Minding the Gap: How Insurers Let CRE Down
On March 16, 2020, millions of businesses in the U.S. faced two chilling realities:
They had to shut down operations, close their doors, and turn away customers to slow the spread of COVID-19. And they learned their business interruption insurance wouldn’t cover ANY of the financial losses from suspending activities.
How was it possible to have insurance for this seemingly exact situation yet receive no coverage? What could’ve been done differently to ensure protection?
These are just two of many questions commercial real estate owners and operators have asked themselves over the past year and a half.
In this article, we’ll cover how insurance companies let commercial real estate operators down and share strategies owners can use to protect themselves from future refusal of insurance claims.
What is business interruption insurance?
Business interruption insurance, also called business income coverage (BI), is a type of insurance coverage specifically designed to shield a business against financial loss in the aftermath of a peril, such as a tornado, tsunami, theft, or fire.
It protects a business from financial ruin by covering underlying operating expenses like rent, payroll, taxes, and lease payments.
The anticipated compensation makes this policy ubiquitous among small- and medium-sized companies in all sectors.
As expected, business income coverage is also popular in U.S. commercial real estate, where nearly 90% of businesses lease — rather than own — their space.
This occupancy trend is the reason commercial real estate landlords, like their commercial tenants, also suffered economic consequences (ranging from mild to catastrophic) during the government-mandated shutdowns.
Why viruses are not covered
Surprisingly, the insurance industry’s move to quietly dump insurance for virus-related peril started decades ago. When SARS broke out back in 2002-2003, nearly halting the Asian economy, insurance companies had to pay out millions of dollars in BI coverage settlements to their customers. Lesson learned!
Evolving from this massive hit to their bottom line, providers subsequently added to most insurance policies a blanket clause that excludes coverage for damage or losses due to viral or bacterial diseases.
This calculated elimination meant that by the time COVID-19 was first confirmed on American soil, almost half of all insurance policies would exclude payments to businesses for pandemic-provoked economic losses.
And thus a severe gap between the reality of COVID-19 and the limits of insurance emerged.
In the fine print: why businesses flopped in courtrooms
Seeing their BI coverage claims being continually denied, owners across the country dragged their insurance companies to court, with over 1,500 lawsuits filed between lockdown and resumption of activities.
Unfortunately for the aggrieved, verdicts for two-thirds of these cases were in favor of insurance companies. Owners couldn’t refute the virus-exclusion clause in their policies and the basic, almost unequivocal, language that required any damage to be physical for businesses to qualify for compensation.
Judges at all levels seemed to agree that unlike fire, hailstorm, or a riot, COVID-19 failed to meet the ‘physical damage’ standard, as it is undetectable to the human eye.
The key to winning
Thankfully, a few businesses were successful in their suits against the insurance companies. The victories of these victims offer case studies for commercial real estate to close the gaps in business income coverage.
Rather than evade the physical damage requirement under the BI coverage, attorneys of the prevailing lawsuits proved convincingly — via a preponderance of evidence — the presence of COVID-19 on a business’s premises.
These savvy counsels submitted results of testing of surfaces, air ventilation systems, and employees, which confirmed the deposit of this coronavirus variant. Their arguments were plausible, as proven by science.
Because COVID-19 spread so easily, it would — in more instances than not — be detectable on-site, thus qualifying a business for a payout. Additionally, a handful of commercial landlords invoked the contamination clauses in their business policies.
They categorized COVID-19 as a ‘pollutant’ capable of shutting a business down and swayed judges to recognize the virus as such. Their ‘pollutant persuasion’ allowed them to introduce a peril that was otherwise exempted from the policy.
It’s also important to note that these lawsuits only prevailed because none of the insurance policies held virus-exclusion clauses. Nevertheless, these successes provide valuable insights that commercial real estate operators can apply to avert a similar ‘no-claim’ crisis in the future.
For the future, odds are on divergent thinking
Given the rarity of pandemics, one isn’t likely to strike anytime soon. But there will come a time when the limitations of business interruption insurance coverage will again become a contentious issue.
Because despite the outcry over the ineffectiveness of business interruption insurance coverage in a pandemic, the fundamental insurance policies largely remain the same. And insurance providers appear keen to retain the current structure indefinitely.
This refusal of insurance companies to accommodate a peril that is otherwise exempted from the policy means the ideal strategy to recover lost business income is to establish the underlying cause as physical.
Therefore, only through a more inventive, open-minded approach will commercial real estate owners and operators successfully protect their revenue.