Loss of Business
It is common to insure against loss of material items or
buildings housing a business. However,
the greater loss is often due to the interruption of the business itself. This is referred to as consequential
loss.
There are some startling statistics: on average it takes up to
six months after a major fire for a retail store to resume sales. It takes up to a year for a manufacturing firm
to resume business.[1] Given these facts, no wonder that 40 percent
of businesses that experience a major fire or direct damage loss are forced out
of business permanently even though they carried adequate insurance for damage
of physical property. Consequential
loss can be insured by attaching the appropriate forms to the Standard Fire
Policy or other basic policies.
When insuring consequential losses the policy may be classified
as those involving a time element and those that have no relationship to
time. The time element coverages include business interruption
insurance, extra-expense insurance, and rent insurance. In each of these policies, the amount of
benefit will be based on the period of time that is required to restore the
damaged property to its normal operational condition.
When the amount of indemnity has no relationship to time, the
policies would include leasehold interest insurance, profits insurance, those
covering the loss of perishables due to temperature change, and those covering
losses resulting from the interruption in supply of power, light or water.
Business Interruption Insurance
No matter how much insurance is carried for physical damage, the
greatest damage to a company is often the loss of the ability to conduct
business. The company looses the cash
flow and they also loose customers.
They loose customers because, during their inability to conduct
business, their competitors get the opportunity to lure in and maintain their
client base. Even when the company is
back in business, part of those lost clients will remain lost to their
competitors. There is probably no way
to effectively measure the true loss of a business interruption.
Most manufacturing, mercantile, or similar businesses carry
insurance to cover fire and other perils.
What may not be carried is business interruption
insurance. This may be known
by other names, including use and occupancy insurance, earnings insurance,
business income coverage, and prospective earnings insurance. A loss of earnings happens because there was
an interruption in the day-to-day activities of the business itself.
There are a couple of elements to loss of earnings: the net
profit that would have been realized if the company were conducting business
and some fixed charges and expenses that must continue in part or whole even
though the business is not actually functioning. Some expenses that might have to continue include payments on
loans, salaries of those necessary to get the business open again (executives
and those on contractual salaries), costs of utilities unless the building is a
complete and total loss, professional services (accountants and lawyers), costs
of advertising so that the public knows the business plans to rebuild, taxes,
rent if the building is not a total loss, trade association dues, and insurance
premiums. This is not necessarily a
complete list. Many companies may have
continued costs that are particular to the industry.
Most business interruption policies are a contract of indemnity that covers only the
actual loss sustained. That means the
policy would cover loss of business only to the extent to which it would have
been earned. This limitation has
resulted in the use of the term prospective earnings insurance. Valued business interruption policies pay a
fixed amount per each day of business interruption without regard to the actual
loss that might be incurring.
A separate and
specific policy
In most cases, insurance covering the interruption of business
and the resulting monetary losses are covered through a separately written
contract. This makes sense because in
many cases the one insuring the building against fire and other perils is not
the same person owning or operating the business within that building. While some business owners do also own the
building, many more rent the space.
When there is a common owner, the insurers may take the position that
there is less danger of confusion if the direct and consequential coverages are
written separately against the potential losses. Exceptions will be in the endorsements to the multi-peril policy
and other package policies. Business
Interruption policies are made by attaching to a blank fire, windstorm, and
other direct-damage insurance policy one of the interruption insurance forms
that describes the nature of the interest covered. The contract will clearly state that only consequential losses
will be covered.
The loss does not have to be total for consequential losses to be
covered. The loss may be partial as
well as total. Of course, in order to
be covered, the loss must be the result of an insured peril. Those perils would typically include fire
and lightning, but there can be endorsements adding other perils. The important point is not which perils are
covered, but rather the fact that the loss must be the result of an insured
peril occurring on the insureds premises. An exception to this is found in mist business interruption forms
by a Civil Authority Clause, which extends coverage up to two weeks to those
situations where the insured is denied access to his premises by civil
authorities due to a fire or other peril insured against that damages other
property in the vicinity.[2] Therefore, if there were riots in Chicago
that caused extensive burning of property near the insured, since fire is
covered by his or her consequential loss property, if the civil authorities
requires the business owner to close until the riot and fires are controlled,
the loss may be covered.
Describing the Property
Any insurance policy will be specific on some details. Since the business interruption risk depends
upon the nature of the property and how the loss of earnings would affect it,
underwriters require that it be specifically and adequately described. The application for coverage will require
accurate and detailed descriptions of buildings, equipment, stock, and the type
of situations that would interrupt earnings.
Most business interruption policies are designed for either
manufacturing or mercantile risks, although there are forms that are used for
mining companies, schools (against loss of tuition), and seasonal crops and
seasonal foodstuffs. This usually
applies to the processing, canning, or freezing of food items.
