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"Business Income Made Simple"
   By Robert M. Swift



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INSURANCE POLICY

The following questions and answers are for your information. The content is believed to be accurate, but it is not guaranteed.

Why do I need Business Income insurance?
Without it, you would be forced to get a loan or use your savings account to fund your ongoing operations while you had no income. Without sales, how would you pay your rent, utilities, etc.?

Are all insurance policies the same?
No. Each insurance company creates its own contract which has been approved in the states where it is doing business. There are a lot of common elements, but each policy has its own coverages, exclusions, and definitions.

How do I choose my limit of insurance?
Take the annual business income amount, times the percentage of a year it will take for recovery. For example, an 18 month recovery is 150%, and then add it to the Extra Expense amount.

What is coinsurance?
This is the insurance company requirement that the insured buy a certain percentage of the total replacement cost, or the business will be penalized at the time of a claim by the amount of error. For example, a $10 million replacement cost for a building insured at 80% coinsurance requires the insured to buy $8 million of insurance. If only $4 million is purchased, the business will be paid only half their claim amount.

Why should I not use my balance sheet for insurance values?
It shows assets at original cost or depreciated cost, not replacement cost which is the valuation used for insurance purposes.

What is inventory at sales price?
This applies to the finished goods of manufacturers and pays them the amount for which the goods could be sold.

How does Interruption Caused by Civil Authority coverage differ from Ingress and Egress? Civil Authority provisions seem common; Ingress and Egress provisions do not.  
The Civil Authority coverage is common, providing up to three consecutive weeks of coverage. For BI, it begins 72 hours after the Civil Authority prohibits access to the property that is covered for Business Income purposes. The form provides insurance on an actual loss sustained basis for loss of Business Income and necessary Extra Expenses that is caused by the action of a Civil Authority that prohibits access to the described premises. The Civil Authority’s action must be due to direct physical loss of, or damage to, property away from the described premises that is caused by a covered cause of loss.

Ingress and Egress coverage, on the other hand, involves the inability to enter or leave the insured premises. Examples are customers not being able to gain access to the premises, or goods not being able to be transported out. Involvement of Civil Authority is NOT required. Not all insurance companies offer this coverage, so individual company endorsements would have to be reviewed for full coverage specifications.

Civil Authority example: There is a major fire in half of a shopping mall. Although Bob’s Retail Store is not damaged by the fire, the municipal government orders the entire mall and its access roads closed for five days while tests are conducted on the structural integrity of the mall.

Ingress/Egress example: A major windstorm downs numerous trees in a wide swath. Merle’s Manufacturing cannot ship products or receive components for five days because the needed trucks cannot maneuver past the downed trees on the area roads. There is no actual government closure of the roads, only caution signs.

How does the direct physical damage apply to Ingress and Egress?  
There is no standard form that we can look to in answering this question. Individual insurance companies will have their own requirements regarding direct physical damage, so you must carefully read their form.

What is the difference between Dependant Properties and Contingent BI?  
Dependent Properties coverage is a type of Contingent Business Interruption insurance. Contingent Business Interruption insurance may be known as Contingent Business Income insurance or Dependent Properties insurance. The ISO Dependent Properties Coverage endorsement provides coverage for four types of dependencies: Contributing locations, recipient locations, leader locations, and manufacturing locations. Individual wording must be reviewed to determine details of the exposure that is covered, how coverage is triggered, and how it is applied.

How do you provide BI for flood losses through a property market?  
The NFIP policy does not cover Business Income, so you have to buy the coverage from a commercial property insurance company. There is usually a limit to how much the company will provide for this peril, say $5 million. If a larger amount is needed, then the insurance buyer usually has to go to an excess surplus lines company to purchase more protection.

