Understanding the options under business income coverage

How do the optional coverages in the business income and extra expense form differ?

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The Business Income and Extra Expense Coverage Form offers the insured two optional coverages, the Maximum Period of Indemnity option and the Monthly Period of Indemnity option.

One big advantage of these options is that they both eliminate the need to maintain coinsurance, as the coinsurance provision is replaced by the chosen indemnity option.

Both indemnity options include the “period of restoration” as a defined term, meaning the period of time that begins 72 hours after the time of direct physical loss or damage. The loss or damage must be caused by or result from any covered cause of loss at the described premises. The period of restoration ends on 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. Coverage ends when the property should be repaired, rebuilt, or replaced; therefore, the insured could not delay in effecting repairs, thinking that there was no reason to rush.

The definition clarifies that the period of restoration does not include any increased period of time caused by the enforcement of any ordinance or law, or any requirement to monitor, test for, treat, or clean up any pollutants.

For example, the loss is June 1. It is an older building, and the codes have changed over time, although the building hasn’t been updated. The repairs to the building will take until August 20. However, because of the need to bring the property up to code, repairs will take an extra 20 days, meaning that the property won’t be repaired until September 9. The period of restoration, however, still ends on August 20, since the extra time to bring the building up to code is not included in the period of restoration. The period of restoration does not end with the expiration date of the policy. For example, if a fire destroys a retail shop and the building cannot be repaired from a covered loss by the end of the policy term, the insured will still have coverage for the lost business income until the insured can resume operations.

Difference in options

The Maximum Period of Indemnity option is considered most beneficial for those businesses that are least likely to have an extended period of restoration, i.e., businesses that can rebound quickly following a loss. Examples would include contracting or service industries that could operate out of a different location following a loss, or businesses with a catastrophe plan in place that would enable them to shift operations elsewhere relatively quickly.

Under this option, the coinsurance penalty is deleted and replaced with a provision stating that the insurer will pay the amount of loss sustained during the 120 days immediately following the direct physical loss or damage; or the limit of insurance, whichever is less.

Under the Monthly Limit of Indemnity option, the coinsurance provision is replaced by a monthly limit of insurance for business income. The monthly limit of insurance can be either one-third, one-fourth, or one-sixth of the total limit of insurance shown in the Declarations.

The selected fraction is indicated in the declarations, and it is the maximum limit available for the month. If the lost income for the month is greater than the limit, the amount in excess of the monthly limit will not be covered. The monthly limit of insurance only applies to business income, not an extra expense.

For example, if the business income limit of insurance is $100,000, and the selected fraction is one-fourth, then the maximum business income limit available for any month is $25,000. The extra expense is not limited on a monthly basis; however, the business income and extra expense combined loss is subject to the total business income limit. If a loss involves only extra expense, the entire coverage limit can be applied to extra expenses incurred to maintain or quickly restore production, regardless of when they are incurred.

To illustrate, let’s assume:

* The extra expense limit is not limited per month. However, the amount available for extra expense is subject to the remaining amount of the business income policy limit. Once the business income limit of $500,000 is reached from business income loss or extra expenses incurred, the coverage ends.

Therefore, it is important that the insured select a business income limit that is adequate for their income levels. As you can see from the illustration, should the insured have a loss that incurs a large amount of extra expense, the business income limit could be quickly exhausted. If extra expenses exceed the business income monthly limitation, the policy limit may not be adequate to cover additional business income losses in future months.

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