A case in point: Amerigraphics, Inc. v. Mercury Casualty Company
Settlements on Business Income forms have been challenging under “normal” conditions. But now with the state of the economy earmarked by businesses closing doors or just surviving we have new challenges to deal with. The first question is whether we, as insurance agent/brokers, should be offering business income insurance to a business client that is not making a profit and the second question is how this economy has changed how claims are being settled. Both of these questions are difficult to answer definitively but we can certainly shed some light on some of the considerations we have to take into account.
Starting with the basics, the following language is the definition of Business Income in the industry standard ISO form CP 00 30:
“Business Income means the:
(i) Net Income (Net Profit or Loss before income taxes) that would have been earned or incurred if no physical loss or damage had occurred, but not including any Net Income that would likely have been earned as a result of an increase in the volume of business due to favorable business conditions caused by the impact of the Covered Cause of Loss on customers or on other businesses; and
(ii) Continuing normal operating expense incurred, including “payroll expenses.”
At first reading this definition appears to be straightforward but is far from plain language when there is a claim dispute. Let’s begin with the premise that an insurance policy is not intended to make an insured any better than they were prior to the loss. Let’s continue that thought by asking whether an insured who is operating at a loss should be paid their continuing operating expenses in their totality when, in fact, they could not have afforded those expenses in the absence of the loss. Looking more carefully at the two paragraphs in the definition we need to determine if they are “grammatical” statements as stand alone concepts or are they “mathematical “ and are dependent on one another to determine a settlement. Will the insurance company pay all of the continuing operating expenses or reduce them to the extent the insured is operating at a loss? Not easy questions—not easy answers!
Our previous way of looking at these two statements has just taken an about face based on a recent California appellate case that overturned a long standing interpretation of the application of the definition of “business income” in a case where the insured was operating at a net loss. The case is Amerigraphics, Inc. v. Mercury Casualty Company, 2010 Cal. App. LEXIS 377 (Cal. App. 2nd Dist. March 23, 2010). The facts of the case involved a building that was leased by Amerigraphics, a printing/graphic design operation, that was flooded with resultant damage to Amerigraphics’ printing equipment, other equipment and tenants improvements and betterments. Amerigraphics made claim under both their property policy and business income coverage. While the property claim was under dispute, the business income claim presented an even bigger problem; to wit whether the insured could make a claim for business income when their actual operating loss was less than the projected operating loss?
Mercury denied business income coverage based on this very argument and Amerigraphics filed suit against Mercury with the result that in a pre-trial judicial determination the court ruled that Mercury’s interpretation was incorrect and that the “projected” operating loss should not have been offset against the actual continuing operating expenses. In simple terms the court ruled that all of the continuing operating expenses should have been paid and not offset by the loss treating the two paragraphs of the definition as separate statements rather than dependent upon one another. The trial court thereby construed the policy in favor of a “plain language” interpretation by an “ordinary” insured to conclude that in the event of a covered loss that forced the complete suspension of its business operation, the policy would provide coverage for any lost profits, and even if there were no lost profits, for ongoing expenses incurred during the period of suspension. If the court had not interpreted the language this way then the insured would be denied benefits under the policy for coverage of its “normal continuing operating expenses”. The courts stated that the two paragraphs are really two different and distinct coverage’s.
Prior court decisions in other states, involving the same coverage form, came to a different conclusion. In Liberty Mutual Insurance Co. v. Sexton Foods Co., a 1993 Arkansas case and Continental Insurance v. DNE Corp., a 1992 Tennessee case, both courts held that the language in the policy required that projected operating losses should be subtracted from the continuing normal operating expenses. The Tennessee court said it best: That to ignore a net loss “…would put the insured … in a better economic position from having its business interrupted…” than if no loss had occurred.
The California court dismissed these prior rulings by stating “…we are not bound by out-of-state authorities and the resultant impact of this decision is to put the insured in a better financial position than if no loss had occurred – the very antithesis of a normal contract of indemnity.
The national result of the California decision is hard to predict at this time. Other states could consider this decision or could leave California in isolation with this unusual decision. The policy drafters could also use this case to make changes in future editions of the coverage. Many courts look to California to take the lead on these types of decisions
Back then to the first question of this article as to whether we, as insurance agent/brokers, should be offering business income insurance to a business client that is not making a profit. There are a couple of thoughts as relates this question. First, I think we should be offering the coverage as there will be many situations for which the policy would respond. Second, while the insured may be operating at a loss when we write the policy their situation could improve and we would use that information for the loss projections. Third, the financial loss could be partly a function of the financial statement and not be of issue in the settlement. And last, based on this decision, the form could provide them with the continuing operating expenses during their suspension if the loss occurred within California jurisdiction.
The second discussion area of this article is how this economy has changed how claims are being handled and settled. In speaking with Robb Greenspan, SPPA, Partner in the Public Adjusting firm of The Greenspan Co./Adjusters International, he identified there is conflict in the settlements based on “projected” income and the effects of vacancies and un-occupancies of buildings. Business Income forms provide that in determining loss, due consideration shall be given to: “the earnings of the business before the dates of damage or destruction and to the probable earnings thereafter, had no loss occurred…” In a weakening economy the insurance companies are taking the position that the economy is only getting worse; they are reducing forecasts of future income; downplaying any argument for increases and looking at a shorter window of pre-loss income for projection purposes. While in the past the companies would take into account prior income from two years prior to the loss, now the companies are cherry picking the prior period they wish to base the income projection on so as to get a better ( lower) projected income loss. All of this makes it very difficult for an insured to “estimate” in any positive light what they could have earned had not loss occurred because of the impact of a downturned economy.
Vacancy weighs heavy on the denial of claims from several angles. The first one is coverage driven based on perils. As the Business Income Coverage form is attached to a Cause of Loss form then any exclusionary language would then follow to coverage under Business Income. Specifically if coverage is denied for a vandalism loss because of prolonged vacancy then that denial would follow through to the Business Income loss. The old argument that an insured could have rented a unit or space that was vacant prior to the loss is falling on deaf ears in the reality of the national vacancy rates. Another impact of vacancy concerns the Business Income adjustment. Should the building owner have a loss, where the building was completely occupied by tenants, many insurance companies are looking at the lease terms, lease termination dates and the types of tenants business and questioning whether the tenants would have continued at the same rent during the restoration period or even if they would have continued at all. A number of agents and their clients have experienced this in recent losses and while most of the clients ended up receiving full compensation for their loss of rents, the adjusting process was less than smooth and increased the proof requirements substantially. . Many insured who would not in the past seek the help of Public Adjusters on their claims now find they need to bring one in to offset the skills the Forensic Accountants have that the carriers employ to protect their interests by reducing claim payments in the claims adjustment.
The questions and concerns we have discussed in this article will be ongoing. The downturned economy will continue to weigh heavily on claims settlements and more and more cases will be brought to court due to unsatisfactory settlements. Only time will tell how this will all turn out but keep a watchful eye on new developments and decisions.
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