Cummins sues insurers over $381M in flood claims

June 29, 2009
Cummins Inc. is battling its insurers in court, saying they're refusing to pay most of the company's $381 million in claims stemming from the flood that immersed its southern Indiana facilities a year ago.

The engine-maker's 13 insurers have indicated they will pay no more than $91 million. They argue Columbus' location on a 100-year flood plain limits their liability, and say they shouldn't have to bear the full expense of Cummins' lost research and development.

"Despite Cummins' efforts to work with all its insurance carriers, significant differences have developed regarding the appropriate level of coverage for the flood-related damages to our sites in Columbus," wrote Cummins spokesman Mark Land in an e-mail response to IBJ questions.

Last June, heavy rain caused Haw Creek to spill into Cummins' Columbus engine plant, its health center, its day care center and its technical center, home of the company's R&D.

The flood, designated a federal disaster, left parts of some Cummins buildings up to 7 feet under water. It also caused $118 million in damage to Columbus Regional Hospital.

The disaster affected thousands of homes in 40 southern Indiana counties, according to the Federal Emergency Management Agency, which has given more than $175 million in assistance.

The legal tangle comes at an inopportune time for Cummins, which is struggling as the
recession depresses demand for its diesel engines, generators and other products.

Company officials had been publicly upbeat about the prospects of a large insurance recovery. In a July 2008 conference call with analysts, CEO Tim Solso said: "We are confident that our insurance coverage will limit the impact of this event."

But discussions dragged on, and on May 22 the company's insurers filed suit in federal court in Illinois arguing they were meeting their obligations. According to the insurers' suit, they already have paid $64.5 million and might owe another $26.5 million, but nothing beyond that.

Four days later, Cummins filed its own suit in Bartholomew County. The case has since been moved to federal court in Indianapolis.

High-stakes litigation

Experts say high-stakes battles between insurers and their clients are not unusual. As the amount of claims rises, frequently so does the likelihood insurers will fight them, said former Indiana Insurance Commissioner Sally McCarty, now an insurance and advocacy consultant for Hemophilia of Indiana.

For example, after a 2006 windstorm badly damaged the One Indiana Square skyscraper in downtown Indianapolis, the building's owner ended up in a legal fight with its insurer over the cost of repairs, including installing a new façade. Experts say the tab for the fixes likely tops $30 million. The case remains pending.

"There's probably not a homeowner in Indiana who had damage from that flood who can't tell you they've dealt with the same thing," McCarty said. "It's a typical day at the office for property-and-casualty insurers to try to limit their losses, especially on a scale of this magnitude. If they can save themselves a couple hundred million dollars, I'm sure they think it's worth going to court about."

Court records show Chicago-based insurance broker AON Corp. represented Cummins when it set up the insurance program. Insurers include Burbank, Calif.-based Allianz Global Risks; Chicagobased Continental Casualty Co.; New York-based XL Insurance America Inc.; and Schaumburg, Ill.-based Steadfast Insurance Co.

Peter Kanaris, a Chicago attorney representing the insurers, said he had no comment beyond what was in court filings.

Cummins' suit itemizes $180.7 million in direct flood expenses, such as $56 million for damage to its buildings and $42 million for damage to its equipment and machinery. It also warns the list doesn't include a business interruption claim worth up to $200 million. And it asks the court for punitive damages.

"Cummins is entitled to a sum that will serve to punish [the] insurers and to deter them and others from engaging in such conduct in the future," Cummins' complaint reads.

Around-the-clock repairs

Land said Cummins' employees worked around the clock for seven weeks after the flood to make the tech center operational. But the company doesn't expect all its repairs to be finished until sometime in 2010.

He added that cleanup is complete at
the engine plant, and the health center reopened in January. Cummins moved its child center to a new location and hasn't decided on future use of its flood-damaged facility.

It's difficult to tell exactly how much R&D work Cummins lost in the flood. According to Land, Cummins' heavy-duty line at its Columbus plant, which machines cylinder blocks and heads for engines, was idled for only a day or two. So the bulk of the company's $200 million business-interruption claim may be tied to partially developed technology.

The insurers' lawsuit boils down Cummins' actual R&D loss to just $17 million.

"Cummins ... is seeking recovery for the theoretical costs associated with the time to redo testing and/or certain research and development of engines referred to as the Test Articles and Golden Eggs," read the insurers' court filing.

"Theoretical costs to replicate alleged lost testing and/or certain research and development of the Test Articles and Golden Eggs are not covered."

Cummins' predicament is similar to one experienced by businesses in areas affected by Hurricane Katrina four years ago, said Larry Larson, executive director of the Madison, Wis.-based Association of State Floodplain Managers.

Property owners along the Gulf Coast thought their policies protected them. Instead, they ended up in court tussles with their insurers, which quibbled over the difference between wind and water damage.

"It really gets down to the fine print," Larson said.

Weathering recession

The legal dispute adds to the financial challenges hanging over Cummins. Though the company reported $755 million in profit last year, 90 percent of it was
booked before the economic downturn gained momentum.

In this year's first quarter, Cummins' $2.4 billion in revenue was $1 billion less than in the same quarter a year before. And its quarterly profit has slipped to just $7 million.

"The company is confident that the facts are on its side in this case, and also remains hopeful that it can continue to discuss the issue with its insurers in order to reach an equitable resolution," Land said. •
As a result, Cummins has been aggressively attempting to cut costs. In the last six months, the company has laid off thousands of workers across the globe.

In his April 30 conference call with analysts, Solso emphasized the company has low debt and access to a $1.1 billion credit line.

"This is my fifth recession in a leadership position," Solso told analysts, "and the most common mistake we've made in the past is, we've waited too long to react.

"And then when we reacted, we were too optimistic about what we thought the demand was going to be. So we're trying to avoid that common mistake that we've made and other businesses have made, and be as realistic as we possibly can and rightsize the organization."

Land said Cummins won't speculate about how long it will take to resolve the insurance dispute, or about how it could affect the company's bottom line.



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