Speaking or writing about property insurance without the mention of business interruption insurance should be difficult. However, many insurance consumers and even seasoned risk managers overlook this key coverage when protecting a business from catastrophic loss.
Business Interruption Insurance
Know the Fine Print
Speaking or writing about property insurance without the mention of business interruption insurance should be difficult. However, many insurance consumers and even seasoned risk managers overlook this key coverage when protecting a business from catastrophic loss. Many fail to fully evaluate its necessity. If the coverage does exist on any particular policy, most assume that all business interruption policies are the same and fail to fully evaluate whether the form variations and limits are adequate.
Insurance is one of the first tools risk managers can deploy in their arsenal of weapons to combat risk. Insurance is the weapon of choice for risk managers when the risks are too unpredictable, or the financial impacts are so high their organizations simply couldn’t win the battle on their own. In many cases, the cost to replace or reconstruct property from a fire loss is less than the money lost while your business isn’t operating. The bills don’t stop stacking up, employees still need their paychecks, banks don’t stop calling, your once loyal customers find your services down the road – the list goes on.
Business interruption insurance to the rescue! Well, maybe. There is a lack of uniformity and nothing standard about this property insurance except it is intended to protect your loss of net profit. There are variations in coverage between insurance companies. How well you are protected depends upon your understanding of all the options, the choices you make in advance of the interruption, and on the plan you make to survive the interruption of your business. Simply put, business interruption insurance can be complicated and claims can take a long time to resolve.
Coverage is Triggered by Direct Damage to Property
Consider this real life scenario:
A local manufacturer loses power for three weeks during a recent storm. His property remained in-tact and sustained no damage. However, overhead power lines and a nearby substation that fed power to his area were severely damaged. The manufacturer was unable to operate or fulfill its production orders and had to send customers away to a nearby competitor. Luckily, he had a contingency agreement plan with this competitor so he would not lose future repeat business. The loss of income during the three week period was north of about $300,000. The claim was submitted immediately, however the insurance carrier denied the claim. Why?
Protection for business interruption is optional. Basically, when this insurance is purchased, the insurance benefits become available only after
- there is direct damage to or destruction of an insured property from a covered cause of loss (peril)
- a waiting period of usually seventy-two hours
- a necessary slowdown, or suspension of operations
- an actual loss of income. If there is no direct damage to property, no coverage will be provided for business interruption.
These are standard rules, however, extensions or broadening of coverage is and was available. The insurance company was just following policy contract and denied the claim based on the coverage form in place. The problem or fault lies with the failure to discuss all the options and endorsements available to ensure this particular circumstance would be covered. Most insurance carriers offer business interruption due to loss of Power, Water, and communication systems even if no damage was sustained by the insured’s property. In addition, Overhead power line failure is also available as a coverage option. The truth in this case is that these options and broadening endorsements weren’t discussed and coverage was assumed. With a little forethought and discussion, this loss could have been covered for pennies on the dollar.
Damage Must Be From a Covered Cause of Loss
Besides direct damage, the event causing the damage must be a covered cause of loss (peril). Typically property insurance is either named peril or all perils except those which are excluded.
Covered causes of loss are mostly defined by insurance companies as either “Basic,” “Broad,” or “Special.” “Basic” and “Broad” are the traditional named peril forms, while “Special” is the new term for the broadest protection covering all perils except those which are excluded. Examples of perils typically excluded are floods and earthquakes.
As new risks have evolved, protection for these new perils is being added by endorsement, and coverage must be purchased separately. Examples are food contamination and communicable disease, and workplace violence, cyber-attacks, etc . Protection against these new perils, a potential gap in your coverage, may not be uniformly available from all insurance companies.
The swine flu outbreaks during the summer of 2009 put lots of pressure on certain hospitality and resort businesses and resulted in some voluntary closures. Programs were cancelled completely, while in other instances, customer vacations were cut short. Here’s the gap!
These hospitality businesses most likely did not receive any benefit from their business interruption insurance because:
- they may not have had coverage for communicable disease events, and even if they did buy the additional peril of communicable disease
- their decisions to close were voluntary and not ordered by the health department
The coverage trigger in the protection against communicable disease events at resorts is the health department must order closure. Increase your knowledge about what triggers coverage and the perils that are and aren’t included in your property insurance program, to address these issues properly.