Not every aspect of the business would affect income. In a manufacturing business, only items that
contribute to future production can cause a loss of
earnings. If the finished goods were
damaged, that would not be considered a consequential loss or loss of
income. Damaged goods would be covered
under a different policy (not under a business interruption contract). Only when a loss affects the production of
future sales would it be covered under a business interruption policy. Separate forms are used for manufacturing
and mercantile risks because what would cause a loss of earnings is different
for each. Even so, the description of
the building and of the equipment in it would be generally the same. It is the term stock
that must be handled differently. In
forms covering manufacturing risks, the term that applies is raw stock. Raw stock is raw materials that have been
purchased, but not yet worked on.
Stock in progress means raw stock that has undergone aging, seasoning,
mechanical, or other process of manufacturing at the specific location. Stock in progress is not finished stock; it
is still in the process of becoming finished stock. If finished stock were lost, it would not affect production. In manufacturing companies, there is always
a distinction between the inability to continue business and the loss of goods
ready for sale.
Generally speaking, insuring the continued business of
manufacturing firms is more complicated than insuring the continued business of
mercantile firms. Some items of
manufacture present risks particular to the business and the insurance
underwriters must use creativity to effectively insure the company. This is usually the case when the
manufacturing process requires years for the products maturity rather than
days or weeks.
Mercantile treats stock differently. In forms covering mercantile risks, the term stock is used
without qualifications because finished stock is what continues their ability
to do business. If the store cannot
sell their stock, they cannot continue doing business. Therefore, future earnings would be
affected.
Indemnity Period
The Period of Indemnity
is the period over which an interruption loss extends. The period of indemnity is affected by the
term stock that was previously discussed.
The business is interrupted until repairs and restocking is
possible. The policy will state: Due
consideration shall be given to the continuation of normal charges and
expenses, including payroll expense to the extent necessary to resume
operations of the insured with the same quality of service that existed
immediately preceding the loss. The
insured does not have the requirement to rebuild or restore the property as a
prerequisite for recovery of the business income. This type of insurance must only restore the business to an
operational level.
The measure of recovery is based on the restoration of business
operations with due diligence and dispatch.
The newer policies have added a clause regarding damage to media for
electronic data processing by a covered peril.
The maximum length of interruption covered by the policy is limited to the
greater of (1) sixty days, or (b) the length of time required to rebuild other
property damaged by the same loss. For
additional premium, the policy may extend the sixty day requirement to ninety
or even 180 days.
The insured is not necessarily forced to replace speedily nor
even required to repair, but the amount of indemnity collectible is based on
the length of time that would be required to do so with diligence and
dispatch. In the case of mercantile, it
would be the time required to replace the stock in the store. For manufacturing firms, it would be the
time to restock raw materials and goods in process.
The face amount of insurance places the upper limit on the period
during which the insured can be indemnified for a shutdown of income. The amount of indemnity purchased will
depend upon the business type. For
those that have seasonal fluctuations, more coverage may be required than if
the business has a stable amount of income throughout the year. It would be foolish to base the amount on a
low period when a shutdown during the peak season would eliminate most of the
years income. We think of seasonal
businesses in relation to crops, but many types are actually seasonal. For example, a business that relies on
tourism, such as gas stations in some areas, motels and even some restaurants,
make nearly their entire years income from only three months business. A shutdown during this peak season could
mean the loss of the entire years income.
This means that seasonal companies must insure for a higher loss since
they must be able to recoup an entire years income in a short period of
time. For companies whose income is
spread out over twelve months, the policy may be smaller since they would not
be trying to recoup an entire years income in a short period of time.
There are special exclusions that restrict the insurers
liability for any increase in loss of earnings because the period of indemnity
is extended due to:
Any ordinance of law,
Delays caused by such things as cancellation of leases or
licenses, or
Delays caused by strikers or other persons that interfere
with rebuilding, repairing, replacing the property, or continuation of
business.
It should be noted that there is no exclusion for strikes that
delay a materials supplier from delivering merchandise or supplies.
Most policies require the insured to utilize other available
options, such as other buildings or locations of the company that could be used
temporarily to keep the business operational.
This might be required even if it would mean additional cost to the
insured to move the business operation to the new site. Remember that the policy requires the
insured to act with due diligence and dispatch to rebuild, repair or replace
the damaged property. If this means
simply moving the operations, that is what is expected of them. Whatever the company is able to earn by
moving operations would be credited against the loss that results from the
suspension of business at the regular location. The insured would be compensated for any additional expenses that
incurred as long as these were not greater than the avoided loss would have
been.
Where moving a business or replacing an item temporarily means
great additional expense for the company, there may be some compensation
possible under the policy. As with all
contracts, the insured must be aware of his or her policy and the conditions
that it contains.
