Wildfires have wreaked havoc on, and caused incalculable losses to, individuals and businesses in California over the last three years. These disasters—caused by a series of conflating events, including massive shifts to the climate—are not limited to the Golden State, as fires have devastated many western communities, and fires as well as other unprecedented weather events, including hurricanes, flash flooding, cyclone rains, and extreme-cold freezes have disrupted businesses across the world.
Most businesses know how to protect their physical offices and facilities with commercial property insurance, including business interruption coverage, in case they are directly affected by physical disasters. But, in today’s business environment, a company may be closely tied to and dependent on third-party suppliers. What happens if a major player in your supply chain is adversely affected by one of these (unfortunately) all-too common climate disasters? Unless you operate at ground zero in vulnerable environmental zones, you may not be aware of the fact that your vendors may be the ones most directly affected, and this might have a devastating ripple effect on your ability to operate a successful business.
Considering what many are now calling the “new normal” for devastating weather events, it is worth revisiting a type of insurance protection known as contingent business interruption coverage (CBI) and its close companion, contingent extra expense coverage (CEE). For businesses operating on a “just in time” supply and delivery model, careful supply-chain logistics are essential. CBI and CEE can and should be considered as logical and necessary complements to that model, and you should review what your current commercial business insurance provides, and evaluate whether you should update or supplement your coverage based on the locations of your key suppliers and/or customers.
CBI is not typically available as a stand-alone insurance policy, but is generally an extension of the business interruption add-on to commercial property insurance. Standard business interruption insurance protects your business if your physical property is damaged, and you lose revenue and profits because of that damage. Contingent business interruption insurance protects you if one of your suppliers suffers physical damage, and because of that, you lose revenue and profits because your own business is affected, even though your own facilities are not themselves physically damaged. A classic example would be if you manufacture a product that incorporates a microchip that you purchase from an outside supplier. If that supplier’s facility is damaged by a wildfire, and there are delays in sending microchips to you, you might yourself experience delays in manufacturing your finished product or filling orders. (Contingent extra expense coverage might apply if you are forced to incur extra expenses, like purchasing replacements for parts that otherwise would have come from your supply company, or pay for overtime work required to incorporate delayed parts into your products so as to meet your own delivery schedules to customers.)
To be sure, CBI coverage is still relatively untested in the courts and claims can be more complicated than other insurance claims. As with standard business interruption coverage, there must be physical damage to property. It is not the physical damage to your own property, but rather, damage to another’s property (e.g., your supplier’s plant) that forms the basis of a CBI claim. That adds an additional layer to the proof required for your claim. To further complicate things, the physical damage to the supplier must be the type of loss that would otherwise be covered under your own property insurance if your property had suffered that type of physical loss. Thus, if earthquake or flood damage is excluded under your business policy, then you may not be able to recover under your CBI policy if the loss arose from that type of damage to your supplier’s facilities (just like you could not get regular business interruption coverage for that type of damage to your own property unless you had special coverage).
When the Mississippi river overflowed in 1993, it devastated 20 million acres of farmland, resulting in $6.5 billion in crop damage. Archer Daniels Midland Company (ADM), which processed farm products for domestic and international distribution, lost many of its suppliers. Due in large part to a broadly-worded CBI policy, which covered ADM against loss of earnings as a result of damage to the property of “any supplier of goods and services . . .”, ADM ultimately obtained coverage for millions of dollars in loss. See Archer-Daniels-Midland Co. v. Phoenix Assurance Co., 936 F. Supp. 534 (S.D. Ill. 1996).
By contrast, when an earthquake struck Taiwan in 1999, disabling a substation providing electric power to two Taiwanese factories, an American company called Pentair received no coverage under its CBI insurance for the losses it suffered for the delays in parts from those Taiwanese plants. The reason? The Taiwanese plants were not physically harmed by the earthquake. They were merely slowed by the harm to the electric power substation. Pentair v. American Guar. & Liab. Ins. Co., 400 F.3d 613 (8th Cir. 2005). Had the Taiwanese plants themselves been physically damaged by the earthquake, then Pentair might have gotten coverage. (But only if Pentair itself was covered for earthquake-type damage.)
As you can see, claims can be complicated, but having CBI coverage could mean protection against a huge amount of loss or expenses at a critical time in a business’ operations.
Question number one is whether your existing business policy in fact provides CBI coverage. If it doesn’t, is this protection something that makes sense for your business? Are you reliant on a limited number of suppliers? It is worth exploring with your broker or other insurance professional. In addition to vendor-based interruption insurance, there are other forms of CBI, like “customer-based” interruption (where you rely heavily on certain customers to buy your products) and “proximity” interruption (where you rely on neighboring businesses to attract customers to your business).
If you do have CBI insurance, you should review the terms carefully with your broker to make sure the policy addresses your particular business needs. For example, how is “supplier” defined? Some policies require you to specifically schedule the suppliers that are covered. Some policies limit coverage geographically, which might do you little good if you rely on an international supply chain. There may also be limitations on when you can claim coverage (referred to as the time deductible) or the period for which you can claim losses (i.e., the period of restoration). These can and should be analyzed in advance, just like any other contingency in your supply-chain logistics.
It is also worth discussing the exclusions and potential endorsements that could further restrict, or conversely, supplement your coverage. For example, many individuals and businesses in California recently lost power for up to a week because the utility in their area pre-emptively shut down the power grid as a result of wildfire risks. Losses relating to power outages are generally not covered, but there are potential endorsements that might protect your business from utility-service interruption.
The recent fires should be a wake-up call—if your supply chain or customer base was impacted, take a close look at your commercial property insurance to see whether you have this coverage. And, if you don’t, it might be time to discuss this protection with your broker or other trusted insurance professional, particularly if you rely heavily on suppliers in parts of the world that are more vulnerable to climate events.