Chapter 9: Business Interruption Insurance

1. Chapter 9: Business Interruption Insurance

2. Objectives • Demonstrate the need for business interruption insurance and discuss the perils and exposures it should cover; • Identify the three chief types of business interruption policy and explain their main features; • Compare the Profits and Gross Earnings forms; • Describe the features common to most business interruption forms; • Discuss the exposures that arise from lease agreements and the business interruption and rental policies used to treat them; • Describe other miscellaneous business interruption coverage and the exposures they cover.

3. Introduction • A business that needs property insurance also needs business interruption insurance. • BII pays for income lost because of the interruption of business or the extra expense necessary to keep the business going after a loss. • The chapter will refer to four case studies found in the Appendix at the back of the book.

4. Business Interruption InsurancePremium Door and Window • Loss of rental income from tenant and cancelled lease on leased building. • Increased cost of leased premises due to location and inflation. • Lost profits and expense will continue even though operations ceased. • Expenses must be broken down between those that will not be insured when operation cease and those that must still be paid. • Employees will be laid off but key managerial personnel must be retained. • Interest on debt continues and taxes need to be paid.

5. Business Interruption InsurancePremium Door and Window • Certain contracts require payments to continue whether or not the services are still needed. E.g. Advertising. • Economic loss - $1,500,000!!!! (Lost profits $438,000 and $1,062,000 continuing expenses). • Large single customer –what if they lose the contract? • To maintain the contract will need to rent space at many locations (inefficiencies) and special order, lease, beg and borrow machinery. • SEE EXHIBIT 9-1 for Projected income following Suspension. • Loss will be $238,000 to retain Acme account. Business Interruption Insurance is Important!!!!

6. Perils to be Insured • Fire and EC or all-risks – make no difference what causes the interruption, the business still loses money but all-risks provides more coverage. Water and electrical supply can also be covered. • May be a Boiler and Machinery (B&M) exposures; don’t forget about these. • Fine’s Flowers v. General Accident 1977– pumps failed to keep greenhouse warm and produce was destroyed. The agent neglected to insure the pumps and the agent (and insurer) were sued. The agent had to pay.

7. Policies Available • Three chief types of policies: • Profits • Gross Earnings • Extra Expense and Additional Increased Cost of Working • P.E.G!– Profits, Extra Expense Gross Earnings!

8. What is the difference between Gross and Net “Gross refers to the whole of something, while Net refers to a part of a whole following some sort of deduction.” www.diffen.com

9. Profits and Gross Earning Compared • Alternative types of income restoration policies. • Profits form covers gross profits, not merely net profits. • Main differences between Profits and Gross Earnings form: • As long as there is a profit loss as a result of the damage cause by perils insurance against - policy will respond. • Indemnity period defined in policy • Payment can take place up to 12 months after the damage took place. • Payment for loss of gross earning is made up to the time required to rebuild the insured damage with due diligence and dispatch. • Premium Adjustment clause limits the indemnity period to a maximum of 12 months as of the date of loss.

10. Profits and Gross Earning Compared • 80% or 50% • No-coinsurance form available for mercantile risks. • Always 100% • No “coinsurance” clause in forms but provision has effect of requiring 100%. • No exclusion • Lost earning cause by damage to finish stock excluded (manufacturers only). • Includes any delays cause by the application of bylaws. • No cover for delays cause by the application of bylaws.

11. Profits or Gross Earnings? • Period of indemnity – main difference • Can business return to normal as soon as damaged property is made good? Yes, maybe gross earnings is sufficient and cheaper (if not, profits). • Quote both, explain the differences in coverage and cost. • Let the client make the choice.

12. Adjustable Policies • An adjustable policy – the insured chooses a sum insured that they believe will be more than adequate and pays a deposit premium based on this amount. • Insured must forecast future results (See Exhibit 9-2) • End of the policy year declares actual figures and premium is adjusted accordingly. • Maximum return premium of 50% of deposit. • Under no circumstances does the adjustable policy provide more insurance than the limit stated in the policy.

13. Stated Amount • Available for BII same as for physical damage. • Avoid coinsurance penalty • Frequently review limits as BII is more difficult due to future sales, expenses and profits. • Stated amount does not solve the issue of adequate limits.

14. Further Differences • Profits uses an addition method for calculating future results • Net profit beforetax is taken and to this we add the bills that continue (without reduction) even with the drop in revenue following an interruption (these are called Standing charges). • Accountant terms these fixed and semi-fixed charges Sum insured = total net profit before tax + standing charges • Best to insure all standing charges, as with a loss of short duration all standing charges continue.

