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Property Casualty

Business Interruption Insurance 101: Everything You Need to Know

Nick Kohlhof
Nick Kohlhof
Client Executive, Property Casualty

Statistics from FEMA show that around 40 percent of businesses do not reopen after a disaster. Some sources say the failure rate is as high as 75-90 percent within 2 years of the incident! Honestly, I don’t know what the true number is, but I do know that recovering from a catastrophic property loss is incredibly difficult for companies.

When businessowners think about a potential loss or disaster scenario and how it should be insured, they typically think about their physical assets first:

  • Their building
  • equipment
  • business personal property
  • etc.

Makes sense. It’s easier to think about the purchase price or market value of those items, so insuring those things is more straightforward.

While it is certainly possible (and likely) to be underinsured on those items, that isn’t usually what prevents companies from reopening. The inability to produce, loss of customers, and loss of employees are much more likely to cause a business to close permanently. Business Interruption (aka Business Income/BI) insurance addresses these items, and getting it right takes some effort and understanding.

What Does Business Interruption Insurance Cover?

Business Interruption may cover your business against certain financial losses that are sustained while your business is unable to operate due to a direct physical loss or damage to your property.

To trigger coverage, the damage must occur to a covered location on your property policy and result from a covered cause of loss.

So, what does that mean? Well, Business Interruption insurance covers net income, operating expenses, extra expenses, ordinary payroll, and extended period of restoration. Let me explain this a bit further.

Net Income

This means profit or loss…not revenue. Keep in mind that insurance is meant to indemnify the policyholder.

Operating Expenses

This encompasses normal continuing operating expenses during the period of restoration (downtime), including taxes, insurance, rent and some utilities, and salary of key employees.

Extra Expense

This includes expenses that are necessary and reasonable to minimize the time your business is unable to operate and to keep operations going. Examples include:

  • Relocation expenses (additional space acquisition while repairs are made at damaged facilities)
  • Outsourcing production
  • Additional payroll/overtime
  • Increased logistical costs

Ordinary Payroll

This means payroll expenses for your employees that become idle after a loss. This coverage is designed for production/hourly employees and does not apply to officers, managers, executives, and other exempt positions that would be expected to continue working even during operational downtime. Also consider employee benefits, union dues, and workers’ compensation premium.

Extended Period of Restoration

This part protects against loss of income that continues beyond the point of normal operations resuming and the normal period of restoration ending. This helps account for the loss of customers during downtime.

How Much Business Interruption Coverage Do You Need?

How do you determine your exposure and the correct limit for your policy?

First, it’s important to realize that Business Interruption claims are complicated. They are often messy and take a long time to settle. Determining the correct limits for this coverage begins and ends with the Business Income Worksheet, which admittedly can be a pain to complete. The one promise I can make is that the number you come up with will likely be wrong.

Now you may be thinking, “great, so what am I supposed to do?”

You still need to fill out the Business Income Worksheet because it is your best chance to get close to the right limit, and because the insurance company will rely on that worksheet for reference while adjusting the claim. The worksheet incorporates:

  • Prior year financials
  • Forecast for the next 12-month period
  • Costs of goods sold
  • Determine your individual company’s exposure for the coverage items described above

In my experience, this can become a daunting topic. What begins as trying to develop a number for the property policy becomes an in-depth conversation about disaster recovery, communication across multiple business units, and planning.

Insurance is just one important piece of the puzzle. Work closely with your insurance broker to complete the worksheet and rely on them for discussion regarding business continuity plans, benchmarking, and industry resources. Business continuity planning is a fluid and ongoing conversation for even the most experienced risk managers. Even a little progress will be valuable for your organization.

If nothing else, having a better understanding of your business interruption coverage and limit will give you confidence that your business will not be one of the 40-75 percent of businesses who fail.

Have questions? Contact us, and we’ll be happy to help you out!

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