Common issues in business income coverage

Questions often arise in business income coverage, particularly with respect to what constitutes a business income loss and how additional coverages apply.

A business loss occurs when there is a physical loss of a property, an insured’s operations are suspended and a loss of income occurs due to the suspended operations. (Photo: Shutterstock)

Questions often arise with respect to business income coverage, particularly with respect to the waiting period, what constitutes a business income loss, and how the additional coverages apply.

Practically everyone understands an insurance deductible and how it applies. Take, for example, a property deductible. A building valued at $100,000 burns to the ground. Assuming it was insured to value, with a $500 deductible, the insured would receive a loss payment of $99,500. The $500 deductible is retained by the carrier as the insured’s portion of the loss.

What seems to be confusing to many is a loss that involves not just property damage, but also a loss of business income and extra expense.

Business income and extra expense is a commercial property coverage option. Business income is also referred to as business interruption or time element coverage. It protects the business income of the insured that would normally be generated if there were no physical damage or loss to property.

Identifying business loss

A business income loss occurs when all three of the following occur:

  1. A direct physical loss to property from a covered cause of loss, based on the perils covered in the applicable causes of loss form (basic, broad or special).
  2. Next, there must be a suspension of the insured’s operations (or rents) during a “period of restoration.”
  3. Lastly, the insured must have an actual loss of income (or rents) due to the suspension of operations.

If any of these three actions do not occur, there is no insurable loss of business income. However, there is one caveat. If an insured chooses not to resume operations or does not resume operations as quickly as possible, then the business income payment will be based on the length of time it would have taken had the insured resumed operations as quickly as possible.

For example, business owners decided following a loss that they would close their business and retire rather than restoring the building and resuming operations. If the insureds were continuing operations, it would take two months to make repairs to the building and restore inventory. Therefore, the insureds will be paid for two months’ loss of business income.

The period of restoration is the time required to repair or replace damaged property so that normal operations can resume using due diligence and dispatch, with reasonable speed. For each occurrence of business income loss, a 72-hour waiting period applies. This waiting period is not a deductible per se; however, it is that portion of the business income loss to be borne by the insured. The 72-hour waiting period applies to the “period of restoration,” and it begins at the time of direct physical damage to property.

The 72-hour waiting period applies in addition to any other property deductible(s) that might apply at the time of loss. For example, if an insured has a fire loss that results in loss of business income, the property deductible will apply to the building loss, and the waiting period will apply to the business income loss.

The “period of restoration” ends as soon as the property is rebuilt, replaced or repaired with similar quality and reasonable speed, or when the business resumes at a new permanent location, whichever comes first.

Determining loss coverage

Typically, the direct physical loss must occur to covered property at the described premises. The described premises can mean several things depending upon the insured’s operations. A property owner’s or lessor’s described premises are all of those premises for which the insured owner or lessor has purchased business income coverage. The described premises includes the area within 100 feet of the premises, or 100 feet of the building (if the insured only rents, leases or occupies a portion of the building), and any area of the building that services the premises. If the insured only rents, leases or occupies a portion of the building, the described premises includes the area used to service or gain access to that portion of the building.

Notably, there are a couple of instances when business income coverage will apply to property not at the described premises.

Civil Authority Additional Coverage will apply if a covered cause of loss causes damage to property not at the described premises. Coverage applies if the civil authority prohibits access to the area that immediately surrounds the damaged property, and the described premises are within one mile of that damaged property. The civil authority action must be taken for one of the following reasons:

Coverage is restricted to four consecutive weeks following the date the civil authority coverage begins, which is 72 hours after the civil authority prohibits access to the damaged property.

For example, a large fire continues to burn for a week, destroying several buildings within a mile radius of the insured’s factory, and the fire department prohibits access to that entire area for two weeks. Business income coverage will be available as soon as the first 72 hours have passed from the time the civil authority prohibited the access that affected the insured’s premises. Note that for extra expense coverage, there is no waiting period, and the coverage begins immediately after the civil authority first prohibited access.

Extended Business Income additional coverage kicks in after the insured’s operations resume after a covered business income loss, giving the insured up to an additional 60 days to restore their income to normal levels. When an insured has a loss, customers will find other sources for their product, or have to find somewhere else to rent. Once the insured is back up and operational, it might still take time for their customers to return or to establish new tenants, and this coverage will give them an extra 60 days to restore their income level.

The Newly Acquired Locations extension permits the BI limit of insurance to apply to property at each location the insured acquires (except at fairs or exhibitions), up to $100,000 per location unless a higher limit is shown in the declarations. The coverage ends when the first of the following occurs:

  1. The policy expires;
  2. 30 days after the insured acquires or begins to construct the property; or
  3. When the insured reports values to the insurer.

The Additional Coverages and Coverage Extension are part of and not in addition to, the Business Income limit of insurance. Extra expense insurance is also included within the limit for business income or may be added as a separate coverage with its own limit of insurance.

Extra expense insurance provides for necessary expenses the insured incurs to continue their operations after a direct physical loss that will enable them to reduce the period of shutdown. The keyword to this coverage is “necessary.” Under extra expense, the business must make every effort to continue operations, and the expenses must be above the insured’s normal operating expenses.

For example, expenses to rent a separate space or equipment so the business can continue part or all of its operations during the shutdown. These additional expenses will reduce the amount of business income loss to the extent the insured can resume at least part of their operations, thus qualifying as a necessary extra expense. Unlike business income, there is no waiting period for extra expense; as such, coverage begins immediately after the time of direct physical loss or damage to property.

Karen L. Sorrell, CPCU, (ksorrell@alm.com) is associate editor of Practical Insights/The National Underwriter Company.

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