Forms
There have been two primary forms for business-interruption
insurance: (1) the gross-earnings form and the (2) earnings
form. At one time, there
were actually five forms for all but unique types of risk. These included:
1. Gross
earnings form for mercantile and non-manufacturing operations,
2. Gross
earnings form for manufacturing risks,
3. Earnings
form with no coinsurance for mercantile and non-manufacturing firms,
4. Earnings
form for manufacturing risks, and
5. Business
interruption form with extra expense.
These five forms have been replaced by a
single form containing an election for selected optional clauses.
Gross Earnings Form
Most business interruption insurance is written under the gross earnings form, which has a coinsurance
clause. For the most part, all
coinsurance forms are similar in that they pay actual loss sustained, subject
to the coinsurance requirement. An
exception to this is the valued outage coverage attached to a Boiler and
Machinery Policy. Therefore, assuming
the face amount meets the coinsurance requirement, the insured will be fully
covered.
The Gross Earnings Form contains a single item in its insuring
clause, which covers the reduction in gross earnings less charges and expenses
that do not necessarily continue during the period of interruption. Each aspect is defined in the policy. Ordinary payroll and all other charges and
expenses are covered by the single insuring clause as necessary to resume
operations with the same quality of service as existed immediately prior to the
loss.
It is important make the distinction between the amount of
recovery provided for in the insuring agreement and the amount of insurance
required to meet the coinsurance requirement.
To calculate the coinsurance, it is necessary to determine the annual
gross earnings anticipated in the policy period.
In manufacturing gross earnings are defined
as the sum of (1) total net sales value of production, (2) total net sales of
merchandise, and (3) other earnings derived from the operation of the business,
less the cost of (a) the raw stock from which such production value is derived,
(b) supplies consisting of materials consumed directly in the conversion of
such raw stock into finished stock or in supplying the services sold by the
insured, (c) merchandise sold, including packaging material, and (d) services,
purchased from outsiders for resale, which do not continue under contract.
Gross earnings in mercantile coverage are
less elaborately defined as the sum of (1) total net sales and (2) other
earnings derived from the operation of the business, less the cost of (a)
merchandise sold, including packaging materials, (b) materials and supplies
consumed directly in services sold, and (c) services, purchased from outsiders
for resale, which do not continue under contract.[3]
The gross earnings form
covers the actual loss of business income.
The measure of loss is the reduction of gross earnings less charges and
expenses that probably do not continue if the business is not in
operation. Some items may or may not
continue depending upon the amount loss.
Heat, light and power are examples of costs that may continue or may not
depending upon the damage to the building and what might still be
operational. Consideration is given to
the continuation of normal charges and expenses, including payroll, if such
continuance is necessary for the business to resume without lowering the
quality of service. As stated, the
gross earnings form has a coinsurance amount.
Obviously, if losses are to be paid in full, the amount of
insurance carried must equal or exceed the amount determined by application of
the coinsurance clause to future earnings.
This is a difficult thing to determine in some cases. For one thing, agents and business owners
must adequately project future earnings.
This can especially be difficult for small business owners who may see
tremendous growth in the years to come.
It is also difficult for seasonal companies whose income is primarily
earned in three to four months out of the year. In these cases, there is always the possibility of being either
under-insured or over-insured. Agents may
try to compensate by using multiple endorsements as time goes by.
There are two endorsements that tend to be used to eliminate or
reduce the problems related to fixing, in advance, face values of
insurance. They are called (1) the
agreed amount endorsement, and (2) the premium adjustment endorsement. In addition, there are two other
endorsements that deal with time and form of payment rather than the amount of
coverage.
The agreed amount endorsement
This may not be available to all who would like it, but for those
in some territories, fire-resistive or sprinklered risks of the mercantile or
non-manufacturing type could qualify for this endorsement. If eligible, the insured files a statement
of values with anticipated gross earnings provided. The policy is written for the anticipated values agreed
upon. This is a substitution of a dollar
amount for the percentage requirement of the coinsurance clause. The endorsement contains a Full Amount or
Honesty Clause, meaning the insured must accurately report past earnings. Failure to fully disclose earnings would
result in losses being paid in proportion that reported values bear to actual
earnings.
Underinsuring consequential losses has been a big problem in
America. Studies have shown that, on average,
there is at least 20 percent underinsurance.
Considering this fact, it is understandable that the Agreed Amount
Endorsement is not casually written or accepted by the underwriters.
Premium Adjustment Endorsement
Although the Agreed Amount Endorsement is important, it is not
the total answer to the problem of estimating future income. Companies that have large fluctuations in
earnings or sharply angled trend lines needed something more. The Premium Adjustment Endorsement allows
the insured to have the benefit of the full amount of insurance that may be
needed during the year while paying only for the amount actually used. The insured overestimates a face amount that
is considered adequate in most cases. A
premium amount based on these inflated figures is deposited with the
insurer. At the end of the year there
is an audit by the insurer to determine the final premium based on the actual
amount of company earnings.
