Business Interruption Claims in the Hospitality Industry
Hotels and other companies in the hospitality industry face unique challenges following a disaster like the Japan earthquake or the Gulf oil spill. Quantifying business interruption claims, particularly after a catastrophe affecting more than one business operation, is difficult. So it is critical to understand all the nuances of your policies to recover the losses you are due.
The thing is, you will have a lot more questions than answers. This is not entirely a bad thing. Losses must be quantified to submit loss claims, but the value of hypothetical questions is undeniable. For starters, what is the size and location of the hotel? Is it a full-service or limited-service property? How long has the hotel been operating? Have there been recent renovations? Is business seasonal? Is the property a destination resort? Are there feeder properties?
And what type of claim is being considered? Typical claims could include direct physical damage, contingent business interruption, loss of attraction, ingress or egress, loss of power, political acts, infectious disease and dependent property.
As answers to these questions uncover more information, pay particular attention to the following factors: reduction in international travel, website disclaimers, indemnity periods and whether or not a property visit is required.
Reduction in International Travel
How could a hotel in the Pacific Rim quantify a business interruption claim from a reduction in travel from Japan due to the March 11 earthquake? The reason for the loss is simple, but try putting a number on it.
After the disaster, many Japanese residents and corporations changed their travel plans. This is a typical consequence of any major catastrophe. If a hotel in Hawaii or Melbourne notices a decrease in bookings and has the appropriate coverage, any number of factors might affect the quantification of a claim.
The first step is identifying lost revenue. The risk manager must determine if the property has amenities, services, advertising or other market outreach targeted to Japanese travelers. If so, can the property identify specific cancellations by Japanese travelers that were booked prior to March 11?
After lost revenue, look for increased expenses. For example, has the property had to reassign Japanese-speaking employees who are not being fully utilized during the period of lower occupancy by Japanese travellers?
On the other hand, every cancellation may not be attributable to the disaster. For instance, were any of the significant group cancellations from those that had no impact from the earthquake and cancelled only due to their own budget constraints? If so, that would be a part of the decrease in expected revenue in the aftermath but not actually part of the business interruption.
Or there may be other causes of unmet revenue expectations. Were there any other events might explain a decrease in bookings, such as the opening of competing properties in the vicinity?
Finally, there is the possibility that the hotel saw an increase in occupancy in other properties in Japan, possibly as a result of travelers spending more nights than anticipated in the country. Such scenarios must be accounted for when submitting a claim.
Another factor to consider is the perception presented to potential guests. If a hotel's booking website contains a statement that the hotel is undergoing construction from a covered loss, could it impact the quantification of a claim related to the event that caused those damages? It could lead travelers to change plans or stay elsewhere.
One thing to consider while attempting to quantify this scenario is the location of the property. Is the property primarily a discretionary leisure destination where the anticipated quality of the experience may matter more to possible travelers? If so, the impact may be greater than if it is a business hub to which many people must go regardless.
The season and traditional occupancy at that time of year can also have a significant effect. Historically, has the property been highly occupied at the time of year that the construction is taking place? Is this the season the property relies upon to get through the leaner times?
Regardless of whether or not that is the case, there is always the potential for make-up revenue. Does the hotel company own other properties in the immediate area that have capacity to absorb lost bookings from the location under construction? If so and those properties see an increased occupancy rate, could they be likely servicing the guests that the company has "lost" at the affected location? It is important to factor this in.
Perhaps the most relevant question to ask is the most obvious: what proportion of bookings originate through other websites or travel search engines that do not display the statement? Travelers using those avenues may not be affected.
Extended Period of Indemnity
If a property expects post-loss cancellations of booked group events and has coverage for an extended period of indemnity (EPI), a claim may be possible for future losses that will be incurred during the EPI. This situation might occur when a hurricane damages a city's convention center, and rebuilding the hotel property is expected to take only a few months, while the convention center takes 18 months to rebuild.
A question the risk manager may ask is whether the adjuster is willing to leave the future claim portion open for further consideration. Can the property settle a current claim submission and still submit additional losses at a later date when they are quantified?
In such a case, it is important to ask follow-up questions to understand the possible merits of quantifying a future loss and submitting it before the actual dates of the cancelled future bookings. For starters, is the lost booking a result of direct physical damage to the contingent location? There may be numerous reasons for cancellation, not the least of which is the organization's future financial considerations.
One thing that may help determine this is whether or not the group rebooked at a later date or with a property owned by another company. And even if the cancellation is directly due to the local disruption, what is the likelihood that this cancelled group can be replaced by another group resulting in no loss to the hotel?
Visiting the Property
At a time of claim preparation fee pressures and reimbursement issues, hospitality companies may question whether it is necessary to have the claim preparer travel overseas to visit the damaged property. Follow-up questions may help determine if such a trip would be cost-effective and important to the claim process. For instance, does the property's coverage include the cost of claim preparation and what is the specific language in the extension of coverage? How complex is the expected loss? How long is the extended period of restoration? Have the current financial results of the property differed significantly from budget or prior year? Does the local management team have past experience quantifying complex business interruption losses?
An example from the earthquake in Chile may help risk managers evaluate when to arrange a visit to a damaged property. In this case, the local management's budget was very conservative given the prior year's flat performance. The actual performance reflected a significant improvement over the previous year, but there were no formal revised projections to reflect this change.
So the claim preparation team traveled to the property in Chile and interviewed the local team, which helped them understand the potential revenue increases that could be realized in the ensuing four to six months after the loss. They determined that the old forecast was obsolete and identified specific support for quantification of expected increases in revenue.
In this case, traveling to the property helped the claim preparation team discover the disparity between the prior projections and the more recent financial performance. So sometimes, having boots on the ground is invaluable.
Judith K. Spry is a partner in the Chicago office of BDO Consulting, a division of BDO USA, LLP.