Business income insurance is an important but often misunderstood coverage. It is designed to replace income lost as a result of an occurrence that is covered by the policy. It can also cover continuing expenses like payroll or extra expenses incurred during the restoration period.
Building and business personal property insurance pays to restore physical property after a covered occurrence. However, physical damages may not be the full extent of the loss. During the time it takes to restore the facility to operational status some programs may be curtailed; others may be held elsewhere by incurring additional expenses. Both actions reduce the organization’s net income. In addition, salaries, benefits, mortgages, and other contractual expenses often continue. Since the standard property contract covers neither the net income difference nor the continuing expenses another insurance form is required. That coverage is business income/extra expense.
This protection is triggered by the total or partial suspension of business operations due to loss, loss of use, or damage to all or part of the building or business personal property as the result of a covered cause of loss. Coverage is provided for the time it takes to rebuild, repair, or replace the damaged property or the period of restoration. The period of restoration is defined as the period of time that begins:
The protection is available only as a result of a covered cause of loss at your described premises.
Business income insurance is used to ensure that the entity is still viable after the restoration period. It helps the organization maintain approximately the same business income position it would have had if there had been no covered property loss. It is what allows the organization to resume operations after reconstruction is complete.
A supplement to business income insurance is extra expense coverage. This component is designed to pay for expenses that would not have been incurred if no loss had occurred and/or to pay for expenses that are incurred to reduce the period of restoration. For example, it allows an organization to establish a temporary location so operations can continue while repairs are being made to the damaged property. Extra expense will also pay the relocation costs to equip and operate a temporary location. Extra expense protection is in addition to the business income limit and will increase the total policy limits.
The Broadened Property Endorsement provides $25,000 in business income/extra expense limits for Redwoods’ insureds who do not elect specific business income/extra expense coverage. If such coverage is elected the chosen limit will appear on the Property Declarations page. The limit is combined for both business income and extra expense.
There are two commonly used ways of writing business income insurance: coinsurance and monthly limit of indemnity.
Coinsurance is the most common method; it is favored because the rates are lower and because recovery is not limited by monthly maximums. However, much more effort is required by the organization to select the most appropriate policy limit. If the selected limit is inadequate a coinsurance penalty will be applied.
The monthly limit of indemnity method eliminates coinsurance but imposes a monthly maximum based on the fractional limit that the organization elects (1/3, ¼, or 1/6 of the policy limits). This form does not limit the length of recovery as is often thought; it limits the amount of business income loss that may be recovered on a monthly basis.
The monthly limit of indemnity method is frequently chosen by entities that elect not to purchase the amount of insurance required by the coinsurance method or by entities that do not want to supply the financial information necessary to calculate the amount of insurance that is needed to satisfy the coinsurance requirement. While no particularly complicated formula is required to determine the appropriate policy limit, it is easy to select policy or monthly percentage limits that are inadequate.
A way to lower the amount of business income coverage an organization needs involves ordinary payroll. Coverage for ordinary payroll, i.e. payroll expenses for all employees except officers, executives, supervisors, and employees under contract including directly related employee benefits, workers’ compensation premiums, unemployment contributions, and the organization's portion of FICA payments, can be limited to 90 or180 days or can be eliminated altogether. If one of these options is desired, ordinary payroll figures would not be added back in the business income worksheet at lines IVa and IVb, but their amounts should be identified and reported so it is clearly understood that coverage for those items is not desired.
Sometimes reconstruction may take more that 12 months. The reason may be project size, extent of damage, material type, construction type, or one or more of the extenuating circumstances listed in the section below on underestimating construction time. A 30-day automatic extension exists and by activating the Extended Period of Indemnity clause coverage may be extended up to 730 days or two years. If the extended coverage is desired the business income limit should be increased to provide adequate funds for the extended period of reconstruction.
Revenues and expenses that are associated with an organization but that are developed from off-site child care or after-school programs can be deducted in establishing the business income limit because the facility closure will not impact revenue and expenses from these off-site operations. If the organization has other programming that is totally off-site and is not dependent on whether the facility is physically open for business, those revenues and expenses could also be deducted.
The most frequent cause for organizations to purchase inadequate business income limits is that they generally think that their facilities will be shut down for only a few months after a loss. While that may be true for minor losses, organizations should plan on at least 12 months for major losses. Frequently, insured organizations are public facilities and as such face stringent building codes. Factors that may affect the time it takes to repair or rebuild are:
Organizations often buy inadequate business income limits on their camps. You may be forced to close your camp because of a fire that requires evacuation resulting in a business income loss. This can be a large loss if the fire or other triggering event occurs during the summer camp season in June or July.