When using the Premium Adjustment Endorsement, the agent for the
business must encourage the owner to highly estimate income, even if he or she
feels the amount estimated will not be reached. In the event of a loss, over estimating will not be a problem,
but estimating too little certainly could be.
The insurer will never pay more in losses than the provisional face
amount. Some policies do carry a
penalty if the insured goes overboard and sets the provisional amount
substantially too high because the provisional premium is based on the face
amount. This means that even though the
insured will recover the overpayment at the end of the policy period, funds
have been unnecessarily tied up during the interim. Some professionals feel this is an unwise use of premium dollars.
WARNING:
Some
policies do carry a penalty
when the
insured estimates income unnecessarily high.
The Premium Adjustment Endorsement, like the Agreed Amount
Endorsement, has an Honesty Clause. The
basic Gross Earnings Policy does not impose a specific time limit on recovery,
but the endorsement does.
Perhaps the most confusing aspect of the endorsement is the
clause that radically alters the operation of the coinsurance clause. It states: liability under this policy
shall in no event exceed the policys proportion of said percentage (the
elected coinsurance percentage) of Gross Earnings that would have been earned
during the 12 months immediately following the date of damage. . . As we previously stated, the basic Gross
Earnings Policy does not impose a specific time limit on recovery, but the
endorsement does. Therefore, if a loss
takes longer than 12 months to recover from, the policy will only cover up to
that 12-month period if this endorsement is attached.
Extended Period of Indemnity
Many companies that are closed temporarily due to a loss from
fire or other covered peril lose much of their customer base during that period
of closure. The fact that the business
reopens does not ensure that their original customer base will return any time
thereafter. Even if the customers do
eventually return, there will be a loss of revenue immediately following their
reopening. This amounts to an uninsured
loss.
To meet this need, an endorsement extending the period of
indemnity is available. The Extended
Period of Indemnity may be purchased in units of thirty days. It continues to cover actual loss of income,
but only for such additional length of time as would be required to restore the
insureds business back to its original income. The endorsement does contain an other
insurance clause, which means that if there is more than one
business interruption policy, the endorsement should be attached to all of the
existing policies.
Deferred Loss Payment
Endorsement
The Deferred Loss Payment Endorsement changes none of the basic
contract provision or limitations, but it does require the insurer to settle
losses on an installment basis rather than wait until the firm is operating
again. This is advantageous where the
loss may involve an interruption of business that is unusually long or when the
amount of the loss may fluctuate widely.
Payroll Endorsements
When a business is interrupted, some employees are essential to
getting the company reopened while others are not. Which employees remain will depend upon several factors, including
local labor markets, employee skill levels, cost of training new employees, and
managements loyalty to some or all of the people employed. Both Gross Earnings Forms 3 and 4 cover
continuing expenses, including insurance adequate to cover the payroll. There are two endorsements that provide the
insured flexibility with regard to ordinary payroll. These are (1) ordinary payroll exclusion
endorsement, and (2) ordinary payroll limited coverage endorsement.
(1) Ordinary Payroll Exclusion
Endorsements are used to exclude ordinary payroll and thereby reduce
the amount of insurance required. Under
the definition used in this endorsement, ordinary payroll is the entire payroll
expenses of all employees, except for officers, executives, department
managers, employees under contract, and other important employees. The terminology is considered loose enough
to allow the insured to define ordinary payroll in whatever way best suits his
or her needs. Even so, there is a
limitation that should not be overlooked.
If the insured elects the Ordinary Payroll Exclusion Endorsement, the 80
percent coinsurance clause must be used.
Otherwise, there could be serious adverse selection against the insurer.
(2) Limited Ordinary Payroll
Coverage Endorsements are used
when the firm elects not to completely eliminate ordinary payroll. This endorsement allows the firm to add back
ordinary payroll coverage for a limited period of time, usually 90, 120, 150,
or 180 days. This particular
endorsement allows a company to keep all their employees when it is believed
the business will be closed for only a short time. Keeping the employees allows the firm to eliminate the need to
retrain new people once they reopen.
The eighty percent coinsurance would still apply.
Simplified Earnings Forms
While the Simplified Earnings Forms have some basic provisions
that are identical to the Gross Earnings Form, there are some differences that
must be recognized by the agent and the insured. First of all, the definition itself of the term earnings is
broader under Simplified Earnings Forms.
This form identifies earnings as the sum of total net profit, payroll
expense, taxes, rents, and all other operating expenses earned by the business. Like the Gross Earnings Form, the coverage
is on an actual loss-sustained basis, which means that payment will be made
only for income actually lost and expenses actually incurred.
The most notable thing about these forms is the lack of required
coinsurance. Rather, this form uses a
monthly limit, which requires that not more than a certain proportion (16 2/3%,
25%, or 33%) of the total amount of insurance carried may be claimed in any one
month of interruption. This limitation
is not cumulative. There is no penalty if the insured underestimates the gross
earnings, although recovery would be inadequate. If the business interruption happens to occur during a peak
period, being underinsured could be quite serious for the company. In comparison, the regular Gross Earnings
Form has no monthly or other limitation. The entire amount of insurance is
available to cover an interruption of any duration if coinsurance requirements
have been met.
