The Lessons Of Major Power Outages

The late summer 2003 power blackout, which shut down parts of Canada and the northeastern United States, was a potent reminder of how businesses of every kind have become ever more interrelated, connected and dependent on each other and on an increasingly complex infrastructure system of energy, transportation and telecommunications.

As a direct result, businesses also have become more vulnerable to major disruptions – including those originating from remote locations – and can experience substantial income losses for reasons largely beyond their control.  Therefore, it is critically important for companies large and small to try to identify various possible sources of risk that can significantly impact their business operations and revenues and to obtain appropriate insurance coverages.

Lessons From August 2003

Even before the joint U.S./Canada task force, comprised of investigators headed by the U.S. Secretary of Energy and Canada’s Minister of Natural Resources, issued a final report that evaluated the cause of the massive August 2003 outages, the insurance industry assumed that its overall exposure would be limited.  In large part, this was because insurers anticipated being able to try to assert an absence of both applicable coverages and the existence of covered property damage.

Under such assumptions, the insurance industry never expected the Aug. 14 blackout to make the “Top 10, and probably not even the Top 30,” of disasters in terms of insured property losses, according to Insurance Services Office Inc. the Jersey City, N.J. – based advisory firm.  From early on, it estimated that insurers would pay approximately $75 million for lost business and property damaged, even though the blackout was the largest in North American history.

At the time, National Underwriter credited the Insurance Information Institute in New York with the comment that the even “might not have much direct effect o insurance claims costs.”  Experts quoted elsewhere (on CBS News and in the Chicago Tribune) characterized the blackout costs as “no more than a ripple in the economy.”

However, many of the businesses caught up in the August 2003 blackout experienced much more than “a ripple” in their operations.  The blackout grounded airplanes, stopped trains, disrupted traffic signals and shut down everything from cell phones to air conditioners in Hartford, New York, Philadelphia, Cleveland, Detroit, Toronto and many points in between.  Mail service was affected nationally and water distribution halted in Cleveland. ATMs stopped functioning.

The Brattle Group, a service interruption cost consultant to public utilities, had been quoted as estimating the potential blackout cost from Detroit to New York at some $6 billion.

Plainly, a wide gap emerged between the estimated substantial cost to businesses from the August 2003 outage and the portion of those costs that the insurance industry ultimately expected to pay.  This must serve as a wake-up call, and all businesses should take note.

Determining the appropriate insurance coverages – including Business Income Coverage – to cover potential loss of income scenarios can be a complex undertaking.  It involves an ongoing process that takes into account an ever-changing business environment and attendant, evolving risks.

A clear understanding of how business income coverage functions is essential.  Most often, it is provided in conjunction with standard commercial property forms, thereby providing coverage for income losses resulting from covered property damage along with the cost to repair or replace that property.

In other words, the damage ordinarily must be caused by a covered cause (risk) at a location encompassed by the policy.

Business Income coverage typically includes two primary components:

1. Income component, or profit that would have been earned had no disruption occurred.
2. Continuing normal operating expenses component, or expenses that still were incurred, including payroll.

Often, business income coverage claims will involve issues over the existence of direct physical damage and whether this damage was caused by a covered cause of loss.  And, it is just this area where many disagreements can arise.  Differing assessments and interpretations by an insurer and its policyholder can lead to different understandings, claim disputes and even litigation.

The Loss Of Utility Services

One of the sources of loss of income whose coverage – or lack of it – is frequently neither adequately addressed nor understood is the loss of off-premises power, whether in a situation broadly impacting many businesses (such as the massive outage that occurred on August 14, 2003), or in the context of one company’s single location.

Following a power outage, subsequent property and income losses may – or may not – be covered under provision of commercial property policies.  Every business decision-maker, particularly those responsible for, and involved with, the company’s insurance program, should take a long, hard and realistic look at the coverages being sold in the marketplace in relation to possible worst case scenarios for damage and loss.  Otherwise, when needed most, appropriate coverages may not be in place.  Identifying all possible exposures and their potential consequences requires a comprehensive team approach among a policyholder’s management and its risk managers, insurance professionals, counsel, and insurance providers.

As a starting point, it is important to be aware that standard commercial package policies often will exclude coverage for loss due to the failure of power (or other utility service) if the failure occurs away from the insured location.

While there are differences among policies, including those used for small business owners and general types of mid – and large-sized commercial businesses, some recurring issues arise.  A fertile area for dispute involves the existence of restrictions on coverage for any business interruption/income loss caused by the failure of power or other utility service supplied to the described premises, however caused, if the failure occurs outside a covered building.

If the failure of power (or other utility service) supplied to the insured location also entails a covered cause of loss/peril on premises, that loss or damage ordinarily will be covered.  For instance, if a fire starts in conjunction with the power failure, the ensuing damage and loss caused by that fire almost certainly would be covered, as would loss of income attributable to the fire damage.  But other scenarios can present more complicated issues.

Special endorsements can add back coverage for an insured’s business income and extra expense loss caused by a utility service interruption originating away from the insured’s premises and “outside of covered building(s).”  However, issues still may remain as to whether the loss was caused by direct physical loss or damage by a covered peril to the utility’s off-premise property, and involved the type of service interruption endorsed.

Direct Physical Loss Required

Thus, even a coverage program with express provisions for service interruption may not be a complete safeguard against potential risks and claim disputes.  The cause of a power outage and whether damage from a “covered peril” took place can impact a policyholder’s claim – as where a rolling blackout is initiated and controlled by a power company in response solely to demand spikes.  In a complete absence of any covered property damage, a controlled cutoff of electric service may present another area of risk and dispute.

If any lesson is to be learned, a policyholder is well-advised to undertake a comprehensive evaluation of its insurance program now and not just if impacted specifically by the August 14, 2003 blackout.  Smart thinking recognizes the importance of updating one’s insurance program before another, even more catastrophic, service interruption occurs.