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Alternatives to Business Income Coinsurance

Author: Chris Boggs

For some unknown reason, many agents are scared by business income coinsurance. This concept should hold no fear for those who attended a VU webinar on this topic. But for those still skittish about estimating coinsurance for a business income policy, there are the three alternatives to coinsurance in the business income policy. These are:

  • Business Income Agreed Value;
  • Monthly Limit of Indemnity; and
  • Maximum Period of Indemnity.

Business Income Agreed Value

Business income agreed value suspends the coinsurance condition for 12 months. Qualifying for agreed value protection still re-quires the insured to complete the Business Income Report/Worksheet (CP 15 15) at the beginning of the policy period and every year thereafter. If an updated worksheet is not completed annually, the policy reverts back to a coinsurance form with all its applicable penalties; so, this is not the best option if the insured (or the agent) is trying to avoid the worksheet.

Not only is the insured required to complete the worksheet, but an officer or other responsible party must also sign and attest to the information on the worksheet specifying: 1) the value the insured has agreed to carry; and 2) the desired coinsurance percentage.

Agreed value signifies that the insured and the underwriter agree upfront on the amount of insurable business income subject to loss. The insured agrees to carry that pre-determined amount of coverage. In return, the underwriter agrees to pay the entire business income loss up to that limit without the application or consideration of coinsurance.

Monthly Limit of Indemnity

This option to traditional coinsurance-based coverage allows the insured to avoid coinsurance completely and sidestep the requirement of completing a business income report/worksheet. There is no real upfront calculation associated with this option. The only calculation done is at the time of the loss, to decipher the maximum limit available during any one 30-day period.

Two decisions are required of the insured when this option is chosen: 1) the limit of coverage; and 2) the monthly limit of indemnity coverage fraction. No “formal" income calculations are done, so the limit is little more than a guess made by the insured. The second decision requires the insured to choose from among the three available monthly limit fractions: one-third (1/3), one-fourth (1/4), and one-sixth (1/6).

The monthly limit fraction serves to cap the amount of coverage available in any 30-day period. The chosen amount of coverage is multiplied by the fraction to arrive at the maximum payout during each 30-day period. For instance, if the insured purchases $300,000 of coverage, the maximum amount available in any 30-day period is:

  • 1/3 monthly limit = $100,000 maximum available for each 30-day period;
  • 1/4 monthly limit = $75,000 maximum available for each 30-day period; and
  • 1/6 monthly limit = $50,000 maximum available for each 30-day period.

One myth surrounding the Monthly Limit of Indemnity option is the function of the denominator in claims settlement and payout. Some believe, and even teach, that the denominator (the bottom number) limits the number of months the insured gets paid. That is, if the insured chooses a 1/3-monthly limit of indemnity, coverage is only provided for three months. This is fully and completely false - unless the limits are completely used in the first three months.

The denominator serves no other purpose than to limit the amount the insured can receive in any one 30-day period.

Continuing with the above example, if the insured chooses the 1/3 monthly limit of indemnity, it has up to $100,000 available for any 30-day period during the period of restoration. Business income loss payments continue until the insured uses up the full $300,000 or returns to full operational capability, whichever comes first. If it takes six months to use up the entire $300,000, that's how long the policy pays.

Monthly limit of indemnity, contrary to its name, is actually a non-indemnity option, meaning that the amount of coverage has no real or known relationship to the insured's business income exposure or estimated period of restoration. As such, the insured is entitled to receive the entire amount regardless of how long it takes. Again, the only two limitations are: 1) the monthly limit (as decided by the fraction); and 2) a return to operational capability before the limits are completely used.

If coverage is provided using the CP 00 30 (Business Income (and Extra Expense) Coverage Form), it is important to remember that the fraction does not apply to the extra expense coverage. However, the amount needed to cover any extra expense must be added to the business income limit purchased.

For example, if the insured wants $300,000 business income (BI) coverage and $120,000 extra expense (EE) coverage, it should purchase $420,000 in total protection. The maximum payout is limited to $420,000, but the amount available for extra expense in any one month is not limited by the fractional amount. If the 30-day BI amount exceeds the fractional limit, the entire extra expense loss is still paid. This payout process continues until the total of both BI and EE losses reaches the limit purchased.

Maximum Period of Indemnity

The last and simplest of the non-coinsurance options is the maximum period of indemnity. This option limits business income and extra expense payments to the shortest of 120 days, until the limit is spent, or the insured returns to operational capability. Like the monthly limit of indemnity, the amount of business income purchased is little more than a guess.

This is a good option only if there is absolutely no question that the insured can return to operational capability within 120 days.

Maximum period of indemnity is a non-indemnity option. Like the monthly limit of indemnity option, the limit of coverage is not based on the actual exposure. Unlike the monthly limit option, coverage is limited to a specific number of days. If the insured does not use the entire limit during the 120-day period, the insured is simply out of luck (to some extent as he still had his business income exposure paid during the 120 days).

Of the three non-coinsurance options, the maximum period of indemnity option carries the highest rate. Of course, the higher rate is somewhat offset by the lower limits likely purchased.

Last Updated: May 11, 2018

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