When wine goes up in smoke

Northern California’s famous wine country has been scorched by two major wildfire incidents and there are still several weeks until the end of the 2020 wildfire season.

On August 16, 2020, a lightning storm triggered multiple fires engulfing over one million acres of land in California. The LNU Lighting Complex fire hit Napa and Sonoma, with thousands evacuated and 360,000 acres burned according to Cal Fire, and over 1,700 structures were either damaged or destroyed.

More recently, on September 27, 2020, the Glass and Shady wildfires hit Napa and Sonoma, destroying historic wineries, damaging vineyards and causing tens of thousands to evacuate.

Experts attribute the increasing numbers of destructive fires to the effects of climate change and an increase in the development of wild-urban interface areas. These factors have made conditions ripe for wildfires, which can ultimately be caused by:

• Lightning storms
• Human activity
• Electrical power/distribution lines
• Faulty electrical equipment

Fires caused by frivolous human activity such as gender reveal parties often dominate the headlines; however, opportunities for subrogation recovery are most likely when defendants have significant financial means. The following are examples of substantial payouts (largely related to property claims):

• Southern California Edison agreed to a $1.2 billion settlement relating to insurance companies’ claims for the 2017 Thomas Fire and subsequent mudslides.
• San Diego Gas & Electric agreed to pay insurers $686 million to settle claims relating to the San Diego wildfires in October 2007.
• Caltrans reached a $27.7 million settlement with insurance companies after investigators found that the 2017 Canyon Fire in the Anaheim hills was ignited by a Caltrans road flare that was struck by a civilian vehicle.

Of particular note is the $11 billion payout by Pacific Gas and Electric to the Ad Hoc Subrogation Group for insurance claims relating to Northern California wildfires in 2017 and 2018.  A significant portion of the payout relates to wine country claims.

Wineries are impacted by fires in many ways, but some of the most sizeable and complex claims relate to the destruction/damage of wine inventory, and it is important to note that wine does not have to be destroyed outright to be affected by a fire.

What can happen to wine during a wildfire?

Smoke taint. The most common issue we see resulting in wine-related claims after a wildfire event is smoke taint. Although there is no evidence that smoke tainted wine is harmful to consumer’s health, the wine will have an undesirable “smokey” taste with an “ashy” aftertaste.

In some cases, the winery may attempt to filter and process the wine to remove the smoke taint; however, this process can also affect the quality of the wine.

Smoke taint can occur as a result of direct contact with smoke residue or through contact with aroma compounds released by fires. The aroma compounds, known as volatile phenols, permeate grape skins and bond with sugars in the grape to form glycosides. The glycosides do not have a smokey aroma, but during fermentation (and over time when barreled or bottled), the glycosides break down, releasing the phenols and the smokey flavor. As a result, the smoke taint may not be detected for months or even years after the loss event.

After smoke taint has been detected during tasting, wineries will typically send samples to a third party for testing, where they will test for six volatile phenols that can lead to the smoke taint.

Other possible effects. Wildfires can also pose the following risks to wineries:

• As wildfire season coincides with the harvest season, wineries may have to abandon the harvest and leave the grapes out at the winery which can lead to spoilage.
• If the wineries are close to the fire or if the cooling systems are impacted due to power shutdowns, the grapes/wine can be damaged as a result of heat exposure.

Key steps to valuing wine

In most incidences, we will take the following steps to value wine:

1. Verify the existence of the wine

Our first step is to review the grape weigh tags for the impacted wine. This allows us to verify both the volume of the wine and the grape varietal.

During a normal harvest, after grapes have been picked from the vine, they will be taken to a weigh station, and a weighmaster certificate (commonly known as a “weigh tag”) will be produced, showing information including the weigh date, grape varietal and appellation, and net weight. (Figure 1)

The weighing process is heavily regulated, and weight tags are mandated for all California wineries by both the Alcohol & Tobacco Tax & Trade Bureau and the California Alcoholic Beverage Control.

It should be noted that we also review inventory records and tank reports to verify the existence of the wine, but the weigh tag is considered the key source document.

2. Determine the impacted wine program

To establish the projected selling value of the wine, we first must identify the program to which the wine would have been allocated. The “wine program” is the term for what you see on the label of the wine and will often specify the vineyard, if the wine is from a single vineyard, or may have a blend name if the wine is from multiple vineyards.

If the wine has already been bottled at the time of loss, this analysis is not necessary, as the program allocation has already been completed by the winery, evidenced by the label on the bottle. However, if the grapes/wine were destroyed or the wine is still in the tank or barrel, it is necessary to determine the program allocation.

