Business Interruption Insurance: Hope for the Best, Prepare for the Worst
Whether you are the insured, the insurer, the adjuster or a consultant, business interruption insurance is one of the most complicated coverages to write and interpret. Despite the fact business interruption insurance dates back more than two centuries, it is typically one of the most misunderstood of coverages.
Business interruption insurance compensates a business for a temporary interruption of its earnings stream. Such an interruption can result from natural or manmade disasters. This type of insurance can also cover ordinary payroll costs as well as costs for expediting and other extra expenses the insured incurs during the recovery of its operations.
This type of insurance originally was known as “use and occupancy insurance” but evolved to become “business interruption insurance,” a term the Insurance Services Office (“ISO”) developed in the 1980s.
Business interruption\ business income loss claims are calculated under the terms of the insurance policy, not the legal theory on which the claim is based. In a calculation under business interruption\business income coverage the policy will dictate:
- If a covered cause of loss exists (causation/proximate cause)
- When the loss period begins and when it ends
- The methodology used for calculating the claim
Business income insurance falls within a general category of time element insurance, either triggered as a consequence of direct physical damage or an indirect result of physical damage.
The ISO promulgates standard forms, which are identified by its number and letter designations. Most commercial property and casualty policies are a compilation of policy forms.
While, ISO standard forms are the most common standard forms, insurance companies frequently deviate from them. Manuscript forms or policies differ from standard or company forms in that they are customized insurance contracts that are the result of negotiations between the insurer and policyholder.
What’s It Take to Trigger Coverage?
Standard insuring agreements typically require three elements be present to trigger coverage:
- A covered cause of loss, as described in the policy declarations, must be behind damage or loss of property;
- Necessary suspension of operations during period of restoration; and
- Actual loss of business income.
Courts have consistently upheld the requirement for actual physical damage and that a mere slowdown of income because of uninsured causes is not sufficient to trigger coverage. Suspension of operations is typically defined as the slowdown or cessation of business activities, or that a part or all of the described premises is rendered untenantable if coverage for Business Income “Rental Value” applies.
Regardless of whether the term suspension is defined in the policy or not, it is normally time-limited by the period of restoration, which is typically defined as the period which begins on the date the direct physical damage occurs and ends on the earlier of:
- Date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality; or
- Date when business resumes at a new permanent location.
ISO forms require that property must be repaired and operations restored “with reasonable speed.” Generally, delays caused by the insurer or general conditions typically do not adversely affect recovery. Non-ISO policies usually include a similar time boundary, such as a requirement to rebuild with “due diligence and dispatch.”
The third requirement is for an actual loss of business income, since the ISO form is written on an actual loss sustained basis. Conversely, commercial property forms use definite terms such as, we will “pay the value of lost or damaged property” or we will “pay the cost of repairing or replacing” the damaged property.
Get to Know the Forms
The three main ISO policy forms you will encounter are:
- Form CP 00 30 10 12: Business Income Coverage (and Extra Expense)
- Form CP 00 32 10 12: Business Income Coverage (Without Extra Expense)
- Form CP 00 50: Extra Expense Coverage
ISO Forms CP 00 30 and CP 00 32 define business income as:
- Net income (net profit or loss before income taxes) that would have been earned or incurred; and
- Continuing normal operating expenses incurred, including payroll.
Note the two items in the definition of business income are tied together by the word “and,” which means net income or loss is coupled with continuing expenses. That means a business operating at a loss before the damage may not be able to recover assets under the policy if the continuing expenses do not exceed that net loss.
Each ISO Business Income Coverage Form is coupled with a Causes of Loss form. Together they determine whether and to what extent business income coverage will be available. Those forms include:
- CP 10 10: Basic causes of loss provides coverage for 11 causes of loss, such as fire and windstorm.
- CP 10 20: Broad causes of loss adds perils of falling objects; weight of snow, ice or sleet; and water damage.
- CP 10 30: Special causes of loss.
In business interruption claims analyses, the question is not what the enterprise earned but how much it would have earned had the insured event not occurred. Clearly, there is no one correct answer to such a question but rather a varying degree of plausibility among competing theories. The accountant must go beyond historical company data to tap additional industry and general information.
What About Extra Expense Coverage?
Extra expense insurance provides coverage for the extra expenditures an insured business incurs as the result of direct physical loss of or damage to property at premises described in the declarations.
Such coverage may be provided independently from other business income coverage with ISO Form CP 00 50, Extra Expense Coverage Form or with ISO Form CP 00 30, Business Income (and Extra Expense) Coverage Form.
Extra expense is defined as necessary expenses incurred by the insured during the period of restoration that would not have been incurred if there had been no direct physical loss or damage to property resulting from a covered cause of loss.
As with business income coverage, the expenses must be necessary, a term that is not defined and may lead to negotiation between insured and insurer. Items that may require negotiation include:
- Rent beyond the period of restoration due to a required lease term; and
- Businesses personal property that must be purchased but can be used in the business after the period of restoration.
Extra expenses must be paid to avoid or minimize the suspension of business at the covered premises or
at replacement or temporary premises, and they generally include relocation costs and expenses to equip and operate a replacement or temporary location.
Additional Types of Coverage
There are three additional coverages included in the ISO forms.
- Civil Authority coverage extends business income (and extra expense) coverage to losses a business incurs because a civil authority has prohibited access to its premises. The civil action must occur because a covered cause of loss has caused direct physical loss of or damage to property elsewhere. ISO form provide a 72-hour waiting period for civil authority coverage and up to three weeks of coverage.
- Alterations and New Buildings coverage extends coverage because of damage to new buildings or structures, whether complete or under construction, and alterations or additions to existing buildings or structures. If the damage delays the start of operations at the new building, the period of restoration begins on the date that operations “would have begun” had the damage not occurred.
- Extended Business Income pays for additional loss of business income that continues past the time that the damaged property is repaired and operations resume. The purpose is to recoup losses until it can return to the level that existed before the loss.
The key to accurately evaluating a loss claim is the ability to obtain complete financial information regarding the claimant/insured’s occupation or business. The mutual goals of the insured and the insurer are to mitigate loss, return to normal operations as quickly as possible and resolve the claim in a reasonable period of time. All this should be done while maintaining positive professional relationships with all who are involved.
The Ericksen Krentel team’s experience reviewing claims involving a variety of industries affords us the skills and depth of experience to provide you with a realistic and effective valuation of a business interruptions claim. That includes helping to obtain documents to support or refute a claim, reviewing the relevant documentation to form an initial assessment of the case and identify areas of loss.
Click here to learn how our claims analysis team can help identify financial concerns in regard to a loss claim, qualify the legal issues and present conclusions through clearly written reports and effective expert testimony.
About Ericksen Krentel
Ericksen Krentel CPAs and Consultants, founded in New Orleans, Louisiana in 1960 with offices in New Orleans and Mandeville, believes that serving as the clients’ most trusted adviser is grounded in going beyond the numbers.
That includes helping clients achieve their business and personal financial goals by providing innovative and exceptional services in the following areas: audit and assurance services, tax compliance and planning, outsourced CFO services and business valuations for a variety of industries; employee benefit plan audits; fraud and forensic accounting; business planning; IT consulting; loss calculations; and estate planning.
Learn more at www.ericksenkrentel.com.