Business Interruption Claims for the Hospitality Industry—Is Your Hotel Protected?

What Is Business Interruption Insurance?

Business interruption insurance exists to help a business return to the financial position it was in prior to the catastrophe that triggered the loss. Generally speaking, most policies compensate the hotel for revenues lost during the "period of indemnity," less expenses that do not continue during that period ("noncontinuing expenses"), plus "extra expenses" incurred.

This seems simple enough in theory, but in fact there are numerous variables that influence each claim, such as insurance policy limits and sublimits, terms of the policy, nature of the loss, and specifics about the hotel and market it serves.

Period of Indemnity

The period of indemnity is the period of time following a loss during which the hotel can, with "due diligence and dispatch," return to the condition that existed prior to the loss. Many hotels recognize that losses may persist even after repairs are complete—as the property works to regain bookings and rebuild market share—and obtain additional coverage for an "extended period of indemnity."

Situations sometimes arise that can make the period of indemnity difficult to determine. What if the owners want to rebuild the property differently than it existed before the loss or decide not to rebuild at all? Another example was the impact on a hotel destroyed by the World Trade Center tragedy. What should the period of indemnity have been for the hotel, where the time to complete repairs was significantly affected by the investigation? Furthermore, what if there is a shortage of labor and materials, such as after Hurricane Katrina? These unique situations can extend the time needed to rebuild and cause disputes regarding the loss period that is covered by the policy.

Lost Rooms Revenues

The two primary factors that influence lost rooms revenues are occupancy percentage and average daily rate (ADR). There are a number of factors to consider in business interruption losses regarding each of the following areas.

• What occupancy and ADR did the hotel expect to realize during the period of indemnity had the loss not occurred?
• Are the projected occupancy and ADR supported by occupancy trends in the specific market? This information may be available from authoritative sources, such as Smith Travel Research, which tracks and reports occupancy and ADR for a competitive set of hotels in the geographic area.
• Can the hotel document canceled reservations "on the books," including conferences, events, and other reservations? (If bookings prior to the loss are higher than bookings a year ago, that may indicate that the trend would have continued in the coming year.)

One issue facing many policyholders, and hotels are no exception, is an often misconstrued wording in an insurance policy that addresses "loss of market." For example, suppose that a resort hotel is on an island, and the entire island is wiped out by a hurricane. Can an insurer contend that the hotel has no insured loss since there was a complete loss of market (i.e., no tourists are coming to the island any more)?

Many other factors should be considered in preparing a claim and developing revenue projections. Consider the following examples that raise interesting questions.

• A hotel is stuck in a deep local recession. The hotel prepares a rolling forecast that reflects a continued pessimistic look of the economy. Then, suppose the hotel suffers a fire that requires 2 years to rebuild. If the economy recovers during that time, is the insured hotel stuck with preparing a business interruption claim based on the original forecasts?
• A hotel is damaged by a hurricane, which also destroys the competitor's hotel next door. Can the business interruption claim projections reflect the uptick the hotel would have received if the hotel was not damaged while the competitor's hotel was destroyed?
• An island hotel is damaged by a hurricane, and the airport is also damaged, resulting in a reduced number of flights to the island. How should the claim reflect the losses resulting from the airport damage versus the hotel damage?
• A hotel/casino suffers a fire that damages half of the rooms. The casino is not damaged. Does the policy provide coverage for the loss of casino revenue?
• A hotel is adjacent to an independently owned casino that suffers a fire, and the hotel is undamaged. The casino owner decides to rebuild the casino twice the size of the old, and it will take much longer to rebuild. Assuming the hotel has contingent business interruption coverage (that covers an interruption of business due to damage or destruction of the casino), how will the loss be measured? (On the one hand, the hotel will lose revenues while the casino is being rebuilt—including the additional time required to expand the size—but on the other hand, the hotel may benefit by having a larger casino when it does reopen.)
• The risk manager for a large Real Estate Investment Trust that owns hundreds of hotels operated under the same brand receives notice from the General Manager of one location that the property has significant bedbug infestation. The property is closed for 3 months for cleanup and repairs, and other hotels suffer losses due to the negative publicity for the brand. Does the insurance policy respond to these losses? If so, how are they measured?

Other Lost Revenues

Ancillary revenues including food and beverage, conferences, retail, golf, spa, and other revenues can constitute a significant portion of a hotel's revenue stream. When an interruption of business occurs at a hotel, any or all of these sources of revenues are also typically interrupted in addition to room revenue. It is important to analyze each revenue stream and consider how much revenue would have been generated based on seasonality, market conditions, groups, and other factors related to the specific hotel had the loss not occurred.

Ownership Issues

A challenging situation can arise when several owners share in one policy. Suppose a large hotel operator has two properties in Chicago, but the properties have two different owners. One property has a fire. The other property realizes higher occupancy as it picks up some of the business from the first property. How should the loss be measured? Is the insurable loss at the damaged property reduced by the "make-up" of business at the other property?

Another issue can arise when a hotel has a contractual arrangement, as is often the case, with a management company, asset manager, and/or hotel "brand, " any of which may receive fees from the hotel that are in some manner tied to revenues or profits. In such instance, would the contractual party be entitled to any of the business interruption proceeds, and, if so, how could this best be addressed in the business interruption claim? Typically, the various parties protect their rights to recovery by having all parties listed as "named insureds" on the policy.

Ordinary Payroll

Ordinary payroll coverage is a common endorsement in many policies that provides coverage if a policyholder wants to retain key hourly employees who are idled after an incident and unnecessary to continuing operations. Suppose a hotel loses one-half of its rooms in a fire, but still needs to retain certain hourly employees (e.g., front desk staff, accountants, bell stand, restaurant staff, etc.) If the hotel has only 30 days of ordinary payroll coverage, is the labor inefficiency covered during the first 30 days? After the first 30 days?

Extra Expenses

Most policies typically allow a hotel to claim extra expenses incurred during the period of indemnity that are necessary to carry on operations and/or minimize the amount of the loss. Consider the situation where, after a major fire closes a hotel for a period of 6 months, management wants to spend $100,000 to have a "grand reopening" to demonstrate to the world that the property is back and is better than ever. Further, the hotel expects that this will improve its occupancy in the immediate months after reopening. Should these costs be covered under the hotel's insurance policy?

Conclusion

Business Interruption claims are complex for several reasons. First, they involve predicting the future. For a hotel, what would the occupancy rate, ADR, and cost structure have been had there been no incident? Second, they also involve important and often disputed coverage issues—how does the hotel prepare the claim so that it is in accordance with the terms of the policy?

Hotel owners and operators are well served to address these critical issues in advance. A well-thought out risk strategy that includes input from the hotel's risk manager, insurance broker, a forensic accountant specializing in insurance claims, and a respected insurance coverage attorney can make a significant difference at a time when the coverage is most needed.