Author: Chris Boggs
Business income IS the most important property coverage. This is not hyperbole; businesses exist to make money, and when money isn't being or can't be made – there is no business, at least not for long.
Don't ever say I recommended this, but it is preferable for a business to underinsure the building but properly insure its income rather than amply insuring the building but underinsuring its income. If the insured didn't purchase enough building coverage, they can get a loan for the difference - if they can show the bank there is income flowing into the business. Try to get a loan to replace the loss of income because of a major property loss (call me and let me know how that goes).
Rarely does a business close following a loss because it didn't have enough building and/or business personal property coverage. Most loss-induced business closures result from a lack of income. So again, business income is the most important property coverage.
Understanding the necessity of business income is important, but understanding one key business income coverage fact is just as and maybe more important – businesses experience two separate income loss periods. Ignoring this fact will severely harm the insured financially following a business-closing loss, and may result in an errors and omission claim for the agent. It's even possible that failure to prepare for this truth will result in the ultimate shuttering of the business.
There Aren't Really 2 Loss Periods, Are There?
To prove that businesses suffer two separate income loss periods following a business-closing loss, analyze the life-cycle of a business leading up to and following a catastrophic loss, then compare the life cycle to the provisions of the business income policy. When a devastating, business-closing loss is viewed through the lens of business income policy language, the two separate coverage periods become evident. The points or time periods on the income loss timeline are:
- Prior to the loss. At this point, the business is clipping along nicely. There are nice sunny days that the insured thinks will never end;
- Loss date. The wind begins to blow, or a fire erupts and the business suffers a catastrophic loss;
- Period of Restoration (not operational). The catastrophe results in a period of business shut down known as the Period of Restoration (POR) when there are no or only limited operations;
- Date repaired or rebuilt. When the building is (or should be) repaired or replaced. One key point to remember about this date - the POR ends at this point;
- Post-POR. The business is considered to have reached "operational capability." This means the business CAN (not will) operate at the same level of production and/or efficiency as before the loss. However, there is no guarantee that the business will return to pre-loss income levels immediately or even soon after the POR ends. The business may continue to suffer an income loss even after operations have resumed; and
- Return to expected income levels. This is the period in time when the insured is generating the same income it would have generated had no loss occurred.
Review this visual representation of the described timeline.
Compare this timeline to ISO's business income policy and the two coverage periods quickly reveal themselves.
Of primary importance is the business income policy's definition of "business income." Both business income forms, CP 00 30 10 12 Business Income (and Extra Expense) Coverage Form and the CP 00 32 10 12 Business Income Coverage Form – Without Extra Expense, limit the time period of a business income loss as per the following policy wording:
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".
Note that this coverage grant, taken from the insuring agreement, limits business income coverage to income loss suffered during the period of restoration. The form goes on to describe/define the "period of restoration" (the business income coverage period):
3. "Period of restoration" means the period of time that:
(1) 72 hours after the time of direct physical loss or damage for Business Income Coverage; or
(2) Immediately after the time of direct physical loss or damage for Extra Expense Coverage; caused by or resulting from any Covered Cause of Loss at the described premises; and
b. Ends on the earlier of:
(1) The date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality; or
(2) The date when business is resumed at a new permanent location.
"Period of restoration" does not include any increased period required due to the enforcement of or compliance with 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".
Pay particular attention to the point at which the POR ends. The POR, and thus business income payments, end the EARLIER of:
- The date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality; or
- The date when business is resumed at a new permanent location.
Two important limitations are found in this "earlier of" provision. The first is the word "should" applied in subpart (1). It's not necessary for the building to actually be repaired or replaced (though that is the goal of the POR), only that it SHOULD be repaired or replaced with reasonable speed and similar quality. This limitation exists to prevent the moral hazard of the insured taking a paid vacation. If there are avoidable delays, the POR is not perpetual and ends when the building SHOULD be repaired or replaced.
The second POR-ending date is the date business/operations is/are resumed at a new permanent location. "Permanent" is the key term in this limitation; if the business is partially reestablished in a temporary location awaiting the repair or replacement of the original location, the period of restoration continues. However, if the insured moves to a new location with no plans to leave, that's a new permanent location and the POR ends.
When the Period of Restoration (POR) Ends
Referring back to the timeline, when the damaged property is (rather, should be) repaired or rebuilt, or the insured resumes operations at a new permanent location, the period of restoration ends. And, again, when the POR ends so do the business income payments.
However, it is highly unlikely the insured's income levels will return to where they would have been had there been no business-closing loss. Why? Because while the insured was closed, its customers developed new buying habits or entered new contracts.
