Whether you are a business owner, adviser, or accountant, all interested parties should have a general understanding of Business Income Insurance coverage and how it is applied. When a business is impacted by disaster, it may be that the survival of the business will hinge on the adequacy of its business income insurance coverage. In this article, we will provide some insights as to how commercial insurance coverage applies to economic damages and business decisions.
Generally speaking, Business Income insurance is designed to provide the business with compensation for lost net income and the business’ continuing expenses that relate to a relevant recovery period for a covered cause of loss. This insurance coverage comes with some specific parameters for measuring the economic damages, such as, but not limited to, the duration of the relevant period(s) (e.g. Period of Restoration, Extended Period, etc.), projected "but-for" net income (revenues minus expenses), identifying continuing revenues and expenses, reasonable and necessary costs incurred that are greater than normal for purposes of mitigating business income loss, etc.
Business Income Insurance does not insulate a business against all potential negative impacts on the income flow of the business. There are some business exposures that are simply not insurable, or at least not insurable at an affordable cost. For example, a business could lose income if a key employee leaves and moves to a competitor. This is a fairly common situation; however, based on our experience, it is not covered cause of loss under the Business Income policy.
Some readers may be tax advisors, auditors, or accounting clients. The first important concept to understand is that Business Income insurance either covers a maximum time period or a maximum dollar amount. There are benefits and drawbacks to each of these types of policies.
Business Owners Policy (BOP)
First, the Business Income policy that covers losses for a specific period of time is commonly referred to as a Business Owners Policy (“BOP”). The BOP policy states that the coverage will be paid for a maximum of 12 months. This policy does not state a maximum dollar amount. The advantage of this type of policy is that no decision has to be made regarding the amount of insurance required by the business. Furthermore, for most business situations, the damage can be repaired within the maximum 12-month time period. The simplicity of this coverage makes it ideal for many, if not most, small businesses. Eligible businesses may include retail stores, small restaurants, office-based businesses, convenience stores with gasoline pumps, etc. However, some types of businesses cannot purchase a BOP policy. For example, manufacturing companies and automobile dealers, among others, are generally not offered this type of insurance coverage.
Business Income Insurance
Second, what we might call the standard type of Business Income insurance policy (as opposed to the BOP policy) does not specify a maximum period of time in terms of a specific time limit; rather, it specifies a maximum dollar amount of coverage. Once the damages reach the dollar amount of the policy limit, there is no more coverage. The drawback to this type of coverage is that it requires the Insured business and their agent to determine the appropriate dollar amount of coverage to purchase. This can sometimes be a challenge. The advantage of this type of coverage is that the coverage applies for the actual time required to restore the damaged property. In those situations where the restoration of the damage requires more than 12 months, this policy is preferable, assuming the business has purchased an appropriate dollar amount of coverage.
For those of you who are advisers to clients or who are responsible for the insurance on your business, your first step should be to inquire what type of Business Income insurance coverage is in force. Does the business have the BOP policy or the standard policy? Then determine if the type of coverage in force was selected for a specific reason. It is very common to find that businesses do not carefully identify their Business Income insurance needs. As a result, they are often insured adequately for Business Income losses when they have the standard coverage with a specified maximum dollar limit. If your business or the business you are advising has an insurance policy with a stated dollar maximum, you need to understand how that dollar amount was determined and, if the dollar limit is appropriate.
Which Option Is Best for My Company?
While it may seem that the simple decision is to always purchase the BOP policy because it does not require a determination of the dollar amount of coverage, some businesses cannot be insured under a BOP policy, as in the case of a manufacturing company. We encourage readers to discuss the business’ needs and options with their insurance agent. The discussion with the insurance agent should include a discussion as to the appropriate dollar amount of coverage needed for the business and whether there are issues within the business that would require a longer than normal recovery if there were significant damage. If there is, this situation would be best served by the standard policy, not the BOP policy, so that there is no time restraint. One example of a potential issue that could extend the recovery time of a business is for a company that has custom equipment or hard to obtain equipment, which could require more than 12 months to replace.
In many, but not all commercial insurance policies, Extra Expense coverage is provided in conjunction with the Business Income insurance. Extra Expense insurance coverage is an important element of any commercial insurance program. For more information regarding Extra Expense, please refer to our published article entitled, “Economic Damages: Evaluating & Assessing ‘Extra Expense’ Damages”.
Summary
The best practice of a business is to have both Business Income and Extra Expense coverage, if possible, and to know what your coverage is before you need it. It is better to be prepared with the right coverage before you find your business in a situation where you need coverage, but do not have it.