EFFECT OF POST-LOSS ECONOMIC FACTORS IN MEASURING BUSINESS INTERRUPTION LOSSES

1. EFFECT OF POST-LOSS ECONOMIC FACTORS IN MEASURING BUSINESS INTERRUPTION LOSSES

2. Panelists: Joseph D. Jean, Esq. Lowenstein Sandler PC 1251 Avenue of the Americas New York, NY 10020 646-414-6906 jjean@lowenstein.com Karen Cusato, CPA, CFE Cusato Consulting, LLC 606 Post Road East #505 Westport, CT 06880 917-273-1096 karen@cusatoconsulting.com Gregory D. Miller, Esq. Podvey, Meanor, P.C. 1 Riverfront Plaza Newark, NJ 07102 973-623-6238 gmiller@prodvey.com

3. The Problem and Context of the Measurement Issue Under ordinary, non-catastrophic circumstances, how a business was performing prior to the loss event is usually an accurate predictor of how that business would have performed if it had not suffered any trigger damage. However, pre-loss performance may not be an accurate predictor of how a business would have performed following a catastrophic event.

4. Is Pre-Loss Performance An Accurate Predictor Of How A Business Would Have Performed Following A Catastrophic Event? Changes in Markets Supply and Demand Population Shifts Short Term Conditions v. Long Term Conditions Relationships Between an Insured and its Competitors

5. Should post-loss economic changes be considered in measuring business interruption loss, or should such changes be excluded from the calculation and instead be measured strictly against pre-loss earnings levels?

6. BUSINESS INTERRUPTION MEASUREMENT PROVISION In determining the amount of the Time Element loss as insured against by this policy, due consideration shall be given to experience of the business before the loss and the probable experience thereafter had no loss occurred.

7. BUSINESS INTERRUPTION MEASUREMENT PROVISION In determining the amount of the Time Element loss as insured against by this policy, due consideration shall be given to experience of the business before the loss and the probable experience thereafter had no interruption of production or suspension of business operations occurred.

8. The Competing Lines of Authority Post-Loss Economy Ignored v. Post-Loss Economy Considered

9. The Economy Ignored Cases Business interruption loss measured by comparing the actual business experience during the period of interruption against the probable experience during that period had the peril or event not occurred. Looks backward and bases the measurement only against pre-loss business levels, without regard to the impact of actual post-loss conditions on the economy, market or demand. See, e.g., Prudential LMI Commercial Ins. Co. v. Colleton Enterprises, Inc., Table 976 F.2d 727, No. 91-1757, 1992 U.S. App. LEXIS 25719, at *8 (4th Cir. Oct. 5, 1992); Am. Auto. Ins. Co. v. Fisherman’s Paradise Boats, Inc., No. 93-CV-2349, 1994 U.S. Dist. LEXIS 21068 (S.D. Fla. Oct. 3, 1994); Consolidated Companies, Inc. (Conco) v. Lexington Ins. Co., 616 F.3d 422 (5th Cir. 2010).

10. The Economy Ignored Cases Some courts equate the phrase “had no loss occurred” with “had no hurricane occurred,” as opposed to “had no insured physical loss or damage occurred.” Result: Policyholder’s business interruption claim is measured based solely on pre-loss projections; unable to reap benefits of what would have been increased revenue.

11. The Economy Considered Cases Business interruption loss measured by comparing the actual business experience during the period of interruption against the probable experience during that period had the insured or other “trigger” damage not occurred. Seeks to place the business in the position it would have occupied in the absence of physical damage had it been operating in the actual, post-loss environment. See, e.g., Levitz Furniture Corp. v. Houston Casualty Co., No. 96-CIV-1790, 1997 U.S. Dist. LEXIS 5883, at *7 (E.D. La. April 28, 1997); Stamen v. Cigna Property and Casualty Ins. Co., Case No. 93-1005-CIV-Davis (S.D. Fla. June 13, 1994).

12. The Economy Considered Cases Some courts equate the phrase “had no interruption of production or suspension of business operations occurred” with “had no insured physical loss or damage occurred,” as opposed to “had no hurricane occurred.” Some courts also equate the phrase “had no loss occurred” with “had no insured physical loss or damage occurred.” Result: Policyholder may consider changes in economic environment in measuring business interruption claim; permitted to reap the benefits of what would have been increased revenue. See, e.g., Stamen, Conco.

13. HYPOTHETICAL NO. 1 Limited Service Hotel Chain. Location damaged by earthquake - Period of Interruption of 12 months. Location experienced an average annual occupancy rate of 75% for the 3 year period preceding the event. Influx of temporary workers in response to earthquake recovery efforts in the region (e.g., adjusters, consultants, etc.).