Our role involves scrutinizing the insured’s projected allocation to see if it is consistent with:

• Blending plans for that wine program and vintage.
• Blending reports for prior vintages of the same program.
• Comparable grapes blended in the allocated program.

In some cases, the insured is able to provide a blending history showing that grapes harvested from the impacted vineyard and block have been used in the same wine program for several years.

Additional complications can arise in the following scenarios:

• The insured claims that the impacted wine would have been allocated to their highest value wine program; however, historically, the wine was used in a much lower value program.
• The insured purchased the impacted grapes from another winery and has never purchased these grapes before, so there is no blending history.
• The insured claims they were going to start a new wine program where the impacted wine would have been used. In this case, there would be no blending history for the program.

In many cases, the program allocation will have the most significant impact on the valuation of the wine and should be scrutinized during subrogation.

3. Calculate sales value & unincurred costs

Most insurance policies state the wine should be valued at “projected sales value less unincurred costs.”

Once we have established the program allocation (see Step 2), we then review sales records for the applicable wine program. This is done to establish both the average selling price of the wine and the sales channel.

Wine is sold through different sales channels that are typically categorized as direct to customer (DTC) or wholesale. Typically, prestigious and expensive wines will be sold entirely through DTC channels. As the wines reduce in quality and price, more is sold through wholesale channels.

Additional complications can arise if the impacted wine is a library wine (limited supply of a vintage held back after debut) as there is often limited sales data, and the projected sales price of the wine can be highly subjective. There is also a risk of obsolescence due to spoilage issues with older wines.

To calculate unincurred costs, review both production and selling costs.

Depending on the production stage of the wine, unincurred production costs may include the cost of the barrel, bottle, label, cap and cork. We may also consider barrel aging supplies, variable labor costs and any mobile bottling line costs.

Unincurred selling costs depend on the applicable sales channel, and examples include credit card fees, discounts, staff sales bonuses, commissions, distributor allowances and unreimbursed freight costs.

Ultimately, the goal is to establish the net loss to the insured based on projected sales price less any costs that the insured did not incur by not producing the wine.

Mitigation efforts

In some instances, the impacted wine may still be sellable, especially if there is only a mild impact on the taste. It may be possible for the insured to use the wine in a lower value wine program or sell the wine on the bulk market.

Coverage complications

In smoke taint losses, the most common coverage complication centers on whether the wine falls under “crop” coverage (lower value) or “inventory” coverage (higher value).

This is often determined by identifying whether the grapes were on the vine or picked when the smoke taint occurred. To assist, we can look at the grape weigh tags to approximate the date the grapes were picked.

During the subrogation process, this could be relevant:

• For a claimant — if coverage was not available for crops during the initial insurance claim, recovery for losses could be pursued during subrogation.
• For defense — to confirm the correct coverage decision was made regarding the valuation basis for the wine (crop vs. inventory).

Changes to the wine insurance market

Before 2019, the California wine industry had looked to Lloyd’s of London for inventory throughput policies. However, in July 2019, Lloyd’s announced that it would no longer be underwriting these policies because of the annual risk to wine production and storage caused by wildfires.

The aggregation of risk in the Napa and Sonoma wine regions means that one wildfire can result in a catastrophic loss event. The retail value of wine produced in Napa and Sonoma equates to approximately 50% of retail value for California while the volume of wine produced accounts for less than 10% of the state’s total.

The move by Lloyd’s has put pressure on the domestic markets to respond. Furthermore, ongoing wildfires have resulted in significant increases in policy rates, particularly for large, high-end wineries with extremely valuable inventory. As a result, wineries have been forced to take on higher deductibles, and many will likely consider using dollars they would have otherwise spent on insurance policies for fire mitigation tools instead.

While fires can cause direct damage to wineries and vineyards, don’t forget about indirect damages, including smoke-taint. Subrogation claims regarding wineries can be complex and often require a team of forensic and wine experts. This can include:

• Trained origin and cause investigators to determine the source of the fire(s).
• Wine tasting experts to determine the degree of the smoke-taint.
• Forensic accountants to determine the actual damages incurred due to the fire/smoke.

This article was authored by Hannah Dingley, Tim Gillihan and Trevor Eaton. It has been provided courtesy of J.S. Held, LLC and was originally published online via J.S. Held University.

Related:

• A familiar scene in Napa Valley as Glass, Zogg Fires continue to burn
• How businesses can minimize their wildfire risk, from Allianz and I.I.I.
• ‘Grape’ expectations: Insuring California’s wine country as risks rise