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Many middle-market businesses whose operations were disrupted by Hurricane Irene are finding they are either uninsured or underinsured for lost income and property damage, especially if it was caused by flooding.
That's because most midsize businesses purchase standard business owner policies that do not provide the breadth of coverage that most large businesses buy using manuscript policies, insurance experts say.
Moreover, because many midsize businesses are especially cost-conscious, most located outside designated flood plains rarely buy flood insurance, even though it is readily available through the National Flood Insurance Program and commercial property insurers, the experts said.
Many midsize businesses also fail to seek reductions in waiting periods to trigger their business interruption coverage due to off-premises power outages, one of the major causes of loss from Hurricane Irene. In addition, coverage on some business owner policy forms is subject to a dollar deductible that must be met after the waiting period has expired.
Although the standard Insurance Services Office BOP form's 72-hour waiting period can be shortened through endorsement, many midsize business owners fail to seek such changes, said Robert Glasser, a partner at Dempsey Partners L.L.C. in New York. Business owners also can seek elimination of other deductibles, though many do not, he said.
“There is a huge difference between availability and what each individual mid-market entity might buy,” said Paul Primavera, senior vp and practice leader for the national claim advisory group at Lockton Cos. L.L.C. in Washington. “The larger clients tend to have flood coverage. The smaller clients are inclined not to. They may be more cost-conscious.”
According to the New York-based Insurance Information Institute, just 5% of flood insurance policies issued by the NFIP are purchased by businesses.
While some midsize businesses affected by the flooding that followed Hurricane Irene now are asking about purchasing flood coverage to protect themselves against future losses, it may not be soon enough, said Meg Errickson, director of claims at the Marsh & McLennan Agency L.L.C. in Somerset, N.J. There is a 30-day waiting period before such coverage becomes effective, she explained, and the arrival of Tropical Storm Lee is already triggering additional flooding.
But even businesses that purchased federal flood coverage may find it insufficient. Because NFIP policies are written on an “actual value basis,” the property's value will be depreciated. As a result, few business owners are able to recoup the entire $500,000 in content coverage and $500,000 in property coverage available through the NFIP, said Bill Oklesen, Chicago-based vp and director of property claims for Lockton.
“That makes federal flood coverage difficult at times. If you have a situation where depreciated value of property is less than $500,000, they'll never pay you more than $350,000,” Mr. Oklesen said.
Moreover, NFIP coverage does not provide business interruption coverage, noted Ken Auerbach, managing director and general counsel at E&K Insurance Inc., a middle-market insurance broker based in Eatontown, N.J.
“A difference-in-conditions policy or inland marine form may provide some business interruption coverage for flood, but it's expensive,” Mr. Auerbach said. “So this is a big problem” for midsize businesses that rely on NFIP coverage.
While midsize businesses can purchase additional flood coverage from commercial insurers, those policies usually attach above NFIP limits, which in some cases can create a gap in coverage, experts said.
One Marsh Agency client, a midsize manufacturer whose facilities near Somerset, N.J., flooded, is subject to a $1 million deductible because it failed to purchase NFIP coverage, said Ms. Errickson. If it had bought the coverage, its deductible would have been only $387,000, she said.
“The majority of businesses in flood zones are covered. We've offered coverage to the businesses outside of flood zones, but they don't purchase it,” she said.
Businesses that have business interruption coverage for off-premises power outages could have difficulty getting their claims paid if they don't also have flood coverage, said Ms. Errickson.
“As long as we have coverage for off-premises power outage, they should be covered. But we're running into situations where the power went out but there is also flooding,” she said. “This will put to the test the wind vs. water litigation that followed Hurricane Katrina.”
A federal judge in Mississippi ruled in August 2006 that an insurer is not responsible for any additional loss caused by water even if the property was initially damaged by wind. Although the decision involved homeowners insurance, it could have ramifications for commercial insurance, experts say.
Many commercial property insurance policies contain “sue and labor” clauses to cover costs incurred to protect property from impending damage, such as boarding up windows, but that coverage is subject to the same deductibles that apply to property damage, which can be substantial, said Steve Gilford, an insurance recovery and counseling partner at Proskauer Rose L.L.P. in Chicago.
Whether a commercial policyholder is also covered for lost income during the time the business is closed will “depend on the policy and whether there is actual physical damage” to the property being protected, Mr. Gilford said.
“The whole area of deductibles with business interruption coverage can be complicated,” acknowledged Randy Paar, a partner at Kasowitz Benson Torres & Friedman L.L.P. in New York. As a result, “the policy can be interpreted in some very bizarre ways.”
In a case Ms. Paar litigated following Hurricane Katrina, the insurer tried to apply a deductible equal to 5% of the value of all of a commercial policyholder's property, even though only one property was affected.
“Some customers in the mid-market are going to find they don't have all the coverage they need and, if they do have coverage, they'll be surprised by the deductibles,” concluded Michael Lebovitz, senior vp at Affiliated FM in Providence, R.I.
Howard Mills, chief adviser for Deloitte L.L.P.'s insurance group in New York, said he expects business income losses to be significant among the retail and hospitality industries. However, whether those businesses will have sufficient insurance coverage is questionable.
“This situation highlights the importance of really understanding your insurance coverage and knowing what's covered and what isn't,” he said.
Businesses that were underinsured for Hurricane Irene should sit down with their brokers to review their losses and determine what coverage is available so they won't be caught off-guard the next time catastrophe strikes, experts say.