How long might it take to return to the expected income levels following the operation's return to operational capability? The answer is little more than a guess. Returning to pre-loss income levels may require a few weeks, months or even years after the insured returns to operational capability (the end of the POR). The time it takes to return to expected income levels once the business has reopened is a function of the business type:
- A convenience store may see all its customers return within the first 30 days because its customers missed the "convenience" of the store's location.
- A restaurant's customers may have found a new favorite place, so it might suffer continued losses for 60 or 90 days after reopening.
- A hotel may require six months to a year to recover due to the loss of event contracts and other issues.
- A manufacturing operation might lose major production contracts during the period its operations are suspended. Twelve, 18, 24 or more months may be required to replace the contracts and recover financially.
As stated previously, income lost during the post-POR period (per the timeline) is NOT covered under the business income portion of the policy! This is the second loss period!
So, What's an Insured to Do?
Because: 1) business income payments end when the POR ends; and 2) the insured continues to suffer income loss even after returning to operational capability, the business income policy language provides a limited amount of protection for this second loss period. Extended Business Income extends (as the name states) business income payments for the difference between what the insured earns and what it could/should have been earned (had there been no loss) for up to 60 days following the insureds return to business.
Three important conditions/caveats apply to Extended Business Income (EBI):
- The coverage period (and payments) begin "on the date property (except "finished stock") is actually repaired, rebuilt or replaced and "operations" are resumed." This date could be different than the date the POR ends. Remember, the POR ends when the building SHOULD be repaired/replaced; EBI coverage doesn't apply until operations ACTUALLY resume. Depending on the time lag, there could be a period where no coverage exists.
- Although located under "Additional Coverages," the amount available to cover the Extended Business Income loss payments is subject to the business income limit. If the entire business income limit is expended during the POR, there is no Extended Business Income protection for the insured – in the unaltered form.
- EBI pays the difference between what is earned and what could or should have been earned had no loss occurred. If the insured could have expected to earn $100,000 during that 60 days, but earned only $40,000, extended business income pays $60,000.
But what if the automatic 60 days is not long enough? Insureds have the option to increase the time period covered by activating the available optional coverage – Extended Period of Indemnity:
E. Optional Coverage
4. Extended Period Of Indemnity
Under Paragraph A.5.c., Extended Business Income, the number 60 in Subparagraphs (1)(b) and (2)(b) is replaced by the number shown in the Declarations for this Optional Coverage.
Activating the Extended Period of Indemnity (EPI) in the application (which shows up on the declarations page) requires the insured to consider and answer two questions internally:
- How long is the coverage needed? and
- How much additional coverage is required (remembering that the unaltered policy takes from the BI limits)?
Length of Coverage
ISO allows the insured to purchase up to an additional 730 days of coverage (that's two years of EPI). Available increments are: 90, 120, 150, 180, 270, 365, 450, 540, 630 and 730 days. Some carrier may have proprietary rules that allow different increments or a longer period of coverage.
Calculating the additional amount of time necessary is, as stated previously, a guess. The insured is required to analyze the facts of its business and contracts to estimate a "worst-case" scenario. In short, there is no easy answer, only estimates regarding how long it may take the insured to return to the same income levels that might have existed had no loss occurred.
Amount of Additional Coverage
Calculating the amount of needed additional coverage is simple. First, the insured divides the 12-month business income amount found in J.1. (or J.2) of the CP 15 15 by 365 (number of days in a year) and multiples that result by the number of days coverage is required beyond the initial grant of 60 days. For example, if the insured feels 270 days of EPI protection in necessary, and its J.1. (12 month business income amount) is $1,500,000, the additional amount is developed as follows:
($1,500,000 / 365) x (270 – 60) = EPI Limit
$4,109.59 x 210 = $863,014
Remember, the 60 days is subtracted from the 270 days for two reasons: 1) the first 60 days is included in the policy limits because of the difference between insurable and compensable business income (a conversation for a different day); and 2) the insured will have some income flowing into the business once it's operational, so there is no need to carry the full 270 days worth of coverage. (There is no coinsurance or other penalty applicable to the EPI limit other than the possibility that insufficient limits are purchased.)
Once the EPI amount is developed, enter the limit on line K.2. of the Business Income Report/Worksheet (CP 15 15).
Covering the Two Loss Periods
As evidenced by the reality presented in the income loss timeline, the insured has exposure to and suffers two periods of income loss following a business-closing loss: 1) the loss experienced during the period of restoration; and 2) the loss resulting from reduced income suffered after the business has resumed operational capability (post-POR).
Both loss periods must be considered and addressed when designing business income coverage. Income lost during the POR is covered by the business income policy provisions. Continued loss of income suffered once operations have resumed are covered or are coverable temporarily under the additional coverage Extended Business Income or on a longer term basis by choosing the option to purchase Extended Period of Indemnity.
Last Updated: May 26, 2017