Business Interruption Issues Series – Part 2 – Time Excesses – Part A

Following on from yesterday’s article on part insuring a standing charge, I move to time excesses for the rest of this week.

When I wrote the first edition of my book on Business Interruption, time excesses were relatively new, except for particularly large risks, especially in the mining industry.

The large number of business interruption claims that arose from the gas crisis in Victoria, Australia in September 1998 highlighted the inherent problems associated with time deductibles. Many of the issues have again been seen following the Western Australian gas crisis 10 years later, in June 2008 as well as natural catastrophe claims and the 2014 Sydney Hostage Crisis.

The purpose of the post today and the next few days is to highlight through case studies, some of the many problems that can arise with the interpretation of a time deductible. And second, equally important, the purpose is to offer suggestions for alternative forms of deductible that may assist each party to the insurance contract in understanding their respective position in the event of a loss.

Case Study 1: 3-Business Day Time Deductible

The first case example is in respect of a large manufacturer that has a Section 2 Deductible of “3 business days”.

The loss of 7 days’ production caused by the gas outage was made up by the Insured through working weekends and public holidays between the date when the gas supplies resumed and the end of the Indemnity Period. The loss was confined to the Increase in Costs of Working associated with making up the lost production.

The position that should be adopted with such a disruption being considered under a policy with a time deductible is that regardless of when the costs are incurred, they should be matched to the benefit that the increased costs have generated. For example, if within the first 3 days the Insured had incurred significant costs, say several million dollars, to convert their production facilities to run on LPG rather than natural gas, but the benefit of this expenditure was not realised until after the first 3 days and was therefore to the entire benefit of the insurer, then the insurer should, in equity, meet the entire cost of the Increase in Costs of Working. This is logical even though it was incurred during the first 3 days.

Conversely, any costs associated with making up lost production suffered during the first 3 days, for instance by way of overtime etc, should be at the expense of the Insured; the first 3 days being the period of time deductible.

This is in line with not only the generally accepted accounting principle of matching revenue with expenses, but also with the spirit of the underlying principle of indemnity which, as we have discussed elsewhere in the text, is to “put the Insured back, as near as money will allow, to the same position that they would have enjoyed but for the loss” [1].

In this case, an accountant acting for the Insured as a claims preparer, argued that there were no lost sales during the first 3 days and, as such, there was no loss suffered by the Insured. They went further to argue that as the Insured ‘stood down’ employees during this period, there were savings made. However, as these were made during the 3-day deductible, these costs should not be taken into consideration in adjustment of the claim. If this was to be accepted (and it was not), it would have converted the deductible into a positive benefit to the Insured. This is because the insurer was being asked to meet all the additional costs to make up the lost production, but was not being granted any benefit of the savings made during the period.

This is a nonsense argument that goes against the underlying principle of business interruption insurance as explained above. What this case study does, however, is highlight the problems that can arise in adjustment of a claim involving a time deductible.

The lesson to be learnt from this case is that the policy must clearly state how the deductible is to be applied.

To learn more please refer to Business Interruption & Claims, Chapter 18.

[1]     Castellain v Preston (1883) 11 QBD 380.

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