Usually the amount of insurance carried is determined by first
estimating the number of months the business might be interrupted. This may be done by considering how long it
would take to restock a mercantile or repair a manufacturers operation. Next the earnings would be projected for the
best earnings month of the year. The
length of time estimated to reopen would be multiplied by the earnings for the
best month.
The rate per $100 of insurance is always higher for this
non-coinsurance form than for the gross earnings business interruption
forms. Therefore, it tends to be used
only for smaller risks where total amounts of insurance are smaller.[4] For those who do not fully understand how
the coinsurance clause works, a limitation consisting of a percentage of the
face amount may be easier to work with.
Contingent Business-interruption
Insurance
It is not unusual for some companies to exist solely because
another company exists. In Seattle,
many small companies cater solely to Boeing, for example. If Boeing were to close or relocate, those
small companies could not survive.
Contingent Business-Interruption Insurance provides protection if there
is an interruption to the insureds business due to an insured peril
occurring at anothers premises that is not owned or operated by the
insured. In some territories, two forms
are used: one for contributing properties and one for recipient
properties. A separate (but related)
form is used if the individuals earning is based on commissions.
It is important to note due to an insured peril. If Boeing relocated, causing the dependent
business to close, the policy would pay no benefits. Relocation is not a covered peril. If Boeing suffered a fire, temporarily affecting the related
business owner, the loss would be covered.
There is also a contingent business-interruption exposure when
the insured depends on another business in the same area to attract customers
to his place of business. This might be
the case with a motel or restaurant that is located outside of Disneyland, for
example. The small business relies on
the traffic attracted to Disneyland for their income. In this case, Disneyland would be referred to as a leader property.
Contingent Business Interruption insurance is usually written
under a policy that is separate from that covering the direct business
interruption loss. This eases the
possibility of misunderstandings related to coverage and it is also necessary
because rates are entirely different.
Contingent Business Interruption insurance must name and give the
location of the supplier or customer on the application. The policy will pay benefits only if that
specified supplier or customer has a covered interruption that affects the
insured at the location that was listed.
The premium rate is based on the rates at the contributing locations,
without regard to exposure at the insureds location. If exact locations are not used in the policy, recovery is
limited to one-half of one percent of the amount of insurance for any one
month.
The policy does require the insured to seek means to continue
business. If their supplier suffers a
fire, for example, they are required to seek out a new supplier. If doing so incurs additional expenses for
the insured, there will be compensation if the net result is a reduction in the
total amount of the loss.
An earnings form of
Business interruption insurance
An earnings form of
business interruption insurance is available to the operator of a small
business. It is a simplified edition of
the mercantile gross earnings form and usually is available only to mercantile
and other non-manufacturing businesses.
Instead of a coinsurance clause (as seen in the gross earnings form) it
has a stipulation that no more than a stated percentage of the face amount of
the policy can be used in any 30 consecutive calendar days. This percentage is selected by the
insured. It can be as high as 33
percent. The cost of coverage under the
earnings form is usually related to the fire insurance rates for the building
and may be considerably higher than other types of business-interruption
policies.
The earnings form of business interruption insurance is normally
bought by small companies. Even though
the cost is higher, since the amount of insurance purchased is also usually
smaller the higher price does not necessarily hinder sales. This is probably because there is no
coinsurance clause.
A major decision in whether or not to purchase this type of
coverage hangs on whether or not payroll must continue. Small companies may find it less expensive
to cover payroll than to purchase business interruption insurance. Even so, consequential loss insurance may
still be prudent.
Extra expense insurance
Business interruption means loss of business
As we have discussed, an interruption in business may mean a
permanent loss of future revenue as customers begin to use competitors during
the time the company is not operational.
Some businesses will go to any length and any expense to avoid the loss
of their customer base. Extra-expense
insurance covers the types of costs associated with staying operational when
that means extraordinary expenses are involved in this effort. Therefore, this insurance is not business
interruption insurance. Rather it is
additional expense insurance. It
covers the extra costs (thus, the name extra expense insurance) over and
above the normal cost of doing business if necessitated by a fire or other
insured peril. The policy will cover
costs (to specified limits) of doing business at a temporary location and for
the cost of any equipment necessary to continue as nearly as practicable the
routine duties of the company. It would
be easy to consider this coverage all inclusive, but that is not the case. As was seen in the case of Travelers
Indemnity Company v Pollard Friendly Ford Company, the policy does not
cover fees for outside professional consultants, advertising costs, and legal
or CPA expenses.
