Business Insurance: Are You Covered?
Disaster Recovery Essentials
This article was first published in the Metropolitan Corporate Counsel, March 2015 issue.
It’s that time of year again, with flooding, rain, wind, snow and other severe weather patterns being seen around the country. Now is a good time to pull out and review insurance policies and determine if you have coverage for an event that could impact your business and its ability to operate as a result of a severe weather event or other natural or manmade disasters. The insurance coverage that is available for these types of events is known as business income insurance.
Business income insurance (BI) covers the loss of income that a business suffers after a disaster while its facility is either closed because of the disaster or in the resultant process of being rebuilt. A property insurance policy only covers the physical damage to the business, while the additional coverage allotted by the business income policy covers the profits that would have been earned. This extra policy provision is applicable to all types of businesses, as it is designed to put a business in the same financial position it would have been in if no loss had occurred.
BI coverage is not sold as a standalone policy but is added onto the business's property/liability insurance policy or comprehensive policy. In sum, BI coverage is generally in addition to coverage under a business owner's policy (BOP). Since business interruption is included as part of the business's primary policy, it only pays out if the cause of the loss is covered by the overarching policy. Without business interruption coverage, one runs the risk of losing out to competitors in the event of a disaster such as a fire. While the premises will eventually be repaired and paid for through property insurance, business interruption insurance compensates for the lost profits and normal continuing expenses incurred during the period of restoration.
The following are typically covered under a business interruption insurance policy:
- Profits – Profits that would have been earned. This is based on prior historical financial information, not on projected information.
- Normal continuing costs – Operating expenses and other costs still being incurred by the business. Again, this is based on historical costs, not forward-looking expected costs.
- Temporary location – Some policies cover the extra expenses for moving to, and operating from, a temporary location.
- Extra expenses – Reimbursement for reasonable expenses (beyond normal costs) that allow the business to continue operation while the property is being repaired.
- Civil authority ingress/egress – Government-mandated closure of business premises that directly causes loss of revenue. Examples include forced business closures because of government-issued curfews or street closures related to a covered event, or the closing of a government building in which a business operates, or a government-imposed travel restriction to certain areas as a result of a natural disaster.
Typically, coverage extends until the end of the business interruption period, which is determined by the BI policy. Most insurance policies define this period as starting on the date of the covered peril and ending on the date the damaged property is physically repaired and returned to operations under the same condition that existed prior to the disaster.
In addition, businesses can purchase policy riders for “contingent business interruption coverage.” This type of coverage pays out when a business is unable to operate because of a covered event that damages the business premises of one of its suppliers, thus preventing it from engaging in normal trade.
While many business entities purchase property/liability coverage, BI policies are less common. Following are some factors that a business needs to be aware of when securing BI coverage:
- Deductibles – Your coverage must exceed certain amounts outlined in the policy before the insurance benefit kicks in. You also need to be aware of per occurrence/per loss/per location language in the policy. A policy with per location language could create separate deducible limits for each location covered under a policy versus one blanket deductible for an occurrence/loss event for an entire organization.
- Waiting periods – Generally an amount of time stated in hours or days before coverage becomes effective. One thing to note is that policy language can be tricky and must be read in full. Some polices before Super Storm Sandy used hours or days, and in many post-Katrina polices, the language says business hours or days.
- No physical damage on-site – A business needs to read the policy language as to coverage for loss due to damage. Sometimes there is no physical damage to the insured’s facility, but there could be a covered loss as a result of damage somewhere else if the right policy riders are in place. An example is New York City, where after Super Storm Sandy many locations did not have physical damage but were impacted by off-site power disruption. They were down for days, and in addition to losing perishable inventory were also unable to reopen without power.
- Lack of understanding of co-insurance provision of a policy – This is a requirement imposed by the insurance company that the insured maintain a certain percentage of the total replacement cost in addition to a BI policy’s standard coverage or the business will be penalized at the time of a claim by the amount of error or underinsuarance. For example, a $10 million replacement cost for a building insured at 80 percent coinsurance requires the insured to buy $8 million of insurance. If the insured buys only $4 million of coverage, the insured will be paid only half its claim amount.
- Civil authority coverage – Generally provides up to three consecutive weeks of coverage for a covered event beginning 72 hours after a civil authority prohibits access to the property that is covered for business income purposes. That is to say, if the loss event happens and there is an order to close an area, coverage generally does not go into effect for 72 hours or business hours depending on policy language.