Sometimes inadequate business income limits are selected under the assumption that a nearby facility can temporarily meet the need. However, most customer organizations are stretched during normal operations and there may be little opportunity for additional programming space or time. Having to travel the distance to the next nearest facility may be an unacceptable hardship or inconvenience for members that might result in a permanent rather than temporary membership loss.
An organization may be unable to provide after school or child care services due to a covered occurrence; business income coverage allows the organization to lease space from a nearby facility to continue to provide local service and not have to close the program. Without sufficient business income limits to cover the extra expense the organization might have to forego this option.
Some organizations do not include grants as revenue. They feel the grant will continue whether or not they provide the intended service. This may be true if the loss occurs late in the year, but if the loss occurs early in the year or before the money is received the funds may be lost. If the organization relies on grants to fund their normal operations they should include grants as revenues.
This organization has purchased a monthly limit of indemnity business income and extra expense policy with $1,000,000 total policy limits and a ¼ monthly limit. The maximum recoverable business income loss is therefore ¼ of $1,000,000 or $250,000. A covered event occurs and the following losses and payments occur over a seven month period of restoration.
|MONTH||BUSINESS INCOME LOSS||EXTRA EXPENSE LOSS||TOTAL PAID|
^ monthly limitation applies to BI but not EE † policy limit reached
As can be seen, the full amount of loss was paid in the first two months, but the third month’s business income loss exceeded the maximum allowable recovery so that $20,000 of the loss was not paid. Loss payments in the sixth and seventh months were restricted because the policy limit had been reached. All of the losses would have been paid in full if policy limits of $1,300,000 had been purchased and the same monthly limitation was elected.
This organization chose to purchase the coinsurance form of business income with a low limit in an attempt to save money. Note: Though the premium may be less with a lower percentage of coinsurance, the actual rates used are higher so the net premium savings may not be as great as hoped and may not represent the best value. Their decision to protect only professional staff salaries and certain ongoing obligations resulted in an after-loss need determination of $500,000 including monies for extra expense. They purchased that amount of coverage and elected the lowest available coinsurance option (50%). During the policy period they experienced a covered occurrence that resulted in $300,000 of business income and extra expense loss…well under their policy limits.
Unfortunately, policy limits are only part of the story. Because their net annual revenue for the policy period was $1,500,000 and they had elected the 50% coinsurance provision, they were required to carry policy limits of $750,000 to receive full reimbursement for their loss. They had carried only ⅔ of the required amount (500,000/750,000) and thus were only eligible for reimbursement of ⅔ of their loss or $200,000, leaving them with $100,000 of uncompensated loss.
Their tight budget just became much tighter. If their calculations led them to believe that $500,000 was the correct amount of coverage they should have determined the maximum monthly amount needed and purchased a monthly limit of indemnity policy with the appropriate monthly limitation. It would have resulted in a higher premium, but would have paid their entire loss.
This organization elected to purchase the coinsurance form of business income after determining the level of protection they wanted and examining the options. They wanted to protect all salaries and benefits as well as other ongoing obligations. Their business income worksheet summaries are shown at the top of the adjacent column.
Having determined that they wished $1,100,000 combined business income and extra expense limits, they evaluated their options. They chose the 70% coinsurance plan because its rate was less costly than the lower percentage options and its minimum coverage amount (70% of $1,500,000 or $1,050,000) was less than the coverage limits they wanted to purchase. They rejected the 80%, 90%, 100%, and 125% plans because though they had lower rates, those plans would have invoked a coinsurance penalty since their required minimum coverage amounts exceeded the coverage limits the organization had chosen.
|Business Income Worksheet|
|line III||revenues less expenses|
|line V||continuing expenses|
|line VI||business income total|
|line VII||extra expense total|
|line VIII||combined total|
The organization experienced a covered occurrence during the policy that resulted in business income and extra expense losses totaling $950,000. The entire amount was covered by their policy because they had adequately determined their needs and had purchased the policy that best fit those needs.
Business income/extra expense insurance is an important coverage. It can keep an organization going during the aftermath of a serious property loss – it is protection for the operation not just the building that houses it. However, it is more like a suit than a rain poncho…you buy it to fit your needs rather than grabbing some one-size-fits-all protection.
Properly selected, business income insurance
Business income losses can exceed the direct property loss. Protection against such catastrophic fiscal loss is critical for financial viability.
Note: When business income is written using the coinsurance method, a penalty will apply at the time of loss if inadequate limits are purchased. The potential coinsurance penalty can be eliminated if the organization agrees to carry limits of insurance equal to at least the coinsurance percentage shown in the declarations multiplied by the anticipated annual revenue for the 12 months following the inception date of coverage (line I on the worksheet) and the worksheets showing data both for the 12 months prior and the estimated 12 months after policy inception are completed prior to the time of any loss.