Like the business-interruption policy, the Period of Indemnity
covers only the period necessary to rebuild, repair, or replace the premises or
contents. The policy does not have
coinsurance requirements, but there are limitations on the amount of benefits
that will be paid. The limit is
generally accumulative. Therefore, if
less than the full limit is used the first month, the unused portion is added
to the limit for the second month and so on.
While there can be variances, usually no more than 40 percent of the
policy amount may be applied in a period of one month or less. The standard formula is 40-80-100, which
means not more than 40 percent of the policy amount may be applied in a period
of one month or less, not more than 80 percent in a period of two months or
less, and 100 percent for a recovery period of more than two months. The minimum period of emergency operation
that will be written is typically three months. There is always the possibility that this is different in some
territory, so it is always important that the agent read every policy
personally.
The premium cost for extra-expense insurance is based on a
percentage of the 80 percent building rate and will vary depending on the
combination of monthly limits chosen by the insured. Since requirements may vary by territory, it is important for the
agent to investigate any specifics for the location issued.
It should again be noted that business interruption insurance is
intended to get a business back into production or ready for business in some
capacity. It does not cover, nor does
it intend to cover, loss of business to competitors due to the interruption. Nor would business interruption insurance cover
the extraordinary expense incurred by a company who continues conducting
business (to avoid losing their customers) regardless of the expense caused by
doing so. That is precisely why a
company might also want to purchase Extra-Expense Insurance. It can be more expensive to stay open
following a fire than it would be to close temporarily. In many cases both business interruption
insurance and extra-expense insurance is needed.
For those agents who write homeowners insurance, the Extra
Expense policy is comparable to the coverage known as additional living expense insurance. Additional living expense insurance is written for individuals who
wish to be insured against the cost of having to live outside of their home
during repairs following damage from an insured peril.
Business Income Coverage
form
The ISO (Insurance Services Office) form with the Business Income
Coverage title may or may not include all of the business-interruption and
extra-expense coverage provided by the five historical standard forms
previously stated. Because the title is
so long, Business Income Coverage Form is often stated as BICF.
Without modification, the BICF provides basically the same
coverage formerly provided by the gross earnings form of business interruption
insurance. However, the term gross
earnings is not used in this form. The
BICF may be written to cover:
1. Business
Income including rental value
2. Business
income excluding rental value
3. Only
rental value
Rental value is placed in quotation marks to indicate that it is
defined in the form.
Business income is
defined as: the sum of (1) the insureds net profit or loss before income taxes
that would have been earning if the interruption of business had not occurred,
and (2) continuing normal operating expenses incurred, including payroll.
Rental value is defined
as: the sum of (1) total anticipated rental income from the insured premises;
(2) the total amount of all other charges that the tenant would have been
required to pay, and which would otherwise be the insureds obligations; and
(3) the fair rental value of any portion of the premises occupied by the
insured.
This definition means that rental value is covered whether or not
any part of the property is actually rented out to others.
The BICF covers only Business Income lost during the time of
restoration (called Period of Restoration) due to the interruption of the
insureds business operation resulting from property damage by an insured peril.
Policy
Definitions:
Period of Restoration means
the period of time that:
a. Begins
with the date of direct physical loss or damage caused by or resulting from any
Covered Cause of Loss at the described premises; and
b.
Ends on the date when the property at the described
premises should be repaired, rebuilt, or replaced with reasonable speed and
similar quality.
Period of Restoration does
not include any increased period required due to the enforcement of any
ordinance or law that:
1) Regulates
the construction, use or repair, or requires the tearing down of any property;
or
2)
Requires any insured or others to test for, monitor, clean
up, remove, contain, treat, detoxify or neutralize or in any way respond to, or
assess the effects of pollutants.
The expiration date of this
policy will not cut short the period of restoration.
Operations is
defined as:
(1) the
insureds business activities at the insured premises, and
(2) if rental value is
covered, the tenantability of the premises.
There are several standard endorsements that are used with the
BICF. The most notable are:
An
endorsement to exclude ordinary payroll;
An
endorsement to limit ordinary payrolls to thirty, sixty, ninety, or one
hundred-twenty days;
Two
endorsements to provide coverage for Business Income From Dependent Properties,
which provide the coverage previously called Contingent Business Interruption;
and
Business
Income Premium Adjustment endorsement, which is functionally equivalent to the
Premium Adjustment Endorsement, used with the older business interruption
forms.
Individual Consequential Loss Insurance
Agents and consumers understand the need for business
interruption insurance, but they are less likely to recognize the need for such
coverage for individuals. There are two
types of individuals who may need this coverage. The first group includes those whose income directly relates to
sales and the second group are the franchise dealers. A large part of the franchise dealers income is dependent on the
output of a particular manufacturer or supplier.
This coverage was designed to cover those individuals who were
not owners of a business, but whose income would be reduced or eliminated if
the business was interrupted. In order
for the policy to cover, of course, the interruption must be from an insured
peril, usually fire. The income covered
was defined as salary, commissions or other earnings accruing to the insured
from operation of the business. . . less any income guaranteed to the insured.