For example, in one form, there has to be direct physical damage of the type insured (cause of loss) to property, but there is no requirement that the damaged property is on the described premises or that it is owned by the insured. The damage must be to the type of property that is not excluded on the policy. Therefore, there must be direct physical damage to property by a covered cause of loss somewhere that causes ingress or egress to be restricted. A general example might be fire (covered cause of loss insured by the policy) to a section of a mall’s center atrium that causes access to other stores to be curtailed. Ingress (access to) these other stores would be curtailed by the fire-caused damage to the rest of the mall.

Do you have a list of carriers with the broadest BI/EE forms?  
Currently, there is no definitive ranking of carriers in regard to the extent of their coverage forms. Many property insurance companies offer Business Income insurance, but we do not rank them by company. Companies that use the ISO Business Owners Policy form also would have fairly broad coverage since the ISO BOP includes Business Income/Extra Expense coverage on an actual loss sustained basis with relatively few onerous restrictions. You may find a comprehensive commercial property form that includes time element coverage, but this form typically would be offered only to extremely large commercial property accounts.

What does Actual Loss Sustained mean?
Actual Loss Sustained means the business owner is eligible to collect the amount of Business Income actually lost due to the necessary suspension of operations during the period of restoration. An Actual Loss Sustained limit is not required, but recovery is limited to the amount of net income and continuing normal operating expenses actually lost, up to the limit on the policy. Payroll that continues is included in that calculation. Keep in mind that specific carriers may amend their Business Owner Policies, so not all companies would necessarily follow this overview.

How would you calculate the BI for a property that will take multiple years to rebuild?
The simple answer is to buy multiple years of Business Income if the underwriter will let you. However, there are two issues: Will the market wait this long for the facilities to be rebuilt? Probably, if it is habitational, probably not, if it is a sales or service organization. The longer the rebuild time, the fewer the amounts of continuing expenses will be incurred. So there is a decreasing Business Income exposure as the years go by. The best business response is to have a Contingency Plan that reduces the recovery time.

If an insured buys Rental Reimbursement Insurance, will it be paid if the rental income is not from a third party?
No. The rental income must be from a third party. For example, the insured has a realty company that the operating company pays rent to. Rental expense is paid to the operating company as a continuing expense unless the realty company is not a named insured on the insurance policy. In that case, the realty company would need to insure their loss of rents on their own insurance policy.

How would you approach BI for a customer whose business is struggling and their financials are showing losses from the prior and current year?  
The Business Income definition is lost profit plus continuing expenses, or continuing expenses minus business loss. Businesses operating at a loss will only be paid their continuing expenses minus the amount of the operating loss. They will not be reimbursed for expenses higher than their income. It is a good idea in this case to review the financial status regularly to determine if the insurance limit needs to be adjusted.

How is an insurance agency's income loss computed when lost sales impact multiple years in the future?  
The Business Income coverage will pay income that is lost only during the recovery period. For most agency’s, their recovery period is usually quite short (a couple of months), unless they own their own building. The income for an insurance agency is from several areas - renewals, new business, and other services. Renewal income is easy to calculate. There may be little loss in this area. Likewise, other services are easy to predict because of the contracts and service agreements involved. Lost new business is harder to predict as the adjuster bases the calculation upon the history of the organization.

Use this as a starting point, then factor in any special circumstances like an unusually large account being negotiated, or any program/business being started, etc. Also, look to the new business plan and any new hires to substantiate the projected new business loss. On the other hand, some agencies who were very well-prepared for a disaster, ended up gaining more business because they recovered quickly and were able to help other businesses that were impacted by the disaster.

Does a BOP "Loss Sustained Coverage" make sense for a CPA firm with $35,000,000 of revenues?
A Business Owners Policy (BOP) is usually used for smaller organizations and has several restrictions, but a comparison of policies would be necessary to determine which would be best for a large CPA firm. A suggestion would be to use the Commercial Property with Business Income insurance policy because it provides broader coverage and a menu selection of protection. This allows the coverage to be more appropriate for a particular business.

