Contingent Business Interruption: Getting All the Facts

What Is CBI Insurance?

Contingent business interruption insurance and contingent extra expense coverage is an extension to other insurance that reimburses lost profits and extra expenses resulting from an interruption of business at the premises of a customer or supplier. The contingent property may be specifically named, or the coverage may blanket all customers and suppliers. CBI insurance is also known as contingent business income insurance or dependent properties insurance. Sometimes the term "contingent time element" is used when discussing both CBI and contingent extra expense. Time element simply refers to either business interruption or extra expense coverage. Companies purchase this type of insurance as an extension to their standard property insurance. Coverage is usually triggered by physical damage to customers' or suppliers' property or to property on which the insured company depends to attract customers. The type of physical damage must be the same as insured under the controlling policy.

There are four situations in which this coverage is widely used.

• When the insured depends on a single supplier or a few suppliers for materials.
• When the insured depends on one or a few manufacturers or suppliers for most of its merchandise.
• When the insured depends on one or a few recipient businesses to purchase the bulk of the insured's products.
• When the insured counts on a neighboring business to help attract customers, known as a leader property.

CBI insurance can reimburse the policyholder in each of these situations, covering the interruption in the insured's business caused by a peril specified in the policy causing physical damage or loss elsewhere. However, CBI coverage does not protect against the interruption of the same insured's company's business from damage to its own plants or third-party plants.

It is not necessary that the customer or supplier property be totally shut down to cause a contingent business interruption loss to an insured. All that is necessary is that an insured loss occurs at the type of location covered under the policy and that the insured's business be interrupted as a result.

For example, the manufacturing of a supply of embedded microchips for an insured might be partially interrupted by a fire at the suppliers' plant. The insured may be compelled to suspend production because it can't obtain the chips. Alternatively, it may be put on an allocation of product. In such a case, the insured will have suffered a contingent business interruption loss, even though the supplier has not been shut down.

Another scenario would be when a fire may close the chip plant completely, but the insured has either ample supply or an alternative supplier and may not be affected or only slightly impacted. In this situation, there may be no contingent business interruption loss, unless the insured cannot find another supplier or has to pay a premium to the new supplier. This scenario could lead into contingent extra expense or CBI in an attempt to avert a business interruption loss.

A good technique that can be used to determine whether CBI coverage applies is to consider the contingent business interruption chain rule.

The Contingent Business Interruption Chain Rule

It is important to know what CBI is not.

• Utility service interruption of an off-premises power interruption
• Civil or military authority interruption
• Lack of ingress or egress interruption
• Interdependency or downstream business interruption, when damage at an owned location causes a loss of revenue to another owned location
• Loss which results from a change in temperature due to damage to heating or cooling equipment

Contingent extra expense is just that: extra expense coverage resulting from a contingent loss.

Types of Policies Will Impact Coverages

Insurance policies must be reviewed in detail to determine how coverage would impact any given loss situation. Policies will fall into three categories: standard forms, such as forms from the Insurance Services Office, Inc. (ISO), company forms, and finally broker or manuscript forms. Most Fortune 1000 companies will have either a company or manuscript form; with the ISO form occurring most often with middle market or small businesses. Generally, coverage is broader in company forms than ISO forms and even more comprehensive with broker or manuscript forms. Coverage under CBI endorsements is provided during the "period of restoration," which is the time it "should" take the dependent property to affect repairs or restoration "with reasonable speed and similar quality" and resume normal operation. However, because the premises that have been damaged are beyond the insured's direct control, this presents something of a quandary for both insurer and insured. Access to the damaged property is often not available, thus the insurer has difficulty determining what the reasonable time for restoration should be. The insured may find itself penalized by decisions of a supplier that decides to improve, move operations, or otherwise delay repairs. Further, the period of restoration does not include any additional time it takes the insured to resume normal operations after the dependent location has resumed its normal operations.

Typically, the form will include a "time deductible" in that the "period of restoration"begins a specified number of hours after the time of direct physical loss or damage resulting from any covered cause of loss at the premises of the dependent property. The "period of restoration" generally does not include any increased period required due to the enforcement of any ordinance or law governing repair, reconstruction, or pollution testing or cleanup. The expiration of the policy does not cut short the period of restoration. Some other interesting considerations are that more recent policies contain CBI coverage that covers loss resulting from damage to property owned by others that are not suppliers, similar to the "attractor" coverage cited previously, or that may cover damage to property owned or operated by the insured which is not insured in the policy.