Coverage for income loss is no longer a standard form. Also discontinued is the Commissions of
Selling Agents Form. While in use, it
allowed the insured to name one or more factories, plants, or warehouses, the
direct damage of which would mean a reduction or loss of income. The measure of loss used was the reduction
in gross selling commissions of the insured under contract for the sale of
products less charges and expenses which do not necessarily[5]
continue.
The form most widely used today is the Business Income From Dependent Properties form. The term personal business interruption
insurance may also be used to identify a form of health insurance used by
doctors and dentists. A similar term is
also used for small sole-proprietorship businesses, so it is necessary to be
sure which insurance form is being referred to.
Rent insurance
Although there can be variances, usually rent insurance protects
the insured against either loss of income from property or loss of use of the
property. The loss might be the result
of the insured property being rendered untenantable by fire or by any other
peril that is covered under the contract.
There must be an insurable
interest before rent insurance will be issued. This is done by simply determining who would
suffer a loss of the type covered by the insurance. The answer to that question would depend upon the nature or terms
of the tenancy.
If the owner occupies the property, he or she would be the one to
loose the use of the property (suffer a loss) due to a fire or other covered
peril. The owner should, therefore,
carry rent insurance. The amount of
coverage should be equal to the rent that would normally have been received if
the property had been rented to someone else.
This is called the rental value of the
property, and the insurable interest is referred to as a rental value interest.
When property is occupied by a tenant (not the owner), the loss
could affect both the owner and the tenant.
It would depend upon the terms of the lease and the state laws. If the tenant must continue to pay rent even
though the property is unfit for occupancy after the damage, the loss would
fall on them, so they need to have rent insurance. In such a situation, full rental value coverage is needed. If the rental value goes up, even though the
tenant may be unable to utilize the property due to the damage, their rent
would still increase.
In most contracts, the tenant is relieved from liability for the
rent if the building is not usable through no fault of the tenant. Even if it is not in the contract, many
states have specific statutes that address this issue and relieve the tenant of
any financial liability. This leaves
the loss on the owner rather than the tenant.
Whether the loss is with the tenant or the property owner, both
types of loss are covered under the same insurance forms, called rental value forms. There are two rental value forms available. The main difference between them is that one
contains a coinsurance clause while the other does not. The form without coinsurance includes a
monthly limit on the amount of recovery in lieu of a coinsurance clause. When a loss occurs, benefits are paid less
charges and expenses that do not necessarily continue following the loss. If coinsurance applies, it is based on the
gross amount of rental value without any adjustment for charges and expenses
that may not necessarily continue following the loss.
Forms
Residential property has several dwelling forms, including the
Homeowners, which provide coverage for rent and rental value losses. There is similar protection in the
Business-owners Policy. The Commercial
Multi-Peril Policy (CMP) has a specific endorsement called the Rental Value
Insurance. Special situations also have
forms available for use. Forms that
cover ordinary risks cover the rental value of all portions of the property
whether the property is actually rented out or not. This means that no distinction is made where property is
divisible into separate occupancies, other than remaining a contract of
indemnity. As a result, it must be
demonstrated that the insured sustained a financial loss by reason of fire
damaging unoccupied premises.
Coinsurance
As we have stated, some contracts contain coinsurance
provisions. When a coinsurance clause
is included, the minimum requirement must be met before the insured may fully
collect any benefits. The required
amount of insurance is found by determining the rent that will be lost in the
year following the damage. The expected
duration of interruption will dictate the coinsurance percentage. The rate decreases as the coinsurance
percentage increases. Premium is higher
for higher coinsurance because more coverage is then required.
An alternative to a contribution form is the Monthly Limitation
Form. This form limits the insureds
recovery to a specified fraction of the face amount of insurance each month
that the rent is lost due to the buildings damage. Selection of the monthly fraction will depend on the extent of
any monthly fluctuations in rental values and the anticipated time of the
income interruption.
Period of Indemnity
Rent insurance losses use the principle of indemnity exactly like
other property forms do. The rental
insurance coverage provides that the company will be liable for the rental
value of untenantable portions of the property less charges and expenses that
may not continue following the damage.
The loss will be computed from the date of damage until the building is
again rentable, with the exercise of reasonable diligence and dispatch. Once the building is again rentable, the
benefits stop even if no renters actually come forward.
Rates
It is always difficult in a course that is used across the United
States to discuss premium rates. There
are too many variables. However, we can
state that rent insurance rates will be based on the fire insurance rates for
the building property under consideration.
The chance of fire determines the chance of a rent insurance loss, but
the severity of fire does not determine the severity of loss. This means that the fire insurance rate must
be modified before being applied to a rent insurance risk. The rate will likely be higher if the
insurance required is equal to the rental value for the time required to rebuild
than if it is equal to the rental value for a full year. In the latter case, a larger amount of
insurance is generally required.
