Japan's Tragedy A Reminder of Need for Business Interruption Insurance

The human, social and economic devastation in Japan from the massive earthquake and tsunami is overwhelming and business losses are just beginning to be tallied.

United States companies that purchase products or supplies from Japanese companies or have operations in Japan have a bumpy road ahead of them and business interruption coverage could be critical to helping these businesses getting back on their feet.

"It's inevitable that there will be hundreds of millions of dollars of losses to American companies for sure," said Finley Harckham, senior partner for Anderson Kill & Olick, a law firm in New York.

Harckham says businesses are now trying to figure out how long the disruption will last and if they have adequate inventory to cover that time period, which should all become clear in the next couple weeks.

"The companies that are going to be affected pretty much know it now but the question will be what is the scope of the losses rather than whether there will be losses," he said.

It is too soon to know what the reaction from the insurance industry will be to this event in terms of a hardening market or a pullback of capacity for business interruption coverage, says Pam Ritz, president of Risk Specialty Agency, but insurers are going to be extra careful in the coming months.

"It will be about 30 to 60 days before everyone realizes what the overall financial impact of the earthquake is, but I do think we will see insurers being very cautious in those 30 to 60 days," she said. "There are a lot of renewals coming up in April in regards to worldwide reinsurance and they will be affected by Japan."

U.S. companies should also check their policies to make sure their business interruption coverage protects them in the event of an earthquake or other event like a tsunami.

Insurance experts agree that the biggest challenge when it comes to business interruption is educating clients on why they need the coverage.

"It is very, very difficult to have those discussions with customers and widen their perspective as to how their business can be interrupted beyond the scope of physical damage to their facility," says Ritz. "Customers still believe that everything is covered under the standard commercial package policy so communicating to customers is so important."

The catastrophe in Japan is just one more example of why this coverage is important to businesses and agents need to be able to explain this to their clients.

"We still find that it's terribly difficult educating the channel of distribution," Ritz says. "It requires knowledge on the part of carriers and agents on those products. Contingent business interruption coverage requires agents to be very eloquent and come up with financial examples and other examples so the client can see and assess their business in aspects beyond physical damage."

Terry Tadlock, president of Coastal Plains Insurance in South Carolina, agrees.

"Education is absolutely one of the biggest problems in this market," he says. "When I teach business income, I ask people what is more important, the building you are in or the money you make? Yet we still spend countless hours just talking about property."

Harckham says that in order for an insured's contingent business interruption coverage to be triggered here in the U.S., the insured would have to have coverage for earthquake or flood.

"The way it works is you have to have coverage for your own property that would have applied if the damage was suffered by your own company," he said. "U.S. companies have to have some earthquake or flood coverage to trigger this coverage."

In addition to having the earthquake or flood coverage, companies would also have to have blanket coverage.

"It gets kind of confusing because lots of American companies have flood or earthquake coverage for specific regions but don't have blanket coverage," says Harckham. "If they don't have it for all of their operations, that could be a problem."

Tadlock says another issue could be that earthquakes are excluded by most property forms, and insureds have to have bought it back to be covered. Even then it wouldn't be triggered unless the company had a specific endorsement for it.

Tadlock says that most people do not buy back the endorsement unless they feel that they are in an exposure area, and as always, you cannot buy the coverage after the fact.

"The problem with earthquake coverage is it's very inexpensive where they don't expect it to hit and in places with exposure, it's quite pricey."

Harckham says hopefully one good thing that can come out of the Japan tragedy is an increase in coverage that will protect insureds' businesses.

"It's a good wake up call for American businesses to be thinking about this coverage and focusing on it at renewal time, which they haven't done in the past," he said. "Or looking at triggers like flood, and whether they are covered domestically or overseas. Insured's need to know if they have the coverage they need."