Here is a trap you may not see coming. Ask an experienced insurance broker about deductibles in business interruption insurance. They’ll tell you there are none, but there is a waiting period.
Upon further investigation you learn your operations must be suspended for at least seventy-two hours that is the standard waiting period, before business interruption benefits are available. This sounds a lot like a deductible by another name.
This waiting period can be eliminated, or reduced to twenty-four hours for an additional cost.
Is Payroll Included in Net Income?
Business interruption insurance is known as business income insurance in the “simplified” language used in policies today. Designed to protect your loss of net profit — defined as accounting net profit plus the expenses which continue (e.g., mortgage, property taxes, payroll, etc.) — so overhead expenses can continue to be paid until such time as the operations can be resumed.
Some insurance companies may apply the ordinary payroll limitation or exclusion to their business interruption insurance coverage. You might want to exclude the payroll for employees such as part time or seasonal employees for example, who would not be retained during an extended business interruption. Their payroll would be considered ordinary payroll. If this is your plan, be sure to remove this payroll from your business interruption limit calculation.
Payroll that would not be considered ordinary would be, but is not necessarily limited to, officers, directors, executive salaries, department heads, and employees under contract. Be sure to include maintenance staff in your thought process. Include these payroll amounts in your business interruption limit calculation as well.
Some directors may want to continue ordinary payroll for a limited period. Underwriters will use this same endorsement to limit ordinary payroll to a period of time during the interruption, for example, ninety days.
Chances are you may want to continue some, but not all, of your payroll expense if your camp operation is interrupted. Check your policies to determine if this endorsement is in use. Review it carefully with your insurance broker to understand its impact so you know what to expect. Make changes as necessary.
After operations are suspended, the business interruption insurance coverage provides for a period of restoration during which debris can be cleaned up and removed and re-construction begun.
Period of restoration is defined as the period of time following the waiting period (if any) and ending on the earlier of:
- the date when the property should be repaired, rebuilt, or replaced with reasonable speed and similar quality, OR
- when business is resumed at a new permanent location.
The gap in this situation is the period of restoration does not include the additional time needed to comply with ordinances or law, or to test for or deal with pollutants.
Obviously, the use of the terms “should be” and “with reasonable speed” will be controversial and can be a source of conflict between the customer and the insurance company in the adjustment process. This conflict will intensify if building materials are in short supply as has been the case in certain instances in the past following a catastrophe.
The potential gap in the period of restoration can be addressed by including an additional coverage endorsement called Increased Period of Restoration. This will allow for the additional time needed to comply with the ordinances or law.
Consider this real life scenario:
A large office building suffers damage during a late summer hurricane. Although the damage to the building is minimal, the tenants cannot occupy the building following the loss. The building takes 30 days to restore, during which time the owner suffers a loss of rental income. The area surrounding the building also suffers significant damage, and local authorities prohibit access to the building (and the surrounding area) for 60 days following the storm. The building owner submits a claim to recover the lost rental income lost for all 60 days.
After evaluating the claim, the insurer states that, because damage to the surrounding area is not an “insured premises,” there would not be coverage for this lost income under the policy, presumably for days 31 through 60. Somewhat discouraged, the owner is nonetheless hopeful that at least the loss of income from the first 30 days when his building was under repair would be paid.
However, the insurer goes on to assert that, regardless of the damage to the building, tenants would still not have had access to the building, and the income loss would have been the same whether the building was damaged or not. The insurer further explains that a property policy is designed to make the insured whole (citing the principle of indemnity). By paying for any of the lost income, the building owner would be better off because the damage to the surrounding area would still exist even if the damage to the building had never occurred. The insurer then denies the entire business income claim.
While policy provisions may dictate whether the insurer can make such an assertion, it is nonetheless a conceivable scenario. So, what can be done to ensure that the building owner has sufficient coverage if such a loss occurs?
When civil authority coverage is included within business income/extra expense insurance forms, income losses arising as a direct result from actions of local police, fire, etc., may be covered. Orders made by civil authority must be the cause of the lack of access to insured premises (or the reason that normal operations cannot continue) due to damage caused by a peril covered under your policy. There must be an act of civil authority for coverage to apply; blocked access to a location alone is insufficient to trigger coverage. (See section on ingress/egress below.)
