Critical Issue Report
Contingent business interruption
Exclusions make finding the right coverage difficult
By Donald S. Malecki, CPCU
Raising the subject of contingent business interruption coverage prompted by the earthquake and tsunami disaster in Japan is like closing the barn door after the animals have exited. For some businesses, it may be too late to ponder the scope of this coverage for any current exposures, given the special coverage requirements.
It is, of course, not too late to explore the need for this coverage and what it can do for insureds who may be prospects for potential future losses, since Japan, like many other countries, is earthquake prone and tsunamis are a natural consequence.
It is not always possible for a business to operate without having to rely on a single supplier of goods or services, or on a single purchaser of a product or component. The preferred risk management technique, however, is not to have to do business that way,
It happens, however, that both small and large businesses sometimes have no choice and must rely on a one-of-a-kind supplier of a component. Floral shops, for example, often have to import from certain foreign suppliers because of the lack of geothermal greenhouses in the United States.
Producers, therefore, should not be under the mistaken impression that global exposures are reserved for multi-national companies. Even the smallest business may have a global exposure requiring special insurance since, when a loss confronts a sole supplier or purchaser, the disruption of business can result in a financial hardship, if not a disaster.
Most commercial property policies limit their territorial scope to the United Sates of America, its territories, possessions, Puerto Rico, and Canada. This means that if coverage is required for exposures globally, special insurance will be required.
A business that has its insurance written on ISO forms and needs loss of business income or extra expense coverage also needs one of two kinds of consequential coverages. The first is the Business Income (and Extra Expense) Coverage Form CP 00 30 or Business Income (Without Extra Expense) Coverage Form CP 00 32.
If the business also has a foreign dependent property exposure, it would need the Business Income From Dependent Properties Limited International Coverage Form CP 15 01, or Extra Expense from Dependent Properties Limited International Coverage CP 15 02.
Both dependent properties international forms have a schedule that requires the name, occupancy, location and limit of insurance to apply to contributing and/or manufacturing locations. Both of these kinds of locations are defined under the form's definition of "dependent property."
A contributing location is defined to mean property operated by others whom the named insured depends on to deliver materials or services to it or to others on the named insured's account. A manufacturing location is property operated by others whom the named insured depends on to manufacture products for delivery to the named insured's customers under contract of sale.
The fact that a business maintains a special causes of loss form on its stateside exposures does not mean that coverage for the same causes of loss must be purchased for its international exposures. To the contrary, the dependent properties international forms give the named insured the option to choose the Basic, Broad or Special Form, along with supplemental coverages, such as earthquake and/or flood coverage.
When this Business Income From Dependent Properties Limited International Coverage Form (or the one for extra expense) is issued, the limits apply separately to each premises described and also separately from any business income insurance applicable to the named insured's own premises.
Furthermore, coverage begins 72 hours after the time of direct physical loss or damage from a covered cause at the premises of a "dependent property" and with coverage ending when the property at the dependent location should be repaired, rebuilt or replaced with reasonable speed.
When direct physical loss or damage occurs to a dependent location described in the coverage form by a covered cause of loss, the insurer promises to pay the actual loss of business income the named insured sustains due to the necessary "suspension" during the period of restoration.
The term "suspension" is defined, in part, to make clear that there does not have to be total cessation of business in order to trigger coverage. Also covered is slowdown of business activities. It is important to keep in mind that some independently filed policies, unlike the ISO forms, still require total cessation of business activities to trigger coverage.
The one exception when coverage is not activated following loss or damage from a covered cause to dependent property is loss or damage to electronic data, including its destruction or corruption.
The big question
The big question when dealing with dependent properties internationally is whether the causes of loss under the appropriate causes of loss form chosen are sufficient. Take, for example, the recent Japanese earthquake and tsunami disaster.
Selecting earthquake and volcanic eruption coverage would not have taken much contemplation, given the fact that Japan is prone to often have earthquakes. However, who would have thought that a tsunami as destructive as the one that followed would have occurred, given that nothing that bad had ever occurred before?
