Insureds have a contractual obligation to mitigate damages after a loss occurs. Most businesses take drastic measures to resume operations swiftly and will spare no expense in minimizing the down time. In a market where delays are not tolerated and consumers are ever more demanding, the efforts to resume operations are more akin to survival strategies than contractual indulgences. These desperate efforts to keep doors open and machines running can eliminate business income losses in their entirety, a feat much appreciated by insurance companies. Even though these mitigation efforts usually save insurers business income benefits they would otherwise owe, some insurers refuse to reimburse these expenses because, although incurred within the period of indemnity, the payment obligations fall outside the period of restoration.
The Standard ISO Extra Expense provision reads as follows:
2. Extra Expense
a. Extra Expense Coverage is provided at the premises described in the Declarations only if the Declarations show that Business Income Coverage applies at that premises.
b. Extra Expense means necessary expenses you incur during the "period of restoration" that you would not have incurred if there had been no direct physical loss or damage to property caused by or resulting from a Covered Cause of Loss.
We will pay Extra Expense (other than the expense to repair or replace property) to:
(1) Avoid or minimize the "suspension" of business and to continue operations at the described premises or at replacement premises or temporary locations, including relocation expenses and costs to equip and operate the replacement location or temporary location.
(2) Minimize the "suspension" of business if you cannot continue "operations."
We will also pay Extra Expense to repair or replace property, but only to the extent it reduces the amount of loss that otherwise would have been payable under this Coverage Form.
Clearly, when an expense is incurred is just as important as the fact that it is incurred at all. The provision expressly states that extra expenses are limited to those actually incurred during a period of restoration. Most policies do not define the term “incur,” and parties often find themselves in court asking for favorable interpretations.
“Incur” is ordinarily defined as “to become liable or subject to through one’s own action; [to] bring or take upon oneself.” Random House Webster’s Unabridged Dictionary (1998).
This definition will typically exclude gratuitous or voluntary obligations (i.e., not otherwise helpful in reducing or minimizing the loss), which would not have been “necessary” and therefore not recoverable even though “incurred”
In Business Interruption-Coverage, Claims and Recovery, Daniel Torpey elaborates on the issue of paid vs. incurred expenses:
When a policyholder buys goods or services in connection with restoring its assets, it will likely do so under some type of financing arrangement. That expense is incurred at the time the goods or services are purchased, but it may be paid over a period of time. The expense is accrued for payment-as accounts payable-under accrual accounting at the time the obligation is incurred. When the actual payment is made, the payable balance is reduced, as is the company’s cash. Most disputes do not typically revolve around these concepts. Insurance companies generally recognize accounts payable and other accrued expenses as legitimate expenses in their loss calculations, although they often require proof of payment of those items before settling the loss.
The issue becomes significantly more complex and contentious when the dollar obligations are large and extend for a significant period beyond the time required for restoration or replacement of the damaged property.
Consider the situation of many major financial institutions after September 11, 2001. While most institutions had backup facilities for vital operations, thousands of employees were displaced by the damage or destruction of the buildings. Assuming that there would be a high demand for office space, some companies took unusual measures-from occupying entire hotels to entering in five or ten-year leases-to assure that they had sufficient temporary space to accommodate employees as quickly as possible and to minimize their business interruption losses during the reconstruction or relocation periods. As it turned out, more space was available than expected in the New York real estate market, and most institutions were able to relocate their work forces to permanent spaces fairly expeditiously. Unfortunately, these institutions then had unneeded space under long-term leases they were obligated to pay. And the soft, post 9/11 real estate market made subleasing virtually impossible.
The obligation for these leases was generally incurred during the period of indemnity for these companies, with the payment of these obligations set to occur over time. These specific issues still have no clear resolution, although most companies asserted claims for the present value of the tail on the residual lease obligations. Disagreements regarding the responsibility for paying these types of incurred, but not paid, obligations continue to be included in the ultimate negotiation of insurance and reinsurance claims. A very strong case can be made, based on insurance policies and simple logic, to support the validity of these claims. As a practical matter, the leases could be terminated – and the expense of doing so rightfully claimed-within the indemnity period.
I could not find a published court opinion that dealt specifically with long-term temporary losses incurred during the period of restoration, but the payment of which fell outside of the period. I believe that a policyholder’s efforts and money spent to resume operations swiftly and which reduce or eliminate a business income loss should be fully compensated, even if the time of actual payment for those efforts falls outside the period of restoration. Public policy should prevent an insurance company from denying coverage for legitimate and documented expenses incurred in accordance with a policyholder’s contractual obligation to mitigate its business income loss.