The initial solution to the claims scenario above may now appear obvious. Civil authority coverage (or endorsement) is provided under most insurer business income and extra expense cover forms, and the insured would be properly covered. However, the terms of civil authority coverage may be too restrictive to grant an acceptable amount of coverage for all policyholders. Four limiting provisions under standard Insurance Services Office, Inc. (ISO), civil authority coverage should be completely understood and potentially amended for your specific situation.
- The proximity requirement stipulating that the civil authority actions must occur within one mile of the “insured premises”
- The maximum period that can be collected is limited to 30 days (after a 3–day deductible).
- Courts have held that access to the premises must be completely prohibited and not just impaired/limited in order for coverage to apply.
- There must be damage to property by a covered peril.
Not every business owner has a compelling need to expand beyond the standard coverage, but actions of civil authority can nonetheless have a dramatic impact on income following a catastrophic loss. If, after evaluating the potential for loss, there is a higher than normal civil authority exposure, adding ISO form CP 15 32 “Civil Authority Changes” (or similar) should be considered. This endorsement allows an insured to expand the mileage radius away from its premises for which civil authority action will trigger coverage and allows an increased period for which coverage will apply beyond the standard 30 days. Some insurers will also provide a strict dollar limit of civil authority coverage that is not subject to a specific time limit.
Another important consideration to the standard civil authority coverage is to amend language so that coverage will apply when access to the insured premises is simply “impaired” and not “denied” or “prohibited” by actions of civil authority. “Impaired” policy language considers the broader impact of a civil authority’s action in the surrounding area and does not restrict coverage if access to the premises is impossible. Typically, this improved language is available on larger manuscript policies.
Finally, civil authority will only apply if it was caused by a loss that is otherwise covered under the property policy. Following the terrorist attacks of September 11, 2001, there were numerous examples of claims filed by businesses that were dependent on airports being operational. After the federal government suspended air travel for an extended period, many of these businesses filed business income claims due to the act of civil authority. However, these actions, while certainly the result of the threat of further terrorist attacks, did not follow a covered loss to the surrounding area (the airport). Therefore, these claims were denied. This condition emphasizes the need to not only ensure that catastrophic loss to windstorm, flood, and earthquake losses are covered but also that civil authority coverage is included when these perils are added to a standard form via endorsement. Sometimes insurers will specifically exclude civil authority coverage when adding certain catastrophic perils.
Ingress and Egress coverage
Some insurer forms also separately provide protection for loss of income due to a lack of ingress and egress to/from insured premises. Like civil authority coverage, ingress/egress coverage is designed to pay for the loss of income triggered by physical loss or damage caused by a covered peril to third-party property that prevents or hinders ingress to or egress from the insured’s business. However, an act of civil authority is not needed to trigger ingress/egress coverage. Any evaluation of the terms and conditions of civil authority coverage should be accompanied by a similar review of ingress/egress coverage as well.
When evaluating potential property and business income loss scenarios, it is important to consider situations in which an off-premises event causes direct financial harm to your business. Having proper coverage for civil authority and ingress/egress can help lessen the potential for portions of a property claim going uncovered.
Extended Business Income
Sometimes when business is resumed the revenue lags and doesn’t return to the pre-interruption levels immediately. Reimbursement for this additional loss of income past the time camp has re-opened is included in most camp business interruption insurance policies for a limited time, usually thirty to sixty days. The purpose of this is to support the business until it can regain the customers and level of income that existed before the loss.
Additional time to protect a continuing loss of revenue for up to two years can be purchased by including an endorsement entitled extended period of indemnity and paying an additional premium.
However, a potential gap in this endorsement exists when there is no coverage for the loss of business income that results from unfavorable business conditions like the recession, which is currently affecting enrollment. Coverage strictly applies to loss of income due to the effect of the suspension of operations.
Understand the Risks and How Your Insurance Works
Knowledge is power! Before your next renewal, take some time to understand how your business interruption insurance works. Consider the gaps and traps we’ve identified. Refine or design a contingency plan to survive a business interruption. Be prepared!
Disclaimer: While every effort has been made to ensure the accuracy of this article, it is not intended to be exhaustive or provide advice specific to your individual situation. Each risk will differ and should be discussed in depth with an expert or insurance professional. For specific technical or professional advice on the information provided and related topics, please contact the author Richard Healy. firstname.lastname@example.org | 901.507.0616