News & Events

By James A. McFall

The aftermath of the September 11, 2001 attack on the World Trade Center (WTC) brought into focus a number of coverage issues that have previously not been confronted by the insurance industry or its customers. Terrorism by nature is a disruptive force. The resulting destruction is not just limited to physical damage but extends to far reaching, yet subtle, economic disruption.

In order to have a viable economy, stability is mandated. The legal system is the most visible manifestation of stability, providing a mechanism for contractual agreements, as well as enforcement of those agreements and a well ordered society. The insurance industry is a bulwark of this stability. Insurance disperses economic risk and creates an atmosphere of economic constancy. The insurance industry provides an efficient mechanism for reallocation of resources to come to the succor of its insureds when calamity strikes. That calamity can range from the minor auto fender bender to a cataclysmic natural disaster. Insurance is a remarkably efficient mechanism for bringing economic relief to insureds. However, in order for insurance to be applicable, the product must be in place. It goes without saying, fire insurance is of no use if one does not first purchase a fire policy. Five and a half years after the WTC attack, the potential short comings of insurance in the business interruption context are becoming apparent.

Coverage Overview

Many businesses are insured with business interruption coverage. The typical business interruption coverage insures for loss of business income resulting from damage or disruption to the insured premises. This type of coverage traditionally affords protection in the event of damage to the insured’s premises. For example, if a business suffered a fire loss to its premises and incurred an interruption in business, business interruption coverage would allow a business to survive during reconstruction or relocation. Traditionally, business interruption covers also contain some esoteric extensions sometimes referred to as “Civil Authority Coverage” or “Ingress/Egress Coverage.” These coverages would provide interruption coverage if access to the insured property was barred by order of Civil Authorities. There are a number of variations in this type of coverage, both pertaining to duration of coverage and the specific conditions required for a trigger of coverage.

Another form of business interruption coverage is sometimes referred to as Contingent Business Interruption Coverage or service interruption coverage. This type of coverage protects the earnings of the insured following physical loss or damage to property of the insured’s suppliers and/or customers. For example, if an insured’s supplier suffered a fire loss at its factory and was unable to provide materials that the insured needed for its business, the insured would be protected for a period of time in order to seek an alternate source.

Service Interruption Coverage is similar. It provides coverage for an insured for disruptions caused by interruptions in the supply of water or power. The various forms of Contingent Business Interruption Coverage are becoming more significant in our modern economy. Businesses no longer have stock piles of raw materials or component parts in sufficient numbers to allow for an extensive interruption in supply. Many businesses, in an effort to reduce costs, have transitioned into “just in time” inventory systems. This policy has reduced inventory cost but left the business open to losses caused by disruptions in the supply. One common trait of all these coverages is they are designed as forms of interim relief for a business that has suffered a traditional covered loss (or at least whose supplier has).

Post 9/11 Business Coverage Implications

Immediately following the attacks on the WTC, Mayor Giuliani ordered the evacuation of the area around the WTC complex. The evaluated area became known as the “Frozen Zone.” Businesses within the Frozen Zone had access to their property impaired by action of Civil Authority. The application of Business Interruption Coverages in those instances were not particularly difficult. However, a more problematic issue arose for businesses outside of the Frozen Zone. Anyone was free to still patronize those establishments if they could get there. Light rail and ferry service from New Jersey to Manhattan had been suspended and highways leading into Manhattan were closed. The FAA had ordered a national ground stop and effectively grounded all civilian aircraft for two days. Reagan National Airport was closed for almost a month. In many instances businesses’ patrons were barred as a practical matter, if not technically so. These implications extended far beyond the reaches of lower Manhattan. Hotel owners in New Orleans attempted to assert claims stemming from the loss of revenue due to the FAA ground stop. The Fifth District Court of Appeals in that instance, found no coverage as a matter of laws since the FAA closure had not directly “prohibited access to the hotels.” Hence, the hotels suffered a loss caused by a governmental action but found themselves uninsured.

The City of Chicago attempted to recoup its losses at Chicago O’Hare International Airport and Chicago Midway Airport as a result of the FAA national ground stop. The city was unable to do so when the court found that the damage was indirect and remote as the physical damage was to the WTC. Again, the losses were undeniable but uninsurable.

As a result of restrictions imposed upon flight following September 11th , the American airline industry was sent reeling. U.S. Airways was particularly hard hit since Reagan National Airport was a hub. U.S. Airways cut over 11,000 jobs and a year later it has only called back 1,900 employees. (9/8/02 Chicago Sun Times, A Year After the Attacks Economic Impact Lingers) U.S. Airways’ problems could not be solely attributed to the WTC attacks. The industry in general, and U.S. Airways in particular, was trying to come to grips with the affects of de-regulation, aging fleets and high fuel costs when the attacks occurred. But there can be little argument that the attacks greatly worsened U.S. Airways’ position. The period following the September 11th attacks was filled with financial woes for U.S. Airways. The airline filed for Bankruptcy protection on August 11, 2002, and then again on September 12, 2004.

As a result of its troubled financial condition, U.S. Airways group announced it would merge with Arizona based America West Holdings Corp (parent company of America West Airline) on May 19, 2005. Although announced as a merger, the move has largely been viewed as an acquisition by America West. The U.S. Airways saga is illustrative of the long range financial impact of the attacks and demonstrates the inadequacy of traditional insurance as a remedy in this instance.

These real life examples show how traditional insurance products do not afford protection for many of the effects caused by terrorist attacks. After the September 11th attacks, air travel dropped precipitously in the United States for a period of time, but businesses around the United States that rely on tourism were equally impacted. Existing traditional business interruption coverage afforded these companies little protection since there was no government authority denying access to either their property or their property had not suffered any physical harm.

Recent events have suggested that attacks on “soft” targets with the resulting economic implications will continue. Terrorist attacks have economic implications far beyond the immediate targets. Traditional insurance products, however, provide little help for the damage caused by the ripples and the insurance industry has little incentive to expand their exposure to embrace these uncertainties, especially in the absence of government support. Interestingly, after the London bombings in 2005, the British pound fell to a 19 month low against the U.S. dollar and markets in London, France, Germany, The Netherlands and Spain all closed down from 1 to 1.3%. By July 8th , the next day, the markets had picked up again when it became apparent that damage was not as great as initially thought, and that Pool Re had ample reserves to cover losses. Pool Re is a mutual insurer set up by the government with leading insurers to reinsure U.K. terrorist liabilities. The Pool re example illustrates how the presence of stable insurance can reassure even in the midst of tragedy.

Conclusion

Traditional insurance products do not afford protection for the massive economic dislocations that can be caused by terrorist attacks. There has been little movement by the insurance industry to unilaterally absorb the risk and fill this void. The void enables terrorist to have an even greater impact than they might otherwise have and increases economic uncertainty. Unfortunately, a handful of suicidal fanatics has been able to exert a disproportionate influence in both the U.S. and in Europe.

This article was published in the June 2007 issue of DRI's For the Defense

James A. McFall is a senior litigator with Neil Dymott in San Diego where he specializes in insurance coverage, bad faith litigation and business litigation with emphasis in environmental/toxic torts and trusts and estates. He is a member of DRI’s Terrorism Risk Insurance Subcommittee.

Back to Articles