The problem is that tsunamis are excluded whether the named insured had purchased Earthquake and Volcanic Eruption Coverage Endorsement CP 10 40 or the Sub-Limit Form CP 10 45 (the latter of which permits coverage for limits lower than the limits of other covered causes of loss and an annual aggregate).
This means that raising an argument that damage or destruction from a tsunami is covered by earthquake because a tsunami does not happen without an earthquake will be futile in light of the specific exclusion under the earthquake endorsements.
The kind of coverage that would be necessary would be flood or other water damage coverage, since the water exclusion in all three of the ISO causes of loss forms specifically excludes, among other losses, flood and waves (including tidal wave and tsunami).
The flood coverage could either be that available from the National Flood Insurance Program (NFIP), or the Flood Coverage Endorsement CP 10 65, which can be used in conjunction with the NFIP coverage or separately and covers losses not otherwise covered by the NFIP. For example, the NFIP does not include consequential losses. When the Flood Coverage Endorsement is issued, however, it also can apply to the loss of business income or extra expense coverage forms.
If a business had the flood coverage under the above endorsement but no earthquake coverage, it would still have coverage for damage or destruction by a tsunami. Any argument that no coverage applies under that endorsement because a tsunami is a natural consequence of an earthquake would be thwarted by this Flood Coverage Endorsement CP 10 65.
The reason is that one of the provisions of this endorsement states that to the extent a tsunami causes the overflow of tidal waters, the exclusion of earthquake does not apply. The apparent rationale for this statement is so that an insurer does not deny coverage by maintaining that but for the earthquake, the tsunami would not have occurred.
Another way to obtain flood (tsunami) coverage might be by purchasing a difference In conditions (DIC) policy. The DIC policy was first introduced when the only causes of loss coverages available were named perils. With the broad coverage provided by the DIC policy (often on a broader scale than what the special causes of loss form provides), and excluding the named perils of the underlying policy, the DIC, in essence, covered the difference between the two policies.
In light of the fact that most commercial property policies are written subject to special causes of loss, the DIC has lost some of its luster and now commonly is viewed as important for purposes of obtaining coverage for various kinds of earth movement and water damage coverages, subject to high deductibles.
The saving grace
Considering that loss of business income coverage can be an expensive proposition for some businesses, particularly dependent properties coverage for international risks, the choice of some businesses might be simply to rely on one of the three causes of loss forms.
All might not be lost in choosing this alternative even when there is a destructive earthquake, or an earthquake followed by a destructive tsunami, if fire or explosion also ensues, and that is common.
The reason is that regardless of the causes of loss excluded by commercial property policies, ensuing fire and explosion commonly remain covered. Looking at the Causes of Loss - Special Form CP 10 30, for example, many of the exclusions make an exception for ensuing fire, such as the nuclear hazard and volcanic eruption exclusions and sometimes also explosion, such as with the earth movement and water damage exclusions.
The intent of any ensuing loss coverage, of course, is to limit coverage to loss or damage solely by that covered cause. While that may be possible in many situations, it is likely to be difficult in a loss such as what took place in Japan, given the magnitude of the destruction by the several perils.
Some large and small businesses do not have the luxury of having spread of risk to the point where they can access multiple sources of suppliers or markets for their goods or services.
To be on the safe side, businesses in this category should consider the purchase of some kind of dependent properties international coverage to protect their loss of business income or extra expenses incurred following a loss at the foreign location.
There are many ways for a business to obtain international coverage for consequential losses. What could be troubling is in determining which of the causes of loss forms should be purchased, along with supplemental coverages such as earthquake, collapse, or flood.
Fortunately, whether the choice of causes of loss is a hit or a miss, most commercial property forms make exceptions to exclusions for loss by fire, explosion, sprinkler leakage and other causes, which often automatically flow from large covered or excluded causes of loss. n
Donald S. Malecki, CPCU, has spent more than 50 years in the insurance and risk management consulting business as a supervising casualty underwriter for a large Eastern insurer, as well as a broker. He currently is a principal of Malecki Deimling Nielander & Associates LLC, an insurance, risk, and management consulting business headquartered in Erlanger, Kentucky.