This article assumes a working knowledge of income statements and other basic business terminology and information. In the interest of simplicity, we'll use the term “agent” to refer to the insurance representative that deals with the commercial account on the coverage level. That person could be the producer, carrier representative, account manager, or have some other title, depending on the organizational setup.
Regardless of title, this material is directed at everyone involved in servicing commercial property insurance, and specifically toward those involved in calculating or reviewing limits for business income (BI) coverage.
There are two areas of the current ISO Business Income Worksheet (CP 15 15, the most recent edition is from 6/95) that are potentially misleading, and which can lead to problems in setting adequate BI limits. Ironically, one area requires following the instructions to the letter in order to avoid problems, while in the second area, following only the instructions on the worksheet can leave an insured with a regrettable shortage in limit (and possible coinsurance penalty) following a loss.
The first potential problem occurs in Section I of the worksheet, with the deduction for “cost of goods sold.” If the preparer follows the instructions on the worksheet, the result of the supplemental schedule on page four (titled “calculation of cost of goods sold”) will show that for the purpose of setting the BI limit, the term “cost of goods sold,” only means “raw materials and direct manufacturing supplies,” for a manufacturer, or “cost of goods for resale,” for a distributor or retailer.
Related: Lost Business Income 101
Unfortunately, many worksheet preparers think the term “cost of goods sold,” includes many additional overhead items. The result of a too-large deduction at this point in the worksheet is an exposure that starts off being calculated too low on Line J.1. As we know, if a calculation starts too low, the inevitable outcome is that the end result is also too low.
If the coverage is being written on the ISO form, which is the case the majority of times, it's vital that the agent verify that the preparer has completed the supplemental part of the ISO worksheet. Too often, the preparer is rushed and only pulls the “cost of goods sold” entry from the GAAP financial statement, which as outlined above, includes additional overhead items that result in too much of a deduction. The agent can also verify the figure by using the breakdown of “cost of goods sold” that is included in many companies' financial statements, but it is still best to confirm with the preparer that the correct deduction was taken in Section I.
The second potential problem area lies in calculation of the limit, and in the instructions that follow Line L of the worksheet.
We know from experience that almost no business maintains consistent levels of production or sales throughout any 12-month period—there are typically peaks and valleys in any graphic depiction of those outputs during a year. The agent should first get an estimate from the preparer of the time it would take to resume operations following a major loss, then focus the preparer's attention on the annual exposure on Line L, and ask the question, “What if the loss (and resulting shutdown) happens at the worst possible time for the operation?”
For example, if the preparer estimates a maximum six-month shutdown following a major loss, and the loss occurs at the worst possible time for the business, it is likely that the BI exposure is much higher than 50 percent of the annual estimate. The potential maximum loss is the figure that should be used as the BI limit.
A great deal of additional space could be devoted toward properly completing the Business Income Worksheet, but it's the aim here to only focus on two of the most common errors found in completing the worksheet and setting the BI limit.
It's vital that agents possess or acquire working knowledge of business terminology and how business income coverage applies following a loss in order to assist in properly completing the worksheet and setting the BI limit on the policy.
As always, the same expertise that an agent can apply to reducing post-loss problems for their own accounts can also be used in finding potential problems in the property coverage of their prospects. While it can take significant time and effort for an agent to fully understand how to set adequate limits for BI coverage, the results can be very worthwhile.
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