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Insurance Against Terrorism-Related Losses

By Scott P. DeVries, Fredric W. Kessler and Yelitza V. Colon

Since 9/11, many companies and public entities have been concerned about the possibility that a terrorist activity could materially affect their business operations. A terrorist strike could damage or destroy an insured’s premises. But the potential damage is not limited to the actual site of an attack. Government orders can shut down operations of businesses located elsewhere, whether by cordoning off nearby property, shutting down air traffic or otherwise. Thus, even businesses not physically damaged by a terrorist attack can suffer from such crippling consequences as being unable to receive raw materials or deliver products and services; similarly, airport closures mean customers, attendees, and audiences cannot reach effected businesses.

It is evident that regardless of whether a company or business is at the center of the attack, it could suffer significant losses in business income. For this reason, the 9/11 terrorist attacks not only had financial repercussions in New York and Washington, D.C., but all around the world. One possible solution for recouping this lost income is the business interruption insurance provision commonly present in commercial property insurance policies.

Business interruption insurance refers to a provision by which the insurer agrees to compensate the policyholder for income lost or diminished because of an interruption of business caused by covered property damage. This coverage is intended to protect earnings the insured would have enjoyed but for the interruption. Covered risks include power failures, explosions, riots, order of civil authority or the elements. Other policies cover “all risks.” Thus, depending on the policy language, this insurance may cover losses caused by terrorists.

Some products available on the market indisputably provide coverage without regard to the occurrence of any property damage. For example, event and trade cancellation coverage covers “loss arising out of the cancellation, interruption, or postponement of an event due to any material reason that is beyond [the insured’s] control, including reduced attendance.” But many other products contain a “physical loss or damage” clause, specifically, requiring physical loss of, or damage to, a specified property — the insured’s premises — because of a covered risk. This is easily satisfied where a terrorist attack destroys a company building. But where the interruption results from a government order to evacuate because of an attack on nearby buildings, the extent of damage to covered property will be an issue. Sometimes, the policy expressly covers where the civil authority blocks access to the covered property because of direct damage to other property; this would cover losses arising from an order that a company close its doors after a terrorist attack. In other instances, courts have found coverage even without a provision, reasoning that physical damage to the covered location is not necessary or that the policy did not explicitly require physical damage. However, other courts have denied coverage by strictly construing the “direct physical loss or damage to” language and holding that a governmental order does not equate to property damage.

The Terrorism Risk Insurance Act of 2002 materially affected the availability and reach of business interruption coverage. The Act requires that all property and liability insurance policies cover defined acts of terrorism and, to the extent existing policies contain a “terrorism” exclusion, delete the exclusion or modify it so that it does not exclude the defined acts of terrorism that the Act requires to be covered. (Policies can, however, exclude certain nuclear, biological and chemical elements.) In exchange for covering terrorist-induced losses, the government covers 90% of losses up to an annual aggregate of $100 billion in the program’s first year, increasing to $150 billion in the third year. The Act pre-empts “all state causes of action of any kind” for property damage, personal injury or death arising from an act of terrorism as declared by the Treasury Secretary, substituting a federal cause of action.

The Act has three important catches: (1) The insurer may increase the premium for including this coverage, and if the insured elects not to pay, the full exclusion will be reinstated; (2) The government may impose a 3% surcharge on the policy premium; and (3) Homegrown, domestic terrorism — that is, not committed by a foreign citizen — is excluded. Also, by capping coverage for all policyholders at $100 billion, a terrorist strike causing more than $100 billion in losses could leave the policyholder uninsured for most of the loss. For example, a strike causing $500 billion in losses would leave the policyholder uninsured for 80% of the loss.

Relatively few policyholders have chosen to delete the terrorism exclusion. The New York Times reported on March 8, 2003 that fewer than one in five policyholders have purchased terrorism coverage. Reasons for nonparticipation included the limited nature of the coverage, the fact that many policyholders do not see themselves as likely targets and the hefty premiums that insurers are charging for deleting the terrorism exclusion. In the last regard, insurers are quoting premium increases from 5% to 200% with 20% as an average. When this cost is added to the higher base for premiums being charged, and a multiyear recession that is prompting companies to reduce costs, it becomes all the more significant.

Companies that have purchased the coverage or are contemplating it should note that having coverage does not mean payment will be forthcoming. Even though the insurer may be on the risk for only 10% of a loss (subject to applicable limits), it can be expected to resist payment. Thus, an understanding of coverage issues is an essential component of the policyholder’s decision about reinstating terrorism coverage.

The far-reaching effects of terrorism mean policyholders must reacquaint themselves with their business interruption coverage policy to ascertain whether their insurance will suffice in the event of a terrorism-related catastrophe. Further, businesses should weigh whether the additional premiums to be charged for deleting the terrorism exclusion warrant the rather limited coverage that will be forthcoming in the event the business will have to seek compensation. 

ABOUT THE AUTHORS

Scott P. DeVries is the firm wide Managing Partner, Fredric W. Kessler is a partner and Yelitza V. Colon is an associate of Nossaman Guthner Knox & Elliott LLP.

riskVue | The webzine for risk management professionals
September 2003