Additional living
expense
Additional living expense is part of the dwelling forms. It is actually a form of extra-expense
insurance applied to an unlivable dwelling.
The form recognizes that the insured who suffers a fire or other covered
loss to the insured dwelling usually faces additional costs to continue living
in the same manner as before.
Short-term rental of an apartment or hotel room, extra transportation,
restaurant costs, laundry bills, and other costs related to being forced out of
ones home generally result when ones home is damaged. These costs are an indirect or consequential
loss to the interruption of the use of their home.
The policy will pay only for expenses that are actually the
result of the temporary loss of the dwelling and only for expenses actually
incurred by the named insured. Payment
will be made only for the actual amount and is limited to (1) the time
necessary to repair or replace the damaged property, or (2) the time required
for the household to become settled in permanent quarters. The maximum dollar amount recoverable under
the combined rental value and additional living expense is typically limited to
20 percent of the dwelling coverage amount in the Homeowners policy.
Leasehold insurance
When a building is damaged, it may affect the businesses in
another way: it may adversely affect the location of their business. That might be because a new lease site is more
expensive or because the new lease site is not as favorably located. Leasehold insurance is designed to protect a
lessee against the loss resulting from the cancellation of a favorable lease
from a covered peril. This is most
likely to happen when it involves long-term leases, or anything that deprives
the lessee of the right to use or sublet the premises.
As we have stated, usually, the lessee may cancel the lease if
there is damage that makes the location unusable. If rental rates have greatly increased, the lessee may be glad to
cancel and relocate. The lessor may
also be glad to cancel the lease if it means that he or she will be able to
raise the rent once the property is again rentable.
The loss of the difference between the present rental value and
the rent that was specified by the lease agreement is the amount of value at
risk for the duration of the lease.
This amount is known as the leasehold
value interest. If the
lessee had sublet the premises to another person or company at a higher rate,
the cancellation of the lease would cause a loss equal to the difference
between the rent that the original lessee was receiving and that which the same
party was paying for the premises. This
is called a leasehold profit interest.[6] The loss is would continue for the duration
of the lease. Therefore, the loss is
not limited to just the amount of time it takes to repair or rebuild the
building to a rentable state.
There may be an additional loss.
In some instances those who are renting have paid a cash bonus to acquire a particular lease
(often due to its location). If no
provision were made for a refund in the event of a fire or other damage due to
a covered peril, the tenant would lose the amount paid for this bonus. The same situation exists when the tenant
has paid their rent in advance, with no provision for a refund in their lease
in the event of fire or other loss due to a covered peril. If the tenant has improved the property for
the benefit of their business, unless their lease specifically repays them for
these improvements, that investment is lost.
Since the person with the leasehold interest cannot also be the
owner of the property, separate policies generally would be written to cover
leasehold interests.
The leasehold interest
cannot also be the owner of the property.
The insured must purchase insurance equal to the discounted value
of the leasehold interest, using a rate of interest specified in the
policy. This usually ranges from 5 percent
to 15 percent compounded annually.
Discount tables covering different time periods are printed as part of
the leasehold forms, so the determination of the amount of insurance is not a
complicated matter. At one time, some
forms required the lessee to over-insure because they were required to insure
an interest to the full undiscounted amount.
This is no longer the case.
Whatever form was used, the loss payment was always the same since all
forms provided payment at the discounted or present value of the leasehold
interest.
It is possible to purchase special forms that provide coverage
for bonuses, prepaid rent, and improvements made to the premises.
The leasehold forms contain some important provisions. The insurers risk depends a great deal on
how easy it is to cancel the specific lease.
Another important provision relates to the right of the insured to
cancel a policy before a loss and to the liability of the company in the event
of covered property damage that might or might not bring about a lease
cancellation.
Recovering profit
losses
It is certainly true that a manufacturer or a mercantile wants to
recover the cost of reopening or continued manufacturing. However, there are also lost profits to
consider. Since business interruption
policies cover only the cost of getting back to business (and not the profits
that would have been made), there are policies available that do cover the loss
of profits under specific conditions.
The addition to the coverage is called a Selling
Price Clause. It is for
certain types of stock of either a manufacturing or mercantile business. The coverage substitutes the price for which
the goods would have been sold over the actual cost of resupplying them. In the case of manufacturing, the coverage
is on all finished stock. For mercantile
companies, the coverage applies only to items sold, but not
delivered. The intent is to cover
losses that fall between the direct-damage coverage and the earnings forms of
business interruption insurance.
Although there are no specific charges made for adding the
Selling Price Clause, one must be aware of the effects it has on the
applications of the basic coinsurance.
The coinsurance percentage will apply to a greater property value, which
could result in a penalty if the amount of insurance proves to be inadequate.