Author: Chris Boggs
We begin with the Business Income's Insuring Agreement: We will pay for the actual loss of Business Income you sustain due to the necessary "suspension" of your "operations" during the "period of restoration". The "suspension" must be caused by direct physical loss of or damage to property at premises which are described in the Declarations and for which a Business Income Limit Of Insurance is shown in the Declarations. The loss or damage must be caused by or result from a Covered Cause of Loss.
Several key terms and phrases from this insuring agreement are important to all business income losses in Insurance Services Offices (ISO's) business income policy:
- Actual loss of business income;
- Suspension of operation;
- Direct physical loss of or damage to property; and
- Covered cause of loss
In a previous article, the lack of business income coverage for governmental shutdown was addressed (see, “Coronavirus: Does Business Income Respond"), so, too, directly or indirectly, were the concepts and realities of suspension of operation, direct loss or damage and covered cause of loss. But because the linked article focused on the lack of coverage for coronavirus related governmental shutdown, one important topic was not detailed – actual loss of business income.
How is the actual loss of business income deciphered? Both ISO-promulgated business income policies (CP 00 30 and CP 00 32) provide guidance on how the actual loss of business income is calculated:
3. Loss Determination
a. The amount of Business Income loss will be determined based on:
(1) The Net Income of the business before the direct physical loss or damage occurred;
(2) The likely Net Income of the business if no physical loss or damage had occurred, but not including any Net Income that would likely have been earned as a result of an increase in the volume of business due to favorable business conditions caused by the impact of the Covered Cause of Loss on customers or on other businesses;
(3) The operating expenses, including payroll expenses, necessary to resume "operations" with the same quality of service that existed just before the direct physical loss or damage; and
(4) Other relevant sources of information, including:
(a) Your financial records and accounting procedures;
(b) Bills, invoices and other vouchers; and
(c) Deeds, liens or contracts.
During this pandemic panic and the resulting business shutdowns by governmental decree, of particular interest is the loss determination provision found in 3.a.(2). Notice the phrasing, “The likely net income…if no physical loss or damage had occurred…."
Assume this scenario, a business, almost any type of manufacturing, retail or other such business where income is production or sales dependent, is forced to close by governmental decree (some call it civil authority, but caution must be used with that term due to the lack of business income coverage). The regulatory authority requires the business to close for a specified time (15 to 30 days); at the end of that period, the government plans to decide if businesses can reopen.
Obviously, the business is losing revenue during the government shutdown and there is no coverage for the loss of income. As if that's not problematic enough, let's add to the business' problems.
Three days into the governmental shutdown period, the operation suffers a fire that severely damages or destroys the building; how is the business income loss adjusted for the covered loss? How will the required shutdown affect loss settlement?
As per policy wording, the loss is adjusted based on “The likely net income…." The “likely net income" during the government decreed shut down is zero. And, what happens if after the initial shutdown period the government extends the shutdown? That extended period also generates zero revenue.
Because the “likely net income" is zero during the government-forced shutdown, the insured is not due any indemnification. The unrealized revenue results from an excluded cause of loss. The proximate cause of the lost revenue is the government shutdown not the fire.
Efficient proximate cause is the basis of business income claim payments. What is the direct or efficient proximate cause of the loss of revenue during the period of business shutdown? If the efficient proximate cause of lost revenue is a covered cause of loss, the lost revenue is covered. If the efficient proximate cause is an excluded cause of loss, there is no coverage for the lost revenue. If an excluded cause and a covered loss cross over, the excluded cause takes precedence. Concurrent causation wording in the special cause of loss form excludes loss for acts or decisions of a governmental body. And unless the government's decision causes the fire, there is no coverage during the governmental shutdown period.
Let's use a “non-essential goods" manufacturer as an example. The governmental authority orders all businesses closed for 30 days. Five days after the governmental decree, the manufacturer suffers a major fire loss. The fire damage takes six months to repair. Historically, the operation averaged net income of $40,000 per month. For easy math, we will assume this six-month shutdown would normally result in a business income loss of $240,000 (very much over-simplified for the example). How much will the insured be paid?
Not the $240,000 because the likely net income for the first month is $0. Remember, a 30-day government ordered shutdown was in force (the 25 remaining days following the fire were rounded to 30 days for ease of the math). Thus, the insured would be paid $200,000 rather than $240,000.
To continue the “what if," what if the government ordered an additional 30 days following the original 30 days – for a total of 60 days? Basically, although the operation is shut down for six months, it is paid for only four months because the first 60 days the “likely net income" was $0 because of the government shutdown.
(Side note: The government shutdown will extend the period of restoration and thus the business will remain closed longer. Maybe or maybe not. There are a lot of post-loss, pre-construction activities that can be completed during the shutdown, so there may not be noticeable delay. Regardless, the time period of the governmental shutdown is not covered.)
Business income calculations in this and similar scenarios are based on proximate cause. Was the proximate cause of the income loss a covered cause of loss or an excluded cause of loss? If a covered cause of loss occurs during a period created by an excluded cause of loss, the carrier only owes what would or could have been earned had there been no loss.
In the absence of the fire, which is the covered cause of loss, the insured would not have earned any net income during the governmental shutdown, thus the business income policy does not owe for income that would not have been earned anyway. Income lost due directly to the covered cause of loss after the government decree is lifted is compensable under business income – because the continued shutdown is directly related to a covered cause of loss.
Business income payments are a function of efficient proximate cause of loss. Adjusting the claim differently would be putting the insured in a better position than they would have been in had there been no covered loss – which violates the principle of indemnification around which property insurance is based.
Last Updated: March 30, 2020