15. Further Differences • Gross Earnings calculates results by deducting items form a gross figure. • Manufacturer: Net sales value of production is added to the other earnings • Non-manufacturer: Net sales or net revenue is added to other earnings. • From the gross figures certain deductions are made. • USE a worksheet, have the client or accountant complete the form. DO NOT accept a rough estimate of the total figure. • Even if a client is operating at a loss they need BII.

16. Stock • Difference between Profits and Gross Earning for manufactures: • Gross Earning excludes finished stock • Profits (and Gross Earning for non-manufactures) does not exclude it. • Stock should be insured against physical damage, manufactures should consider a Gross Earnings policy and physical damage should cover stock for it’s selling price. • There are instances where with profits or gross earning policies stock is insured for cost price.

17. Ordinary Payroll • Both Profits and Gross Earning insure the full the wages and salaries paid to key employees. • Usual to insure wages for a short period (except key employees) • Insured should be guided by ease (or difficulty) of obtaining replacement workers, training time and legal requirements (union contract). • Gross earnings and Profits handle ordinary payroll differently. • Profits does not insure at all (add special item) • Gross earning covers 100% payroll and includes the amount in any coinsurance calculation (endorse this form accordingly).

18. Auditor’s Fees for Preparing a Claim • Often necessary to bring in accountants (insurer will bring in accounts in a claim). • Accountants are expensive – wise to include an item to pay for their fees. • Not subject to coinsurance.

19. Suppliers’ and Customers’ Premises • Business can be affected by damage at a key supplier’s premises • Arrangement with alternative suppliers if the usual supplier is down? • Damage at suppliers premises can be insured (Profits and Gross Earnings forms) • Degree of dependence could affect additional premium. • Dependant on one or a few customers??? • A retailer in a shopping mall with a large department store that attracts customers to the mall could be damaged by loss of the store. • Leader or magnet property

20. Suppliers’ and Customers’ Premises • Technical name for these coverages:

21. No-Coinsurance Form • Useful where the client has a limited BII exposure, wants a simple policy and wants to pay as little as possible. • Available for non-manufacturing risks on gross earning basis (no cover for loss arising afterwards). • NOTE: Amount payable is limited to 25% of the sum insured for each 30 consecutive days of interruption. Coinsurance

22. No-Coinsurance Form • Two assumptions underlie this restriction: • Interruption will only last 120 days or about four months • The loss will be evenly spread throughout this period. • Sum insured must be adjusted to deal with fluctuations in monthly sales. • Monthly earnings may be based on month with largest sales. • Is it really worth while??

23. Extra Expense and Additional Increase in Cost of Working • All profits and Gross Earning policies will pay what may be thought of as Economical extra expense. • Covers only the extra charges (expenses) incurred to keep a business going. • Designed for business and profession that can continue at extra cost and must do so if possible. E.g. Newspaper, realtor, doctor and other “services” businesses. • See Pg. 19 for Extra Expense Worksheet (Guide only – insured may incur other expenses not listed). • No coinsurance but limited to certain percentages of sum insured per month.

24. Extra Expense and Additional Increase in Cost of Working • Extra expense based on the gross earning concept until damage is restored and no longer. • The equivalent on a profits basis (until results are back to normal) is Additional Increase in Cost of Working (AICW). • Some business may need both earnings coverage (Gross Earning or Profits) and extra expense (Extra Expense policy or AICW). • In such instances offer like coverage for both exposures.

25. Limitation – Media for Electronic Data Processing (EDP) • This limitation is a feature in almost all BII policies. • Limits period of time for which insurer pays when interruption results from damage to EDP media (disks, tapes, etc.) and programming records. • Time Period is: • 30 consecutive days; or, • Time required to restore other damaged property, which ever is greater. • Limitation does not apply to damage to hardware (e.g. Computer) • Rating: percentage of the rate for physical damage (E.g. fire and EC)

26. Coverage Extension – Interruption by Civil Authority • This clause provides limited coverage when access to premises is prohibited by civil authority (policy, town, etc.). • Coverage is subject to two important provisions: • A time limit of two weeks; • The prohibition must be the direct result of damage to neighbouring premises by a peril insured. • Discuss with client if this time period is adequate – period may be extended for additional premium.

27. Exclusions • The Gross Earnings form has a section called Additional Exclusions. • Profits form exclusions are found under Provisions. • Limitation and exclusions for the Gross Earning forms are similar. • Includes: Manufacturing and non-manufacturing Gross Earnings, Earnings No-Coinsurance, Actual Loss Sustained, Extra Expense and Rent and Rental Value forms). • Profits, AICW, and Gross rentals form are similar.