It is generally found that the broader and less restrictive wording in the manuscript forms, as compared to the ISO forms, tends to eliminate the specific naming of contingencies, does not constrain the indemnity period or apply a time based deductible. While wording may become more restrictive after September 11, it is important that companies' key contingencies are not excluded from the policy. An in-depth look at an insured's operations will be necessary to consider wide reaching contingencies.

Oftentimes, contingencies may not be a function of a third party but of an insured's own operations. For instance, companies that maintain massive data processing operations must consider a practicable long-term switch to an alternative system should the data processing unit suffer from a physical loss. If the data processing unit is owned and operated by the insured company, it will not fall under the CBI coverage but rather traditional property and business interruption (BI).

As a result of September 11, many companies are looking to ensure some form of triangulated back-up system. The term triangulation refers to three reference points or three support points. Triangulation is often used to pinpoint the geographic location of a radio transmission or a cellular phone user. Contingency plans that are triangulated will ensure that at least three systems (power, water, communication) are not separate in their grid or supply location to the site.

Litigation and Contingent Claim Challenges of September 11

Historically there are only a few cases that have been decided under a contingent business interruption clause. In Archer-Daniels-Midland Co. v Phoenix Assur. Co., 936 F Supp 534, (July 17, 1996), ADM sought coverage for increased raw materials and transportation costs due to the flooding of the Mississippi River and the resulting crop damage. The federal district court ruled that Midwest farmers and the U.S. government were suppliers of goods and services to ADM. Thus, ADM was entitled to coverage when flooding prevented those suppliers from supplying the company with necessary raw materials and transportation services. The losses from September 11 will likely result in some form of litigation arising from CBI coverage.

Contingent claims from September 11 include damage at an attraction property (World Trade Center) and damage to a variety of businesses and industries that collectively include both suppliers and customers. Further, claims may also include losses as a result of other policy endorsements such as: ingress/egress, civil authority, and service interruption. Many of these losses lack a tangible link to any property damage at the insured's premises. These less tangible loss areas could be a great challenge for the adjuster because they potentially represent areas of increased subjectivity and scrutiny due to information that may not be available to the company (policyholder). Yet, adjusters will be looking for the greatest level of detail to document their claim analysis to the insurance company.

The most obvious difference between a CBI claim and a BI claim is that an insured is not dealing with damage to its facility and will not be handling a property damage claim. However, the documentation requirements for a CBI usually end up being more voluminous than a typical BI claim. The increased documentation is a result of the analysis and documentation that may have to be completed and compiled to identify the loss impact of an event outside of the insured's core business and company records. Ironically, these documentation requirements are not discussed in any policies.

Further, policies emphasize that the policyholder will make available their internal books and records and do not discuss information that is outside of the insured's organization. You need to go beyond the policy to properly document a claim for the insurance company and its representations. (See "Beyond the Policy: Documenting a Business Interruption Claim.") This endless search for documents that may or may not exist can cause great angst to the policyholder. To avoid a battle over documents, the policyholder should take on the responsibility to document the claim as completely as possible in order to communicate an effective and reasonable claim calculation to the adjuster.

Getting These Ideas To Work for You

Establishing a plan to quantify the claim in compliance with the policy will be paramount to obtaining a fair settlement. Look to identify a claim preparation and claim management leader on your team who can champion the effort for your company in an independent and skeptical way that can help you expedite settlement. (See "The Shakleton Approach:Effective Leadership Throughout the Claims Process.") The firm you choose should be independent from your insurance company and their agents, and one that will be engaged by your company.

It is important for the risk manager to consider and be ready for the four key elements to successfully handling a CBI claim. First, you must identify and understand the impact of other business on your operations.

Second, plan for such events by having a business continuity plan. Third, consider the need for CBI insurance and incorporate the correct policy wording and limits for your circumstances. Finally, should a CBI event impact your company, be prepared to spend the extra time and effort to identify all the potential areas of loss and document them effectively.