The current and projected financial impact on Louisiana fromHurricanes Katrina and Rita has reached into the hundreds ofbillions of dollars, according to figures released by Gov. KathleenBabineaux Blanco's recovery panel. The Louisiana Recovery Authorityestimates that the 2005 hurricanes had an impact between $75-100billion on property and infrastructure and $15-20 billion intemporary relief services. In addition, the storms are expected toinflict between $50-70 billion in losses to Louisiana's economy and$8-10 billion in lost state and local revenue over the next fiveyears.

The figures reflect the cost to recover, the cost to rebuild,and the cost to address economic and fiscal losses. This type ofevent was so massive that it significantly impacted the entireeconomy of the area. Should the economic impact be included in thebut-for calculations of the losses sustained, or should theeconomic impact be excluded?

Ideally, the parameters for calculating business-interruptionclaims, including post-event economic impact, should be clearlyspelled out in a business-interruption policy. As a result ofHurricane Andrew in 1992 and the terrorist attack on New York andWashington, D.C. in 2001, many policies do just that, but asignificant number still use a now-antiquated approach.

Many of the policy forms in existence up until 1992 did notcontain language on how to factor the regional and nationaleconomic issues into the claim calculation following a majordisaster. A debate remains over whether to include or exclude theeconomic conditions after a loss that is impacted by the eventcausing the loss. There is no doubt this issue will play asignificant role in computing business-interruption losses forrecent claims in Florida, New Orleans, the Gulf Coast, and theCaribbean.

Self Interest vs. Consistent Approach

The logic of a policyholder or insurance company can be viewedas suspect when the position it takes plays to its benefit. Forexample, some insurance companies argued that the general economicconditions should not be taken into account after Hurricane Andrewstruck, with policyholders taking the opposite view. After 9/11,some policyholders argued that general economic conditions shouldnot be taken into account, with insurance companies taking theopposite view. The difference was that after 9/11, the New Yorkeconomy suffered a downturn, whereas after Hurricane Andrew,impacted regions enjoyed an economic windfall due to increasedbusiness from relief workers, insurance professionals, not tomention homeowners and businesses with insurance proceeds inhand.

In the case of the Gulf Coast losses during the hurricane seasonof 2005, economic data cut both ways, depending on the locale. Inareas devastated by the hurricane that still remain depopulated,the economic loss, considering the subsequent economic conditions,would show no loss of income to businesses since there are nocustomers left in the impacted areas. Therefore, had a businesssuffered no loss and could open its doors for business the monthafter the storm, there would be no customers to serve and no incometo be made. In areas suffering moderate damage, any business thatcould open its doors had a windfall of business, due to lack ofcompetition and the influx of relief workers, construction, andinsurance professionals. That means a consistent use or non-use ofsubsequent economic data for the 2005 hurricane season losses alongthe Gulf Coast would result in both higher and lowerbusiness-interruption amounts than should otherwise be consideredlost.

It makes good sense to suggest some guidelines that would enablea more consistent approach regardless of who may benefit.Accountants typically use a but-for analysis to quantify a loss. Inthis type of analysis, one projects what the results would havebeen had no loss occurred. A key issue in setting up the but-foranalysis is to determine what the insurance policy means by theword loss. Is the measurement restricted to the narrow losssuffered by the insured? Or is it a broader loss caused by theimpact of the event itself to the entire geographic region?

The Island Theory

Hurricane Andrew was the first time many claim professionals hadexperienced a disaster event that impacted the region in which thedisaster occurred. One actual case from Hurricane Andrew laid thegroundwork for how to calculate claims according to the IslandTheory.

In the midst of all the devastation in South Florida, one largenational retailer's store amazingly was not significantly damagedand was open for business relatively quickly, long before many ofits competitors. Quite naturally, people and businesses thatsuffered damage to their properties and were eager to buy emergencysupplies and other merchandise flocked to this location. Thestore's sales skyrocketed far beyond pre-event projections and madethe retailer, quite literally, a retail oasis amidst thedevastation.

The Island Theory suggests that the coverage and but-formeasurement should assume a business was undamaged and all theothers around it, including its competitors, were damaged. Thebusiness, therefore, would be able to claim a portion of anyunanticipated uplift in the post-event economy. The retail sector,for example, often experiences a boom in sales after propertydisasters, as homeowners and commercial businesses purchasereplacement building materials, furniture, clothing, etc. Thistheory, though, restricts the definition of the loss to thatspecific business' loss. In other words, the loss or damage, whoseimpact the accountant should ignore in the but-for analysis, is thedamage to the national retailer's store. Clearly, the damage tothis particular store did not require thousands of relief workersto come to its city. However, the event causing the damage to thestore resulted in thousands of relief workers coming to thecity.

Variations of the Theory

The situation in which a retail establishment is damaged andrepairs will take a number of months to complete, however, is lessclear-cut. Should the policyholder be allowed to keep at least someof any post-event uplift? Say, equal to its pre-event market shareit was unable to generate?