28. Exclusions • Bylaws (Gross Earnings Forms) • Gross Earnings exclude delays cause by operation of bylaws. • If bylaws included in physical damage is also need in BI insured. • Bylaws can cause delays and prolong period of interruption. • Bylaws (Profits Forms) • Includes delay caused by the application of a bylaw but does not extend the period of indemnity beyond the time stated in the declarations. • Endorsement can be added to extend indemnity period • Premium Adjustment clause has no time restriction on period of indemnity.

29. Exclusions • Fines, Damages or Penalties (Profits and Gross Earnings Forms) • This exclusion is the only one Profits has in common with Gross Earnings. The following are excluded: • Fires, • Damages for breach of contract for late or non-completion of orders, • Penalties of any nature. • Interference (Gross Earnings forms) • Interference by strikers or others in the rebuilding, repair, replacement or resumption.

30. Exclusions • Suspension, Lapse or Cancellation (Gross Earnings Forms) • Loss of income resulting after the indemnity period from suspension, lapse, cancellation of a lease, license, contract, or order is excluded.

31. Leases • Amount of lease must be known to properly insure. • May be a requirement for the tenant to pay a percentage of the earnings derived from the business to the landlord (E.g. retail) • Landlord should insure against these lost earning in case of loss or tenant should have BII so these payments to the landlord could continue. • Does damage to the premises reduce or eliminate the rent until repaired? • Two types of lease clauses that affect this point: • Rent Abatement clause; • Fire clause.

32. Leases • Rent Abatement Clause • Provides that if the premises are wholly are partly untenantable by damage form specified causes, such as fire or explosion, the rent ceases or reduces in proportion to the extent the premise can not be used. • Not all leases contain this clause. • Ask client to check lease with lawyer as tenant could pay useless rent for years.

33. Leases • Fire Clause • Applies to damage by other causes (normally same one as rent abatement clause if any). • Concerned with serous damage that will take a long time to repair lease may be cancelled. • Landlord needs coverage as if lease is cancelled tenant is absolved from paying further rent and landlord will lose income.

34. Leases • Is the rent a bargain? • Ask client and obtain usual rental per square foot for different types of property (ask people in real estate). • Tenant may lose benefit of bargain long-term lease if lease is cancelled by landlord and may have to pay extra at other premises. • Leases are not standard • May contain special features – Check, how is insurance affected.

35. Rent Insurance • Insure rent’s as part of BII coverage. • If rent is the only or chief sources of income, rent insurance is usually sufficient (E.g. apartment block). • Separate rent insurance. There are two policies: • Gross Rentals • Rent and Rental Value • Gross Rentals follows the profits approach – providing coverage until result return to normal subject to a time limit (normally 12 months but can be adjusted).

36. Rent Insurance • Rent and Rental values follows the gross earnings approach – coverage stops when restoration has been completed (or could have been completed had diligence been used). • Gross rentals is preferable unless client is confident they can re-lease as soon as damage is made good. • Obtain quotations on each basis • Coinsurance is 100% for Gross Rentals but may be less for Rental and Rental Value • Rental Value refer to a situation where the premises of an owner/occupier are damaged and they have to rent elsewhere.

37. Leasehold Interest • Can be arranged to provide cover if the landlord cancels the lease. • Claims are settled by a cash payment which is discounted at a rate of interest stated in the policy because payment is made immediately instead of at intervals as the increased rent is payable. • Not cancellable except in a few situations specified in the policy. • Make sure client is aware of this.

38. Delayed Opening • Start-up date delayed because of damage during construction, expected earnings will not be achieved. • BII (profits or Gross Earnings basis) can be arranged based on projected earnings. • Same effect may result form damage at the premise of a major supplier and these risks can be insured. • Review if client has this exposure • Note: Delayed opening is the term used with Gross Earnings policy. The Profits term for the corresponding coverage is Advance Profits.

39. Selling Agent’s Commission • Coverage can be arranged that will pay commission lost by selling agents or manufacturer’s representatives because the manufacturer’s premises have been damaged and production interrupted. • Important where this constitutes a large part of their income.

40. Tuition Fees • Educational institutions stand to lose tuition fees if they cannot provide instruction. • Can lose fees for an entire year or more. • Schools have other sources of revenue in addition to tuition - insure proper coverage. • Profits form does not need much change since coverage is not limited to the time required for restoration of damage, but indemnity of 12 months may need attention.

41. Tuition Fees • To provide for the special needs of schools a Gross Earning policy can be modified as follows: • Coverage may be provided from the date of damage to the day before the beginning of the school year following restoration. • If the restoration is not completed 30 days before opening day, coverage extends to the day preceding the second school year after restoration. • The definition of gross earning must include not only fees, but also any items of additional income. • Universities have similar exposure but also more scattered campuses.

42. Questions??? www.poulingild.edublog.org