November 2010: Business Interrupted…Where’s Your Cash Flow?

By November 19, 2010 July 18th, 2011 Business Insurance, Business Monthly Email

When business owners consider a loss to their operations, many immediately think about the physical damage to their building or contents which would be covered by property insurance. However, the key to surviving a disaster could really depend on loss of business income protection.

If your operations are interrupted, have you determined that you:

* have a means to pay your bills?

* can afford the expense of relocating to a temporary location while your property is being renovated or rebuilt?

* can make payroll for your workforce, or at least the vital key members?

Business Income Insurance provides protection of your income when your operations are interrupted because of damage to your property by a covered loss. Extra Expense reimburses you for expenses incurred to reduce the business income loss.

Non Profit Organizations

To determine an appropriate business income for non-profits, it is critical to look at all sources of income (ie., memberships dues, donations, grants at risk, admissions, store sales, other income) and then determine the amount of this income that would continue even if there is a loss.  Fortunately the continuing income is often a good percentage of the income.

To determine the business income basis:

1. Total Revenue

2. The amount of revenue that would no longer be available if a loss should occur.

3. Expenses that would not continue after a loss (e.g. rent, utilities, cleaning, maintenance, etc.).

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4. 100% Business Income Value

To determine the appropriate extra expense:

1.  “Initial costs” following the loss that would not have occurred if a loss had not taken place (e.g. temp. facilities deposit, improvements to temporary facilities, temp. personnel, utility deposit, etc.)

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2.  “Monthly Extra Expense” (e.g. temporary facilities rent,  transportation of personnel, increased utilities, increased overtime, discounts given, etc.).

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3.  Estimated Extra Expense Value

It is crucial that a non-profit be properly insured in order to carry on with its vital mission.

Determining Your Exposure

When determining your exposure, you need to consider your “Probable Maximum Loss (PML)” which is the largest loss you are likely to sustain (i.e. total of net income and operating expenses that would have been earned or incurred, had no loss occurred, for the 12-month period beginning with the policy inception) plus Extra Expenses you would incur to reduce your Business Income loss.

The calculation of extra expense limits is often a more daunting task because it is not taken from actual hard facts. It is looking at worst-case scenarios within your operation and guessing what might need to be done.

In order to best determine your exposure, Business Income and Extra Expense worksheets need to be completed. Then it is necessary to review your operations to determine your appropriate insurance protection. This varies greatly with the type of business as some can easily resume operations at another location with minimal impact on revenue but encounter a higher level of extra expenses (e.g. offices) while others may need to cease operations entirely until their facility is restored (e.g. manufacturer).

Based on your business’ needs, you must then select one of the following forms which will dictate your loss settlement:

  • Coinsurance – standard forms utilize a coinsurance clause requiring a policy limit to be maintained that is equal to or greater than the coinsurance percentage (50, 60, 70, 80, 90, 100, 125%) times the estimated annual loss.
  • Maximum Period of Indemnity – deletes coinsurance but limits payment to the lesser of the policy limit or the amount of loss sustained during the 120 days immediately following the loss.
  • Monthly Limit of Indemnity – deletes coinsurance but limits the payment recoverable during any month of business to a stipulated fraction (1/6, 1/4, 1/3) of the policy limit.
  • Agreed Value – suspends coinsurance as long as the policy limit is equal to the value agreed on by insured and insurer.

It is important that your exposure and limits be calculated annually, or sooner if there is a substantial change in your revenue.

Although determining your exposure can be time consuming, it is vital as excess limits will result in unnecessarily higher premiums and limits too low will cause financial hardship at the time of a loss.

Business Income/Extra Expense Worksheet

Extra Expense Worksheet

A Guide: Completing the ISO Business Income Worksheet

Additional Coverage Considerations

Depending on your business’s individual needs and exposures, one or more of the following endorsements may be required as part of your insurance program to provide adequate coverage:

Ordinary Payroll Limitation or Exclusion

Either limits coverage for ordinary payroll expenses to a specified number of days or excludes such expenses completely allowing for a lower limit to be carried to satisfy coinsurance requirements. This may be beneficial to businesses that have a substantial amount of unskilled workers who do not need to be retained during restoration period. Including coverage though can help retain valued employees during the restoration period.

