Catastrophe Risk and Your Insurance Policy
Catastrophic events such as hurricanes, terrorist plots and power outages affect all businesses but have a disproportionate impact on the hospitality industry. A guest's primary objective is often the safe and quiet enjoyment of a room and the hotel's grounds. When catastrophic events alter this formula, hotel owners and operators stand to lose significant profits or incur increased expenses, sometimes much greater than the cost of physical restoration. Short- and long-term economic consequences often permeate well after the property has returned to its pre-loss physical condition.
In response to the financial risk of catastrophic events, hoteliers have paid more attention to disaster recovery planning, including emergency response, guest safety, back-up of critical records, advance retention of construction contractors and a host of employee issues. Having a disaster recovery plan helps mitigate potential losses, but certainly doesn't eliminate them.
The residual economic losses, however, are often the subject of insurance claims, which could become a lengthy, sometimes-disagreeable process that is alien to many hotel operators and owners. This article highlights some of the insurance claim-related surprises encountered by hoteliers over the past few years. Many of these issues remain controversial today. By understanding these issues, you can be better prepared for the true financial risks from catastrophic events.
Limits on coverage
There is often a limit to the duration of insurance coverage for lost income from a catastrophic event. Physical damage is the most common trigger for business interruption coverage, although there are other perils, such as civil authority, ingress/egress and service interruption that often result in lost income to hotels. The most commonly insured period of indemnity ends with the physical restoration of the property. As history has shown, a hotel may take years to recover from a catastrophic event. Frequent and loyal customers may migrate to competitors. Long-term employees may move to other properties and, worst of all, the hotel's reputation can be tarnished. Insurance policies rarely cover the full duration of such long-term losses. Instead, income losses are generally limited to the stated time limit in the policy. The hotel must absorb subsequent losses.
Loss of market
After a catastrophe, insurance underwriters and their adjusters often argue that the economic effects from non-physical damage to the surrounding community is not covered under the business interruption policy. For example, if potential convention business diverts to another city, despite the completion of physical repairs to your property, insurers often argue that some or all of the resulting loss of income is a result of a “loss of market.” Insurance carriers may assert this position irrespective of whether a loss of market exclusion is present in your policy. Underwriters argue that they insure a hotel and not the entire city or town.
Make-up or recovered business by another entity
Diversion of business from one commonly owned hotel to another may not be considered a compensable loss. For example, if Hotel A, which is owned by Owner 1, loses a group booking to Hotel B, also owned by Owner 1, Hotel A is unlikely to be compensated for its loss. Complications arise when hotels are insured under different policies, and operators are different while ownership overlaps. Other make-up scenarios include the re-booking of a group in the future. Not all re-bookings qualify as “make-up.” If the re-booked party causes displacement of potential guests in the future, the re-booking should not be considered “make-up.”
Deductibles, self-retention limits and co-insurance
Deductibles, self-retention and co-insurance may significantly reduce your compensable loss. Many in the hospitality industry, especially those in catastrophe-prone locations, must absorb large deductibles in order to procure affordable coverage. Deductibles for business interruption may be expressed in hours, days or percentages and often exceed the amount contemplated by the insured. Another misunderstanding arises when the insured is under-insured and the policy carries a co-insurance penalty. The co-insurance penalty serves to make the insured proportionately liable for losses to the extent of their under-insurance. In its simplest term, if the insured only insures 50 percent of the total value, then the underwriters will only indemnify 50 percent of otherwise covered losses.
Subjectivity of business interruption losses
Business interruption losses are subjective, and reasonable accountants may disagree on the quantification of lost income. If the hotel maintains detailed booking records, including historical pick-up data, turndown data and historical forecasts, the exercise may become more objective. Hotels with inconsistent performance, newly renovated facilities or start-ups, as well as an unreliable history of revenue projections, further complicate the exercise.
The development of a disaster recovery plan, including appropriate and timely modifications to account for current and anticipated business conditions as well as periodic testing of the plan, will help mitigate some but not all of the risk. When insuring the residual risk, a thorough understanding of your insurance policy and the positions often taken by underwriters and their adjusters following catastrophic losses will help hotels to properly measure the total risk of loss from catastrophic events.
Glenn Pomerantz is a partner in the New York office of BDO Seidman, and Judith Spry is a partner in the firm's Chicago office. BDO Seidman is a national professional services firm providing assurance, tax, financial advisory and consulting services to a wide range of public and private companies. Glenn can be reached at 212-885-8379 or email@example.com. Judith can be reached at 312-616-4637 or firstname.lastname@example.org
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