Business Income

Exam 1

Introduction

• Business income insurance covers the reduction to a business’s income when operations are interrupted by damage to property caused by a covered peril.

• Also referred to as “business interruption” insurance.

• Time element coverage.

Measurement of Business Income Losses

• Net income = Revenues - Expenses

• Business income insurance covers reduction in net income.

  • Expected net income (could be a net loss) minus actual net income.

• Expenses

  • Continuing and non-continuing expenses

  • Extra expenses

• Property and perils involved

  • Covered property/perils

  • Non-covered property/perils

Events that Could Cause a Business Income Loss

• Damage to property at the organization’s own premises.

• Damage to property away from the organization’s own premises.

  • Owned

  • Non-owned

Damage to Property at the Organization’s Own Premises

• Analyzing exposure to business income loss resulting from losses of your own property should be part of any comprehensive risk management program.

  • Usually done in connection with assessing property losses.

• Usually these are the easiest exposures to recognize.

Damage to Property Away from the Organization’s Own Premises

• Own property off premises

  • In-transit

  • With a bailee

• Dependent property exposures (contingent business income)

  • Supply chain (key suppliers/manufacturers)

  • Key buyers

  • Leader properties

  • May consider reducing dependency

• Interruption of utility services

• Acts of civil authority

• Adverse weather

Time Factors of Business Income Loss

Must also consider time elements:

• When do we expect business income to be reduced?

  • Important if there are seasonal variations in business income

• How long do we expect business income to be reduced?

How Long?

• Time required to replaced damaged property

• Time required to restore normal rate of income

  • Loss of customers

  • Loss of licenses, leases, market share, etc.

• Time required is not necessarily related to size of physical loss

  • Bottlenecks

  • Pollution

  • Information technology

• Time required affects continuing and non-continuing expenses

Measuring Business Income Severity

Most conservative approach is to assume a worst-case scenario business interruption. Assumptions for the estimated maximum loss (EML) include:

• Longest possible duration

• Worst time for loss

Calculation of EML

• The coinsurance basis (the exposed loss) provides starting point for EML estimation

• Adjustments to coinsurance basis:

  • Non-continuing expenses

  • Time required to restore property

  • Peak seasons

  • Extended business income loss

  • Changes in expenses/revenues during restoration period

  • Extra expenses

  • Anything else (e.g. potential errors)

Business Income Worksheet

• Purpose of business income worksheet

  • Calculate insurance limits necessary to comply with coinsurance condition of business income insurance

  • Reports business income values to insurers

  • Assists underwriters in accurately evaluating business income exposure

• Coinsurance basis:

  • Not EML

  • Business income exposure for 12 months (estimated loss for 12 months)

  • Net income plus most operating expenses (again, over 12 months after policy inception)

Adjustments to Coinsurance Basis

• Non-continuing expenses

• Maximum period of restoration

• Peak Periods

• Extended business income loss

• Changes in expenses/revenues during the restoration period

  • Do projections change?

• Extra Expenses

• Allowance for mistakes/errors/oversights

Coinsurance Percentage and Limit of Insurance

• Coinsurance percentages:

  • Coinsurance percentage options include: 50%, 60%, 70%, 80%, 90%, 100%, and 125%

  • As always, as coinsurance percentage increases, rates decrease

  • Appropriate coinsurance percentage = EML/(Coinsurance basis)

• Limit of Insurance

  • Choose higher of:

    • EML

    • Amount needed to satisfy coinsurance requirement (Coinsurance percent times coinsurance basis)

Business Income Coverage (BIC)

• BIC without extra expense

• BIC with extra expenses

  • Business income including rental value

  • Business income other than rental value

  • Rental value only

• Extra expense coverage form

BIC Insuring Agreement (I)

• Actual loss of income sustained

  • Net income that would have been earned

  • Continuing normal operating expenses

• Due to the necessary suspension of your operations

  • Includes partial or total disruptions

• During the period of restoration

  • For insurance purposes, usually starts 72 hours after loss (waiting period)

  • Ends when property should be replaced or when business is resumed at new permanent location

    • Does not allow for ordinance/law or pollution cleanup.

BIC Insuring Agreement (II)

• Caused by direct physical loss of or damage to property at the described premises

• Caused by a covered loss (use any of the Basic, Broad, Special cause of loss forms)

Extra Expense Coverage

• Necessary expenses the insured incurs during the period of restoration that would not have been incurred if there had been no physical loss caused by a covered peril.

