What is Business Interruption Insurance?
What is Business Interruption Insurance? –
We are going to use an extreme example to show the importance of this coverage.
Let’s say, for example, you are a business owner of a computer store, with both software and hardware for sale.
The building the computer store catches on fire, and burns through the computer store.
In this peril, computer inventory and business records, both faced total loss, with nothing remaining.
You have insurance on your computer store, so you do not worry about the damage and loss.
Time Element – Commercial Insurance
The element of time is an important factor or denominator in many insurance claims and losses.
This changes to scope, however, once the insured of the policy realizes another element exists in the insurance equation, and this factor is business profits.
Why do you ask? Because, if the time to repair your business to functional levels, may take an enormous amount of time.
Extended Time Amount
This time amount could be roughly six months to a year, in many of these loss or claim, types.
So, as you can imagine, once the computer store owner realizes the length of time to complete all necessary repairs, worry starts to set in.
The stress factors take form when the business owner learns of the amount of business downtime.
This unexpected business income loss was never factored in when many business owners decide to purchase their BOP policy.
Standard Policy – Business Interruption
On a standard commercial property policy, protection against direct loss is considered the actual physical damage. This damage can also be considered the destruction of property.
The perils that caused the direct damage to the business operations, can also cause other types of losses.
These types of losses are labeled:
• consequential, or
• indirect loss.
Indirect Coverage Loss
This type of loss results from the disruption of effects from the property damage itself. There exist various coverage indirect types, and as you can, the need for them is considerable.
This is because, the monetary value of an indirect loss, can easily exceed the amount of the underlying direct loss.
Decreased Business Profits
As an example, if a small property loss, in turn, causes the operations to a halt, the indirect loss, would be the lost profits.
These lost profits would result if the operation came to a halt, meaning no supplies can be processed or sold.
Not only does this indirect loss of profits take a hit at the bottom line of a business owner, but also the labor equation.
Total Operation Loss
For example, if the operation suffers a halt due to a direct loss, employee labor would also be factored into this equation.
The total operation as a whole would be impacted by this type of loss, for example.
So, a large indirect impact occurs from a relatively small direct impact.
This all depends on the industry type and direct loss impact. This is just for illustration purposes, in hopes, to magnify the example.
Importance of Business Interruption Insurance
You may already know the immediate benefits of having business interruption insurance coverage.
However, having business interruption insurance does more.
It can help recuperate from any loss, prolonged or not, that a business may encounter over its life cycle.
Security Seal of Coverage
This type of protection can provide a sense of security and peace of mind if a business should face such an issue.
Many small business owners will find that a standard business owner’s policy, will cover the most risk.
However, for that added protection, especially for online business owners, e-commerce insurance coverage is available.
There are different types of e-commerce insurance options, even under this type of protection.
However, before we begin exploring the different components that are underlying this package option, let’s look at the actual form that a Business Interruption Coverage takes place on.
Insurance Coverage Form – Business Interruption
The business income coverage form is the form that the coverage for business interruption losses is written on.
This insurance program was revised and updated by the ISO back in 2000, where the form included several additional coverage options.
These coverage options that insurance companies now offered, were part of a flexible outline and plan for the coverage of time element.
This was an important move in the right direction for program development and a channel for further development of coverage, such as e-commerce.
Business Interruption Coverage?
This type of insurance coverage will apply to the actual loss of business income. The business income that suffered a loss, would have to be a loss that was covered under the program.
If the loss was a covered loss, then the downtime of the business, regaining its operation would be considered a “suspension of operations”.
Suspension of Operations
During this suspension of operations, a period of restoration will take place. It is in this period of restoration where a business can lose income.
This is inevitable if an operation must close for a certain period.
The cash flow would halt unless the operation was built on a more technologically advanced system, where destruction or loss, was slim to nonexistent.
This obviously does not represent the real world, but it is worth noting and taking note of the actual loss covered for business interruption.
Type of Loss for Business Suspension
The type of loss for business interruption insurance to kick in would have to result from a direct physical loss.
This physical loss includes damage to your actual business property at the premises.
This also includes any property that is located 100 feet of the actual business premise.
Keep in mind, however, this loss must have occurred as a result of a covered loss.
Meaning, it the loss is not listed as a coverage risk, then no coverage would be applied under this package.
So, as a side note, make sure to review the actual declaration pages of your insurance policy.
Look at the exclusion page, and see if you have a standard or broad insurance policy form.