- Ingress and egress coverage – involves the inability to enter or leave the insured’s premises not due to physical damage or obstructions. Involvement of civil authority is NOT required. Not all insurance companies offer this type of coverage, so individual company endorsements would have to be reviewed to determine if policy coverage is in force. Examples of ingress/egress without civil authority include the following: (1) Access to the facility that houses your inventory has been impeded due to a sinkhole that has collapsed in the street leading to the facility. Employees cannot get to work if the roads are closed or otherwise blocked; and (2) A large office building suffers damage due to a hurricane. The damage prevents the tenants from occupying the building following the loss for 30 days while repairs are completed. The building owner loses income and submits a claim for same.
As a result of the various natural disasters that have occurred over the past decade, business interruption policy language and coverage have changed significantly. Business owners need to be informed and understand not only that they have coverage under a policy but also what specifically is covered and not covered. As they say, the devil is in the details, and with a BI policy, the coverage is in the details.
Just recently, we experienced a situation where two New York City-based companies in similar lines of business with BI coverage through the same insurance carrier had drastically different coverage for a BI loss claim. This was discovered as a result of Super Storm Sandy, when they came to us for assistance with their BI claim analysis. Based on our review of each company’s policy, it was clear they both had BI coverage, but only one had the proper coverage for its claim. Company #1 had “off-site utility service interruption coverage,” and company #2 just had “utility service interruption.” Since many claims in New York City were due to loss of electricity because of transformer damage in central New York City – and not a result of physical damage to the insured’s facility causing the outage – policy language was an important factor in identifying the loss that was covered. Company #1 had coverage as a result of the “off-site” language, and company #2 did not have coverage because its service interruption was not a result of damage to its physical location. Just some simple wording in the policy (the term “off-site”) made the difference. In addition to the general policy language and coverages that often go overlooked, there are extra riders that businesses can add to their BI coverage in order to address issues that may be unique to their industry or geographic location.
Business income coverage is often misunderstood or misinterpreted by the policyholders: It is generally viewed by business owners as a cost of doing business as opposed to a necessary coverage product. As such, many people focus on policy pricing as opposed to policy coverage and limits. All too often, business owners get an insurance renewal notice with a premium increase, and their initial reaction is to call their brokers and ask them to sharpen their pencil or else the owner will shop the business with other carriers. Business owners will get a call back informing them that their premium is the same or only slightly higher than last year, but generally, when a policyholder is told the renewal price isn’t going up, he or she should ask what, if anything, changed in the policy coverage and related riders and endorsements. In most cases, you don’t get something for nothing. There was a reason for the premium increase, and there is generally a cost in coverage to keep the premium flat from year to year.
In addition to having the proper BI coverage, it is also important for a business to develop a business continuity plan (BCP). A BCP is a plan to help ensure that business processes can continue during a time of emergency or disaster, such as a fire, flood or any other situation where your business is not able to operate under normal conditions.
Business continuity planning begins with assessing how potential risks to your business will impact the ability of your business to continue to deliver products and/or services in the event of an interruption. By assessing and understanding the potential impact of possible risks by performing a review and financial analysis, you will be able to identify and prioritize the steps you may need to take to repair your business after an unexpected disruption. Identifying and defining potential risks enables you to develop strategies to mitigate the impact of a disruption. While you can't plan for everything, it is important to understand that proper planning provides a framework that helps minimize the exposure as a result of an interruption event.
A typical business continuity plan involves the following:
- Analysis of organizational threats
- A list of the primary tasks required to keep the organization operations flowing
- Easily located management contact information
- Explanation and communication of where personnel should go if there is a disastrous event
- Plan for data backups and organization site backup
- Collaboration and input among all facets of the organization
- Buy in from everyone in the organization
Businesses need to look at all such potential threats and devise BCPs to ensure continued operations should the threat become a reality. Having the proper BI coverage and a BCP can help minimize the effect of an interruption event and help mitigate the potential financial damage a business may face. It is good business practice to annually review your BCP and BI policy coverages to evaluate your business risks and potential coverage needs. By working with your insurance, financial and accounting advisors and risk managers, you ensure that a proper continuity plan and adequate BI coverage is in place.