• Three categories:

  • Extra expenses incurred to avoid or minimize the suspension of business and to continue operations (at or away from the premises)

  • Expenses incurred to minimize the suspension of business if operations cannot be continued

  • Expenses made to expedite repairs.

Civil Authority

• Extends BIC to include losses of business income incurred if access to the premises has been cut off by action of civil authority if:

  • A covered cause of loss caused damage to property not at insured premises

  • Access to the area immediately surrounding the damaged property is prohibited by action of civil authority.

  • Insured premises must be in the area (not further away than one mile (radius))

  • Action of civil authority must be due to dangerous physical conditions or to enable access by civil authority.

• 72 hour waiting period

Other Additional Coverages

• Expenses to Reduce Loss (for BIC without extra expense form)

  • Extra expense coverage

  • Covers extra expenses only to the extent that they reduce business income loss

• Alterations and new buildings

  • Not subject to 72 hour waiting period or 30 day limit (as in BPP)

• Extended business income (EBI)

  • Adds 60 days to period of restoration

  • Begins when operations are resumed

  • Extended Period of Indemnity option allow for further increases (up to two years)

Other Additional Coverage/Coverage Extension

• Additional Coverage:

  • Interruption of Computer Operations

    • $2,500 aggregate limit

• Coverage Extension:

  • Newly acquired locations

    • Must have 50% or more coinsurance

    • $100k limit per location (in addition to limits)

Conditions

• Duties in the event of loss

  • Similar to BPP

  • Also must resume operations as “quickly as possible”

• Loss determination (factors)

  • Insured’s net income before the loss

  • Likely net income if no loss occurred

  • Operating expenses (including payroll) necessary to resume operations

  • Other relevant financial information

  • Determine extra expense (for Extra Expense form)

  • Salvage value

• Coinsurance

Coinsurance Options

• Maximum Period of Indemnity

  • Removes coinsurance clause

  • Pays business income loss up to 120 days

  • Higher insurance rates

• Monthly Limit of Indemnity

  • Removes coinsurance clause

  • Choose “limit fraction” (1/3 , 1/4, or 1/6)

  • Pays business income loss subject to 30 day limit of “limit fraction” times limit

• Agreed Value

  • Suspends coinsurance

  • 10% rate increase (as compared to 5% for BPP)

• No Coinsurance

Endorsements (I)

• Blanket Business Income Insurance

  • Good for interdependent locations

  • Locations must be owned

  • No minimum coinsurance

• Payroll coverage endorsements

  • BIC includes payroll expenses necessary to resume operations

  • Ordinary Payroll Limitation or Exclusion endorsement

    • Can limit payroll to 90 or 180 days or fully exclude

  • Discretionary Payroll Expense Endorsement

• Power, Heat, and Refrigeration Deduction Endorsement

  • Allows manufacturers to exclude these expenses in coinsurance calculation

Endorsements (II)

• Utility Services–Time Element endorsement

  • Extends property utility services endorsement to include business income loss

• Ordinance or Law–Increased Period of Restoration endorsement

  • Allows for length of interruption and/or restoration to include time needed to comply with ordinances

• Food Contamination Endorsement

Dependent Property Endorsements

• Endorsements for dependent property exposures

  • Business Income From Dependent Properties–Broad Form

  • Business Income From Dependent Properties–Limited Form

  • Extra Expense From Dependent Properties

  • Can choose between contributing locations, recipient locations, manufacturing locations, or leader locations

  • International coverage

    • Business Income From Dependent Properties Limited International Coverage

    • Extra Expense From Dependent Properties Limited International Coverage

Educational Institutions Endorsement

• Business Income Changes–Educational Institutions endorsement

• Period of restoration

  • Changed to end at the earlier of: day before opening of the next school term or date when school term is resumed at a permanent new location

• Extended business income

  • If damaged property is repaired, rebuilt, or replaced within 60 days (or less) of the next school term, policy covers losses during the entire school term

  • Extension of Recovery Period can extend business income loss coverage to twelve months after period of restoration

• Can limit coverage to operations that generate tuition or fees

Extra Expense (only) Coverage Form

• Limits on loss payment

  • Popular limiting combination is 40%-80%-100%

• Determining the extra expense limit

  • Often hard to do/no general rule of thumb

  • Must consider limiting percentages