The Insurance Application
The insurance portion of this section applies to the loss and expense that was related to an interruption of normal business operations.
This is defined in your policy declaration page of the “operations of your business activities” at the premises.
The premises of the business will be listed and described in your policy declaration page.
Most pertinent information can be found here, if in doubt of a certain exclusion or loss.
If the term tenantability is used, it would also include the rental value portion of coverage that is written on the policy itself.
Remember, only losses that occurred during this period of restoration or business downtime would be eligible for business interruption coverage.
As a tip, keep in mind of the restoration period, as well as the coverage and risk loss terms.
This will help prepare you for the unaccepted in any business situation, and as business owners, peace of mind of your machine is primary.
Period of Restoration
In discussing business interruption insurance coverage, the period of restoration cannot be ignored from further detail.
It is such an important part of the insurance equation, so, lets begin with what you need to know about this period.
This period of restoration will begin on the date when the actual direct physical loss to your business property happened.
It will also include the dates it ends and a list of what items were damaged in the process.
These damaged proprieties, under this business coverage property terms, will fall under the following probabilities.
These probabilities are itemized under certain coverages, in order for coverage to take place:
These types of restoration actions, also come with other conditions regarding the process, which include:
• Reasonable speed
• Similar quality
If you have suffered a loss under these terms, and now must go through the restoration process, you may also want to keep in mind with other limits and terms.
For example, you would not be required to repair or replace the damaged property with speed, however, your insurance carrier may limit the period of coverage, if reasonable speed is not used.
This can be questionable at first glance, but it is more of the practice of common sense.
So, it should NOT take 6 months to paint 1 small wall of your business, due to a covered loss, if this was the only damage incurred.
This would be an extreme case of not using your time reasonably, and also, an illustration of how the time element of being unreasonable, may appear in an example.
You can always find further clarification in your policy documents, regarding terms and conditions.
Business Insurance Income and Extra Expense Form
When discussing the business income and extra expense form, found on your general insurance policy, a few other components will be found in the policy structure.
Five types of coverages exist on this type of insurance form.
However, out of these five, only four of them are identified as “additional coverages”.
Keep in mind, however, that none of these types can increase additional coverages to your policy.
Meaning, the limit of insurance cannot be increased, just because you add on these additional forms.
Business Coverage Types
Let’s discuss the five coverages that can be applied to your policy:
1. Business income – which includes 3 options
2. Extra expense
3. Extended business income – a max of 30 days
4. Alterations and new buildings
5. Civil authority – 2 weeks maximum
What is Business Income Coverage?
Great question, since if you decide to add on one of these forms, you will have a clear understanding of terms and conditions.
Business income coverage will pay your actual loss of business income.
Business income would be defined as the net income, which includes the net profit or loss, before any income tax.
Make sure to also factor in the operating expense to maintain business.
The gross revenue would not be covered.
This is due to many expenses, such as electricity or heat, as an example.
This may be discontinued when the business actual closes its door.
The continuing expenses such as:
• Debt payments
Profit and Loss Margin
There are all covered, since the net profit or loss is, what is the leftover after your continual business expenses are paid.
Keep in mind, however, that if the revenue to cover the ongoing expenses is not replace, it will reduce the total net income.
As an example, let’s say that an insurance agency has a monthly revenue of $500 thousand and a total expense of 200 thousand, with a monthly net income of 300 thousand.
Now, consider the insurable business income amount is greater if there were expenses to continue operations.
If the 100 thousand dollars of the expense continues during this business shutdown, you would need additional monies to recover the 400 thousand.
To be indemnified, or to make whole again in the insurance language, a recovery amount of 400 thousand would need to be collected.
This is factored into the equation for indemnification.
This equation would start with taking the 400 thousand, as stated above, and minus a 100 thousand for continual operational expenses, this would equal out to 300 thousand of net income.
Insurance – Profit and Loss Equation
Make note that, the net income definition is defined as the net profit or loss.
So, if a business operation is at a loss, it would suffer the same loss after being indemnified.
This indemnification would be covered by the insurance.
This equation would spell out as if the net income was a negative 100 thousand dollars.
Operational Coverage and Expense
This is in addition to continual operational expenses, totaling 300 thousand,
would leave a recovery figure of only 200 thousand.
So, as you can see, the purpose of the business income coverage is, to restore you, the business owner or insured, to the position you were in before any disruptions of operations occurred.