14. CON’T HYPOTHETICAL NO. 1 Policyholder alleges that it would have achieved 100% occupancy if it had been open because of the increased demand for rooms following the earthquake due to influx of temporary relief workers (Economy Considered). Insurer alleges that allowing such a recovery results in “windfall profits” for the insured, as compared to merely putting the insured in the earnings position it would have been (75% occupancy) had the earthquake not occurred (Economy Ignored).

15. HYPOTHETICAL NO. 2 Full Service Luxury Hotel Chain in business. Location also damaged by earthquake - Period of Interruption of 12 months. Location also experienced an average annual occupancy rate of 90% for the 3 year period preceding the event. Immediately prior to loss, forecasted that occupancy level would have remained the same during the following 18 months. Location attached to a Convention Center that suffered major earthquake damage and will be closed for at least 12 months. If insured was operational, it would have experienced a significant decrease in revenue due to the location’s reliance on convention business.

16. CON’T HYPOTHETICAL NO. 2 Policyholder alleges that it would have achieved 90% occupancy had the earthquake not occurred (Economy Ignored). Insurer alleges that allowing such a recovery results in “windfall profits” for the insured, as compared to merely putting the insured in the earnings position it would have been had no insured physical loss or damage occurred (Economy Considered).

17. Neither the Economy Ignored nor the Economy Considered methods of measuring Business Interruption Losses consistently benefit the insured or the insurer, but rather the outcome relies on the unique facts in each case.

18. HYPOTHETICAL NO. 3 Medical diagnostic company suffers physical damage by hurricane. New Location: Insured only open for 6 months. Insured projected 8% annual increase in earnings. Policy includes contingent/dependent time element coverage. Population exodus. Period of Interruption –12 months. Extended Period of Liability – 180 days.

19. CON’T HYPOTHETICAL NO. 3 Insurer argues Economy Considered – Need to account for reduction in population. Even if Insured has not suffered any physical damage, sales would have decreased. Insured argues for Economy Ignored – Population exodus is irrelevant. But for hurricane, it would have experienced 8% increase. Issue: Projecting sales in young company with little to no historical sales figures.

20. HYPOTHETICAL NO. 4 Major manufacturer of sheetrock damaged by fire. Period of Interruption of 12 months. Prior to loss, operating at a loss due to excess supply. Due to plant’s shutdown, the national wholesale price of sheetrock increases.

21. CON’T HYPOTHETICAL NO. 4 • Economy Ignored – BI loss based on negative operating earnings. • Economy Considered – Same result, since change in wholesale market price caused solely by the physical damage to the insured’s facility. • Insured cannot take advantage of inflated price because results in true windfall.

22. HYPOTHETICAL NO. 5 Oil and gas refinery is directly supplied by a pipeline owned and operated by a major oil and gas producer. Pipeline supplying refinery is damaged by mudslides – 3 months to repair the damage. Cost of unrefined oil increases because of reduced supply. As unrefined oil prices increase, the refinery’s profit margins decrease. Policy includes contingent/dependent time element endorsement.

23. CON’T HYPOTHETICAL NO. 5 • If Insured argues for Economy Ignored, BI loss based on profit margins before damage to supplier’s pipeline. • Windfall because loss should be based on reduced margins that exist following the loss. • If Economy Considered followed, the result is the same. • Goal: Place Insured in position it would have been in had the coverage triggering physical damage not occurred. • Had the pipeline (i.e., coverage-triggering property) not been damaged, its profit margins would have been greater. • Economy Ignored and Considered have the same result because the economic change being considered is a direct detrimental change in the insured’s business caused by a covered event.

24. BUSINESS INTERRUPTION MEASUREMENT PROVISION “Business Income” is to be determined by: (1) The Net Income of the business before the direct physical loss or direct physical damage occurred; (2) The likely Net Income of the business if no physical loss or no physical 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 See, e.g., Rimkus Consulting Group v. Hartford Cas. Ins. Co., 552 F. Supp. 2d 637, 640 (S.D. Tex. 2007).

25. Practice Pointers Understand policy before the loss. Plan ahead. Understand what law might apply. Does consistency matter? Evidentiary issues. Other policy considerations.

26. QUESTIONS?

27. Policyholder Counsel: Joseph D. Jean, Esq. Lowenstein Sandler PC 1251 Avenue of the Americas | New York, NY 10020 Tel: (646) 414 6906 | JJean@lowenstein.com

28. Insurer Counsel: Gregory D. Miller, Esq. Podvey, Meanor, P.C. 1 Riverfront Plaza | Newark, NJ 07102 Tel: (973) 623 6238 | gmiller@prodvey.com

29. Forensic Accountant: Karen Cusato, CPA, CFE Cusato Consulting, LLC 606 Post Road East #505 | Westport, CT 06880 Tel: (917) 273 1096 | karen@cusatoconsulting.com 29