Chapter seven
Managing non-physical damage business interruption

Physical Damage vs Non Physical Damage

 Traditional Business Interruption cover is triggered by property damage however we’ve seen an increase in cases where businesses are disrupted even though there was no physical damage at their premises.

For example an important supplier suffers physical damage but your own premises have none. In this circumstance, you could potentially be left uninsured.

In response to this, insurers can expand cover to allow clients to “deem” the damage to the supplier’s premises to be damage to the insured premises. This can extend to instances such as infectious diseases, damage to an airport runway, Loss of Attraction or cyber for example.

This is simple to execute and was actually done back in the 60s, 70s and 80s. However cover is often provided by extension resulting in hybrid versions of the original BI policy which in turn can result in claims uncertainty. Oftentimes it’s better to go back to a simple tried and tested version that is clear and transparent to all parties.

Back to basics

At Swiss Re Corporate Solutions, what we have done is go right back to the basic cover, we’ve put a few words in it as we can, so a ‘less is more’ approach. Then we’ve made it quite simply something that you can bolt additional cover onto.

These days, people would say, ‘Well, I’m not happy with just fire explosion’ or ‘I’m not just happy with the standard all-risks policy, I would like terrorism cover. Can I do that?’ ‘Can I bolt that onto the policy?’ ‘I’d like cover for machinery breakdown. Can I bolt that on? And so on.

Even things like key man insurance. If a client is running a small business, and it’s dependent upon one or two very key individuals, if one of them gets knocked over, one or both of them are killed in a road accident or otherwise, or another sort of event befalls them, could that client make a claim on the business and direction policy? The strictest answer would be, “Well, no you can’t, because the policy is only triggered by insured damage, and the loss of two men is not insured damage.”

However, if you go back to basics, you can actually come up with a clause that says, ‘In the event that the key men named in this policy are injured, or unable to work, or are killed in any accident, that shall be deemed to be damage to property at the insured premises and the policy will be triggered.’ So you can deem anything. You can deem even cyber-attack.

Cyber-attack is questionably not damage to tangible property and there are legal arguments around that. But there are ways around this. You could deem within your policy ‘Cyber-attack on this organisation shall be deemed to be damage to property insured under the policy,’ and straightaway you’ve got the policy triggered. You don’t need to touch your business interruption wording.

Theory versus practice
Natural disasters can cause wide area damage and the tourism industry can be especially affected with losses having the potential to impact business earnings outside the area physically affected.

Without property damage however, a traditional Business Interruption policy will not respond and businesses can be faced with significant losses to their revenues in the case of a large Nat Cat event.

Clearly defining the differences with clients is the first step in making sure the policy fits the client’s needs. It comes down to definitions. Any business interruption that resulted from physical damage is covered and that’s been the traditional way of doing things.

Traditionally, it was easy to tell if physical damage had occurred, and it was relatively easy to assess the business interruption coverage actually resulting from that physical damage. There was some sort of correlation between the two. But now, if we are talking about non-physical damage, it is a new and relatively untested area for clients and new territory for insurers.

Deciding how much business interruption coverage is justified from this non-physical damage is difficult for both parties. There are norms in terms of trying to quantify what an insurer’s exposure is as an underwriter, because there’s no physical connection between that business interruption and something like physical damage.

Misunderstanding of what is and is not covered is a common tug-of-war between insurers and insureds. While most laypeople understand the basic concepts of what is covered by insurance, the devil is in the detail and the detail is where the most common pitfalls occur for clients in my experience.

One of the biggest problems is making sure that everybody has a similar understanding of what is covered when it comes to non-physical damage. Again, with the older, traditional policies, it’s pretty easy to determine when physical damage has occurred, because something has burned, or something has fallen down, or something has been flooded, or whatever.

When we are talking about non-physical damage, which maybe a consequence of a threat of a terrorist incident, which has an impact on the number of visitors to a hotel, how do the insurer and the insured actually quantify that and does everybody have exactly the same understanding of what is covered and what’s not. There’s much more room for interpretation of the loss of revenue, or the business interruption that a client would be subject to from an incident like that.

Case study: Cyclone Pam and a Pacific Island hotel
The Insured operated a hotel on a Pacific island, which in 2015, was hit by Cyclone Pam as it swept across the islands causing wide spread damage. Their policy provided cover for the Loss of Gross Profit over a Maximum Indemnity Period of 36 months and while the hotel was reinstated in June 2016, turnover did not return to pre-loss level.

What was the challenge?
Tourism is an important part of the economy for the island and as a result of the wide spread damage to the islands, there was a significant dip in visitor arrivals with total visitor numbers dropping 19% following the cyclone. Therefore, the Business Interruption Loss sustained by the Insured was not solely a consequent upon physical damage to the Insured’s property as a result of the cyclone but also:

• The falling visitor numbers directly impacted by the cyclone event.
• Issues with the local airport runway, which resulted in reduced flights to the island.

Being one of the largest hotels on the island, its occupancy is closely correlated with the number of visitor arrivals. As such, the tourism statistics obtained from
the Government were used to measure the Standard Occupancy. This approach excludes additional factors that impact the Insured’s Turnover other than as a result of damage to insured property.

What was the impact?
As the Insured’s policy did not have a Loss of Attraction extension, the impact of falling visitors and a reduced market was factored in to reduce the amount payable.

Lessons to be learnt

• Particularly in Nat Cat prone zones, consideration should be given to the likely consequences of the natural disaster and how the business will be affected directly and indirectly when choosing the appropriate policy, extensions and Indemnity Period.

• Basic Business Interruption Insurance policies while covering the Insured for losses arising from interruption to their business as a result of damage to the Insured property, typically do not provide sufficient cover in the event of wide area damage where financial losses can be incurred where these occur not as a result of damage to the Insured’s property, but as a consequence of the event itself.