Judge Hall, of the 4th U.S. Circuit Court of Appeals, stated thesituation clearly in his dissenting opinion for Prudential v.EconoLodge (1992 U.S. App. LEXIS 25719):

“The majority persists in framing the issue as what the motel'ssituation would have been had the hurricane not occurred at all.However, the contract states that 'due consideration' be given topre-damage earnings and 'the probable earnings thereafter, had noloss occurred'. [The phrase] 'had no loss occurred' does not referto the overall loss in the surrounding area; rather, it clearlyrefers only to the loss incurred by the insured. The partiesstipulated that, had the motel not been put out of commission byHurricane Hugo, the motel would have realized a profit of $192,000in the months after the storm.

“The majority acknowledges that proof of an imminent generaleconomic up-turn, or of a lost-profit opportunity thwarted by theloss-causing event, can justify recovery under a lost-earningsprovision. I assume, then, that had the motel been destroyed by anisolated fire the day before Hugo hit, the majority would rule thatlost profits would have been recoverable because the cause of theproperty loss (the fire) was not the same as the cause of theprofit opportunity (the storm). Similarly, if gold were discoveredthe day after Hugo and the entire region filled with gold seekers(as well as relief workers), I assume that lost profits would becovered. Although Hugo caused both the property loss and createdthe profit opportunity, it does not strike me as an'intuitively-sensed logical flaw' to permit recovery under thesecircumstances.”

This dissenting opinion clearly highlights the dilemma thatoccurs when the cause of a loss, not the specific covered loss paidfor by a particular insurance policy, is also the cause forchanging economic conditions after the loss. Judge Hall analyzedthe policy language to determine if the contract defined the lossas the generalized loss that impacted the economy, or the actualproperty damage loss paid for under the policy, which did notimpact the economy.

Looking at several pertinent clauses of a typical policy'sbusiness-interruption coverage can guide our response to thequestions posed above. These clauses are not exact quotes from anyparticular forms but are an amalgamation of similar clauses fromvarious policies. Of course, not all policies contain identicallanguage. That is why it is very important to read and understandthe language in the specific policy with which you happen to bedealing. The following is a basic insuring clause:

This policy insures business-interruption loss as defineddirectly resulting from physical loss or damage of the type insuredby this policy to property: described elsewhere in the policy andnot otherwise excluded by this policy; utilized by the insured;located at an insured location; and during the period of liabilitydescribed in this policy.

We can seek guidance from the following phrase, which is similarto clauses included in many commercial insurance policies: Dueconsideration shall be given to the experience of the businessbefore the date of loss or damage and to the probable experiencethereafter had no loss or damage occurred. The experience of thebusiness before the loss is easy to discern in various ways. Oneway is to compare the actual results with projections for similarperiods over time. Then reasonable conclusions can be drawn aboutwhat likely would have occurred but for the loss or damage to thestores.

But is that enough? Should not the probable experience after theloss also consider increases in the post-event economy caused bythe hurricane event? Isn't it reasonably probable that if ahurricane hit South Florida with the magnitude of Andrew, aneconomic uplift in the retail sector would occur as homeowners andbusinesses began to replace their damaged properties afterreceiving insurance proceeds? If the regional economy had simplytanked after the event, might insurers likely consider that as amitigating factor in responding to an insured'sbusiness-interruption claim calculation as they did after 9/11?Then why would it not be reasonable to consider the uplift?

No Loss or Damage

The phrase “Had no loss or damage occurred,” which appears inseveral of the clauses, can be read to mean, “Had no loss or damageoccurred to my property (but the disaster event still caused thedamage around me).” However, another broader, more generalizedmeaning could be “Had no loss or damage occurred to anyone,” which,in effect, means, “Had no disaster event occurred.”

The first, narrower interpretation supports a reasonableargument for including the uplift in the business-interruptionloss. It suggests that our retailer ought to be able to claim, inaddition to any shortfall against its pre-loss projections, theamount of the post-event uplift equal to its pre-event market sharethat it was unable to achieve due directly to its physical damage.The broader interpretation suggests the opposite; that the retailercan claim only what it could have sold if the disaster event hadnot occurred. In other words, our retailer would be permitted onlyto recover what it could reasonably support without consideringpost-event economic conditions.

As each business-interruption policy's language can be slightlydifferent from that above and one another, it behooves both sidesto study the words in their specific contracts before drawingliability conclusions and drawing lines in the sand.

A Simple Solution?

One of the many important lessons learned is that explicitlanguage dealing with the post-event economy can preventsignificant conflict over business-interruption claims. Suchlanguage may read similar to this:

Regional Economic Impact: In no event will this policy pay forany increase in business-interruption loss occasioned by the impactof the event upon the economy of the region where it occurred.

When this phrase or one similar to it is contained in thebusiness-interruption forms, it would be much more difficult for apolicyholder to expect to recover a share of post-event uplift. Ifan insurance policy does not contain a clause such as this, andwhere the impact of considering post-loss economic conditions ismaterial, it would be wise to seek the opinion of coveragecounsel.

Michael LoGiudice and Steven Kessler are directors ofadvisory services, dispute analysis and investigations, forPricewaterhouseCoopers. LoGiudice is located in the firm's Chicago,Ill., office, while Kessler is based in Houston, Texas.