By Allan Manning
A large number of business interruption claims arose as a result of the gas crisis in Victoria, Australia in 1998, which highlighted the inherent problems associated with time deductibles. Losses arising from failure of supply from public utilities continue to occur each week for a variety of reasons across our region. The purpose of this paper is to highlight some of the many problems that can arise with the interpretation of various time deductibles. A second equally important purpose is to offer suggestions for alternative forms of deductible that may assist each party to the insurance contract, in understanding their respective position in the event of a loss.
Case Study 1 is in respect to a large manufacturer which has a Section 2 deductible of "3 business days". The loss of seven days production caused by the gas outage may well be made up by working weekends and public holidays between the date when the gas supplies resume and the end of the year. The loss is therefore likely to be confined to the increased costs of working associated with making up the lost production.
As a loss adjuster, my position has been that regardless of when the costs are incurred, they should be matched to the benefit that the increased costs have generated. For example, if within the first three days the Insured had incurred significant costs, say several million dollars, to convert their production facilities to run on LPG rather than natural gas, but the benefit for this was outside the first three days and therefore to the entire benefit of the Insurer, then the Insurer would meet the entire cost of the increased costs of working. This is logical, even though it was incurred during the first three days. Conversely, any costs associated with making up lost production suffered in the first three days by way of overtime etc, should be at the expense of the Insured; the first three days being the period of the time deductible.
In this case, the claims preparers are arguing that there were no lost sales during the first three days and, as such, there is no loss suffered by the Insured. They go further to argue that as the Insured stood down employees during this period, there were savings made, but as these were made during the three day deductible, they cannot be taken into consideration in adjustment of the claim. This turns the deductible into a positive benefit to the Insured, as the Insured is being asked to meet all the additional costs to make up the lost production, but will not have the benefit of the savings made during the period, as these will be to the Insured's own account.
This is a nonsense argument, but highlights the problems that can arise in adjustment of a claim involving a time deductible. The lesson to be learnt from this case is that how the deductible is to be applied must be clearly stated in the policy.
Case Study 2 involves another large manufacturer. The wordings for the time deductible contained within the Public Utility clause states that cover does not commence until "24 hours after cessation of supply". To avoid major damage to the insured plant, the gas supplier allowed the Insured to implement a staged shutdown of the gas supply that, over the site, took 11 hours to complete. In other words, 11 hours passed between the shutdown of the gas supply to the first machine and when the shutdown was effected to the last machine. Does this mean that the Insured in fact suffers a 35-hour time deductible? That is, 24 hours from the cessation of supply, plus the 11 hours of disruption the Insured suffered during the shutdown process. The question of what sales were lost during the period, etc is also being introduced.
Case Study 3 involves a wording which states that the policy will not cover losses within the first 24 hours.
In many cases of smaller commercial and industrial premises, the Insured was not advised to shutdown their gas until after 5.00pm on Friday, 25 September. If they had no planned production within the next 24 hours, they suffered no losses and, as such, the time deductible will not apply. Had the shutdown occurred at the same time on Sunday, Monday, Tuesday, Wednesday or Thursday, then a deductible would have applied.
However, taking restaurants as an example, Friday and Saturday evenings are often their busiest nights. They therefore are penalised by pure chance if the loss occurs on a Friday or Saturday. For them, if the loss occurred on a Sunday or Monday, the reduction in the claim due to the application of the deductible would be much less. Rather than know their respective positions when a loss occurs, it could be said that the Insurers and operators of businesses that do not operate 7 days a week, are both playing Russian Roulette with 5 bullets in a 7-chamber gun.
So what is the answer? I would suggest that there are several, and I would like to explore three of these.
Option 1 is to replace the excess with a franchise. If the insured business is disrupted, whereby an event covers a period of less than the franchise of say one, two or three days, the loss will be at the full expense of the Insured. If it extends beyond the period of the franchise, then the entire amount would be met by the Insurer. This would mean that the Insured would carry the risk for minor periods of disruption, but beyond that, they would have the comfort of having full insurance subject to adequacy of insurance etc.
Option 2 is to apply a monetary deductible which both the Insured and Insurer know and understand in advance. I would suspect that this would be easier for the Underwriter to underwrite, and the Insured would be in a much clearer position to know the effect of the deductible in the event of a claim. It would also reduce the stress and claims handling costs following a loss.
Option 3 is simply a combination of the first two. The monetary deductible would apply after the franchise period had lapsed.
While space limitations have only allowed three case studies to be provided, Underwriters and claims staff involved in the handling of any business interruption claim with a time deductible can provide similar examples of complications arising when time deductibles are interpreted. At the very least, time deductibles need a review to incorporate clear details in the policy as to how the deductible should operate. Alternatively, the deductible should be replaced with a franchise, a set monetary deductible or a combination of both.
Food for thought to improve what, in the main, is a very good product.
This article featured in Allan Manning's popular publication titled Business Interruption Insurance & Claims: A Practical Guide to Business Interruption Insurance for Business Managers, Insurance Brokers and Agents.