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