For large businesses, do you recommend coverage for multiple years?
Every business needs to calculate how long it will take them to recover from a disaster, and then purchase the corresponding income protection. Most of the longer recovery periods are a result of long rebuild or long replacement times.

What if there are interdependent foreign operations?
Usually the foreign operations are not part of the coverage territory, which means there has to be two policies. Each policy protects its operations (domestic vs. foreign) and buys contingent coverage for the other operation. Be careful about different coverages, exclusions, and calculations in the two policies.

What does Business Income insurance cost?
Not as much as losing the business or being sued. The rating calculation is based upon a percentage of the building rate and whether ordinary payroll is included or not, times the percentage of the annual business income amount.
For example, the building rate, .08 X.90 (100% of the BI amount) = .072 times the limit of insurance purchased.

What is your source for the statistic that all commercial property policies are undervalued by 20%?
The commercial property undervaluation of 20% has been quoted by insurance company executives in several periodicals. Since the number varies between 20% & 30%, use the smaller of the two.

What is Gross Profit called in service industries?  
The Business Income calculation of net profit plus continuing expenses can be restated the opposite way-net sales minus discontinuing expenses. Financial statements list income then expenses. So sales minus discontinuing expenses approximate:

  • Gross Profit for a manufacturer.
  • Gross Margin for a wholesaler or retailer.
  • Revenues for a service organization. (Be careful with "net" revenues as that is a term defined by each particular financial statement).

Are there any industry-specific Business Income Worksheets anywhere?  
We have developed the only interactive, industry-specific worksheets and they are only available on our website, BISIMPLIFIED.COM. We have also made the Extra Expense section more user-friendly, conforming to a typical Business Contingency Plan. We will be adding new worksheets as users request them.

Is it true that most (if not all) policies specify that co-insurance does not apply to "Extra Expense" coverage?  
This is correct. The coinsurance penalty in most cases does not apply to Extra Expenses.

I am looking for a direct tie to the Business Contingency Plan (BCP) and the calculation of the Extra Expense Worksheet.
The direct tie between the Business Contingency Plan and Extra Expenses is to quantify the costs of implementing the BCP. Once you have a tested Contingency Plan, which is based upon a cost benefit analysis, you may assign costs to the various components. Some of the biggest costs are renting other facilities, subcontracting operations, expediting inventory replacement and distribution, additional personnel, and travel costs.

What is the Margin Clause Property Coverage definition?
This coverage provides inflation protection to the insured. At the time of the
claim, if the replacement cost or lost income is higher than the insurance limit, this clause will provide some additional money. For example, a 3% margin clause on a $10 million policy will provide an additional $300,000 of coverage.

What is the Coverage Restoration definition?
Some insurance policies say that the insurance limit is reduced by each claim during the year. The restoration feature keeps the total limit of insurance available all year, regardless of the amount of claims made.

What is Extended Period of Recovery?
This is a policy coverage that will pay for lost Business Income for a stated amount of days beyond the restoration period. The intent of this protection is to allow the company to reach its projected sales level after operations have been resumed. Most policies include 30 additional days past the restoration period for no charge, but the majority of businesses need at least 90 to 180 days of protection, especially if there is disagreement on when the operations were restored.

Besides materials and supplies, are there some operating expenses that will discontinue?
Possibly. Not all operating expenses (below Gross Profit) are continuing. However, since you usually do not know which ones will absolutely discontinue, use the practice of conservatism to estimate a little high. As you know, serious BI claims usually result in more loss than the insurance limit carried. However, try to get the business owner to review the expenses for items that will obviously discontinue. That is why a Contingency Plan is so important, as the business owner will go through the exercise of identifying income and expense trends to properly protect the organization.

What if most of my sales are made at a certain time of the year?
There is a "peak season" endorsement that allows you to report your sales on a regular basis so you do not have to insure your highest month’s sales amount for the whole year. This should be discussed with your insurance professional.

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