Since Sept. 11, 2001, American companies have been concerned about the possibility of renewed terrorist activity that could impair business operations, including large losses in business income.
A terrorist strike may damage or destroy a policyholder's premises, but the effects are not limited to physical damage. Governmental orders may be issued that effectively black out operations. And operations need not be nearby to be affected—the 2001 terrorist attacks had financial repercussions across the United States and around the world.
An insured company could suffer significant loss of income. This lost income can be recouped through the business interruption insurance provision commonly present in commercial property insurance policies. Insured companies should examine the language of their policies.
The scope of available coverage was materially affected by the Terrorism Risk Insurance Act of 2002. The act requires property and liability insurers to offer coverage for acts of terrorism. In exchange for covering terrorism losses, the government would cover 90% of covered losses up to an annual aggregate of $100 billion.
There are three catches, however:
- The insurer may increase the premium for including this coverage and, if the policyholder elects not to pay, the exclusion will be reinstated.
- The government may impose a 3% surcharge on the policy premium.
- By limiting the insurer share to 10% of the loss and limiting the federal government share to $100 billion, the policyholder may become uninsured for most of the loss.
But merely reinstating the coverage does not guarantee payment. Even though the insurer might be liable for only 10% of a loss subject to applicable limits, it would surely raise various defenses to coverage. Thus, an understanding of these issues is essential to the policyholder's decision on whether to reinstate coverage.
Under business interruption insurance provisions, the insurer agrees to compensate the policyholder for income lost or diminished due to an interruption of business caused by covered property damage. This coverage is intended to protect earnings the insured would have enjoyed absent the interruption. Covered risks commonly include power failures, explosions, accidental damage to machinery and riots. Other policies cover "all risks." Depending on the policy language, this insurance may cover terrorism losses, whether caused by physical attacks or through computer hacking.
While some policies provide coverage without property damage—for example, event and trade cancellation coverage covers "loss arising out of the cancellation, interruption or postponement of an event due to any material reason that is beyond (the policyholder's) control, including reduced attendance"—most other products contain a "physical loss or damage" clause, requiring a covered physical loss or damage to a specified property, usually the policyholder's premises.
This is easily satisfied when a terrorist attack destroys a company's building. But when the interruption results from a governmental order to evacuate due to an attack on nearby buildings, there is an issue of whether there has been damage to "covered property."
Sometimes, the policy expressly covers situations in which the civil authority blocks access to the covered property due to direct damage to other property. In other instances, courts find coverage even where there was no such provision reasoning that physical damage to the covered location is not necessary or that the policy did not explicitly require physical damage.
But other courts deny coverage by strictly construing the "physical loss or damage" language and holding that a governmental order does not equate to property damage.
The "physical loss or damage" provision is also pertinent when computer hacking leads to an interruption in business. Insurers argue that hacking is not physical damage or that loss or damage has not yet occurred.
Companies must re-examine their business interruption coverage language to ascertain whether it will suffice in the event of a terrorism-related or computer hacking catastrophe. And they need to carefully consider whether the additional premiums warrant the rather limited coverage that will be forthcoming.
Scott P. DeVries is managing partner and Yelitza V. Colon is an associate in the San Francisco office of the Los Angeles-based law firm of Nossaman Guthner Knox & Elliott L.L.P.
Usage permission provided by BUSINESS INSURANCE. Issue of March 31, 2003, copyright 2003. Crain Communications Inc. All rights reserved.