Business interruption insurance: What does it cover, and should I purchase it for my business?
October 2020 Footnote
Editor's note: Updated September 30, 2020
We’re living through one of the biggest interruptions of our lifetimes. It’s affected our home lives, our social lives and, yes, our business lives.
So, does a pandemic displacing millions of workers and thousands of businesses fall under business interruption insurance? How about the civil unrest the nation has experienced since late May, which was sparked right in our backyard of Minneapolis? Read on.
Business interruption, more commonly referred to as business income coverage, provides income replacement to a business in the event income is lost in a disaster. There are three elements that must be met for an event to qualify for coverage under a standard business income policy:
A physical loss or damage to property covered under the policy.
The loss takes place during the policy period and within the territorial provisions of the policy.
The loss must be a result of a peril not otherwise excluded by the policy.
Virus- or COVID-19-related claims have largely been denied under the premise that the presence or threat of the existence of the virus did not constitute a physical loss or damage. Many cases are being litigated in various jurisdictions; to date, the denials of coverage have largely stood.
Breaking down business interruption insurance
Business income coverage is offered by almost all property and casualty insurance companies, and it is usually written in conjunction with the property insurance coverage provided to a business owner.
The simple formula for business income coverage is net income plus continuing expenses. The net income is estimated using a forensic accounting process that takes into consideration prior month’s performance as well as the trajectory of what profits would have been had there been no loss. Continuing expenses are simply those business expenses that do not stop simply because the business is not in operation. Examples include rent, loan payments, taxes and even employee wages.
Many business interruption forms include additional coverage for extra expenses. Examples of these types of expenses include:
Advertising costs to inform customers of the interruption.
The cost to rent temporary locations to run partial operations.
Transportation over and above the normal costs to transfer property to new locations.
Overtime payments to employees.
The duration of coverage provided typically runs from the date of loss to the end of the interruption of the business, which is usually defined as the date the damaged property has been repaired or replaced. The standard business interruption policy provides an additional 30 days of payments beyond the repair/replacement date, but additional coverage may be offered by some insurance companies, up to 360 days of extended period of indemnity. Typical deductibles, or waiting periods, are 48–72 hours. This is the amount of time the business must be interrupted before coverage will apply.
Should business interruption insurance be purchased for my business?
The Federal Emergency Management Agency (FEMA) estimates that nearly 40 percent of businesses fail to reopen following a natural disaster. In addition, nearly 20% of businesses suffer some sort of disruption every year, and an estimated 25% of those businesses never reopen successfully.
Some considerations when analyzing the need for business income insurance include:
- Cost. Business income coverage is rated using a rate that is generated from the property rate that is being charged on that coverage. Typically, that business income rate is 10–25% greater than the property rate because exposures to loss, and the amount of loss, are more difficult to predict.
- Redundancy of operations. Businesses that run similar operations at several locations may have a lower exposure to major business interruption losses. Factors impacting this are the capacity at these locations to take on more work, the proximity of the locations to each other and the costs associated with transferring work between locations.
- Adequate limit. Calculating the correct business interruption limit is not an exact science. There are numerous worksheets available to get business owners moving in the right direction. However, simply looking at the financial numbers does not tell the complete story. It is even more important to investigate the business’s disaster recovery plan to arrive at the proper coverage limit. Elements of the disaster recovery plan can provide the underwriters with important information that may make them feel more comfortable with the risk of loss and, thereby, be able to offer coverage at a lower rate.
- Exposure to loss. Standard property policies provide coverage for numerous perils including fire, wind/hail, theft, burst pipes, vandalism, strikes and riots. However, additional exposures to loss may require additional coverage endorsements that need to be purchased. These include:
- Earthquake. Where is the business located? Is there an exposure to loss from earthquake?
- Flood. Is the business located in an area exposed to flood loss?
- Utilities. Is the business reliant on overhead powerlines in its manufacturing operation? If so, additional riders would need to be purchased to cover this peril.
- Mechanical breakdown. This is a peril that is a standard exclusion on a property policy. Manufacturing firms that rely on specialized equipment are especially exposed to losses in this area.
A critical choice
Business interruption is a critical coverage for most business operations. Careful consideration should be given to each of the factors discussed above to make the proper decisions regarding this coverage. As always, you should use the expertise of your commercial insurance agent and insurance company to assist you in making an informed decision.
Tim Gallagher is the senior VP — business insurance middle market for Marsh & McLennan Agency LLC. You may reach him at tim.gallagher@MarshMMA.com or 763-746-8296.