Power, Heat and Refrigeration Deduction

Eliminates power, heat, and refrigeration expenses from coverage allowing for a lower limit to be carried to satisfy coinsurance requirements. This may be beneficial to businesses who do not have these expenses continue during restoration periods (i.e. manufacturer)

Ordinance or Law Increased Period of Restoration

Provides loss of income incurred during the additional time required to comply with building ordinances or laws.

Utility Services Time Element

Coverage for loss of income resulting from off premise interruption of utilities and communication services.

Business Income from Dependent Properties

Protects against income loss due to physical loss occurring on the premise of a business that you depend on for materials, products, or sales.

Extended Business Income

Coverage, for a specified time period, for income losses that continue after the period of restoration ends and business initially resumes.

Multiple Locations – Blanket Limit

A single limit of insurance covering the combined business income exposure of all locations. Blanket insurance responds as if the entire company, regardless of the number of locations were under one roof. Blanket limit is commonly used when a business is more complex involving several locations or divisions.

Civil Authority

Covers loss of income and extra expense incurred because of action of civil authority that prohibits access to your premise.

Ingress/Egress

Coverage for losses suffered when, as a result of loss, entry to or exit from your property is impaired.

Business Income Claims

Understanding Business Income–both when the coverage is purchased and when a claim is adjusted–is every bit as critical.  As with property and liability claims, the insurance company will immediately investigate the claim to determine the cause of the loss, the applicable coverage, and whether any subrogation is likely.

You will need to quantify the Business Income claim. This may require you to provide:  monthly profit and loss statements, inventory reports, production reports, general ledgers, cost accounting reports, sales and production forecasts, budgets, copies of leases, invoices, purchase orders, etc.

A key to an accurate and efficient claim is being able to provide clear documentation to substantiate your loss.

Real Estate Owner – fire – $2,000,000 Business Income Loss
A mid-sized building suffered a fire which damaged two floors including the elevator shaft.  The building was forced to shut down for three months while being repaired.

Real Estate Owner – pipe burst – $250,000 Business Income Loss
A sprinkler pipe burst on the third floor of an office building causing considerable water damage on first through third floors.

Manufacturer – equipment breakdown – $3 million Business Income Loss
A critical piece of equipment at a tool and die manufacturer suffered a machinery breakdown. The manufacturer needed to order a new part and had to wait two months for it to arrive from Germany. The manufacturer suffered business income loss as they were not able to provide the market with their product.

Manufacturer – power surge – $1.5 milion Extra Expense Loss
A plastic bottle manufacturer facility burned to the ground after a power surge. Even though they had a second facility, it did not have the proper equipment required to manufacture the bottles. It needed to rush order new equipment to fulfill its orders.

Retailer – fire – $500,000 Business Income and $1,000,0000 Extra Expense Loss
A swimsuit retailer was gearing up for the summer season and had all its stock in a warehouse ready to ship to stores.  A major fire erupted and all the stock was lost.  The retailer had to purchase more swimsuites, expedite the shipping of the stock to a new warehouse, and hire extra workers to get the new stock ready for sale.

Retailer – drain backup – $300,000 Business Income Loss
Designer store located on first floor of mall.  After 10 inches of rain in a 48 hour time period, a drain backed up into the store damaging the stock.

How we can help you

At the Toole Agency our goal is to make sure our clients have sufficient Business Income/Extra Expense coverage so that at the time of a loss our clients can focus on the future instead of suffering the consequences of having insufficient coverage. We want to make sure you are able to keep your key employees, retain your clients, and pay your ongoing expenses after a loss. We can assist you with determining your appropriate coverage, as this can be a complicated and tedious process. Contact us today to make sure your business is adequately protected. riskmanagement@tooleinsurance.com

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