A severe property loss, such as damage from a fire orexplosion, can cause significant financial hardship. Althoughmost companies have Property insurance in place to protectthemselves against such losses, the income lost during ashutdown can be even more devastating. Without the rightcoverage in place, the company might suffer a blow from whichit will be difficult to recover. Business Interruption insurance might be the one thing that keeps the company in business.
The standard Business Interruption policy promises to pay forbusiness income lost due to a necessary suspension ofoperations caused by loss of or damage to the businesspremises. For coverage to apply, the cause of loss must be onethe policy insures against, such as fire, lightning, windstorm, or aircraft. It is important to understand that “businessincome” does not necessarily mean “profits.” The policy defines “business income” as the net income (profit or lossbefore income tax) that the firm would have earned, plus continuing normal operating expenses. Therefore, the policywill not bail out a company that was headed for a period of unprofitability. If the company was expecting a $100,000loss and continuing expenses (including payroll) of $150,000, the most the policy will pay is $50,000 ($150,000expenses less $100,000 loss.)
When a loss occurs, the insurer will determine the actual loss the business sustained. To do this, it will examine thecompany’s financial statements for the time periods leading up to the loss. It will determine which costs were fixed,such as debt payments, permits, and salaries. It will also separate out costs tied directly to sales, such as the costof producing goods not yet produced. Finally, it will calculate the company’s expected profit or loss for the period.The sum of expected profit or loss and normal continuing expenses equals the actual loss sustained.
The actual period of the loss might differ from the period the insurer calculates. The insurer will pay for businessincome lost during the “period of restoration.” This period begins 72 hours after the damage occurs to the premises. Itends on the date the damaged property should be repaired, rebuilt or replaced with reasonable speed and similarquality or on the date when business resumes at a new permanent location, whichever is earlier. If the businessowner is slow to approve architectural plans or if rebuilding takes longer because the owner decided to makeimprovements, the insurer will not pay for the entire period of loss. Also, the insurer will reduce the loss period if thecompany can reasonably take steps to shorten it. These steps might include using temporary facilities, shifting workto undamaged sections of the building, or adding work shifts to make up for lost production.
If the company has to spend extra funds to reduce the amount of lost income, the insurer will cover at least some ofthem. Examples are additional rent for a temporary location, express shipping charges necessary to get machinery inplace sooner, and increased construction costs to hasten the repairs. The insurer will not pay more than the amountof income the company would have lost, and it will only pay for expenses that actually reduce the business incomeloss.
Many options are available with Business Interruption insurance, having to do with the length of the recovery period,amounts available each month, required amounts of insurance, and others. To help determine those options that afirm might need, a thorough discussion with one of our insurance agents is in order. This coverage is too important toa firm’s survival for anyone to treat it casually.
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