When a building or critical piece of equipment is damaged, many times the expense of lost business is even greater than the expense of repairs. Orders go unfilled, routine customers purchase elsewhere while you rebuild, and all the while additional expenses crop up that are not otherwise covered. These extra expenses may be a need to rent temporary office space, to pay double to expedite an order on a special piece of replacement equipment, or to retain key employees during the outage. Business income coverage protects against these risks and is available for income-producing buildings, equipment, and even vehicles. The reduction of net income and increase in extra expenses after a disaster are the reason why FEMA reports that twenty-five percent of businesses that experience a catastrophic loss never reopen.
However, this risk is not unique, but common to all businesses. Business income insurance with extra expense pays for:
- Lost net income (bottom line profit, including from lost customers),
- Necessary continuing expenses (key employee salaries, debt payments, etc.), and
- Extra expenses that would not have been otherwise incurred (rental of temporary space, storage fees, overtime, etc.)
Business Income Coverage Methods
Below are the most popular methods of protecting against lost business income. However, each one answers the same two questions, just in different manners. If damage occurs and the business is stalled, 1) how much money will be lost and, 2) how is that loss spread over time? With current supply chain challenges, labor shortages, and high inflation, clients must understand that losses today will be higher than in the past and repairs will take longer. Insurance policy limits must be adjusted to compensate or not only will coverage be inadequate, but co-insurance penalties may apply.
Monthly Limit
A monthly limit option for business income coverage is a simplified approach. The client selects a desired insurance limit and the amount of time for it to be available. This limit is split evenly over the period selected. Time period options are three, four, and six months which are termed 1/3, 1/4, and 1/6 monthly limits on the policy, respectively. Payment is provided one month at a time and there is no carryover from month to month for unused portions. This method is usually more expensive than coinsurance (see below), but no coinsurance penalty applies. Thus, this is a great option if a client simply needs to receive a specific amount of money over a limited time period in the event a claim puts them temporarily out of business. This method should not be chosen if coverage is needed to be front-loaded or back-loaded, nor if income loss will last more than six months.
Example: A restaurant estimates that if they lost their building, they would be out of business for 4 months and would lose $10,000 of business income plus extra expenses per month. Thus, the total loss would be $40,000. The proper way to insure using a monthly limit option would be $40,000 at 1/4 monthly.
Maximum Period of Indemnity
A maximum period of indemnity option for business income coverage is available for time periods up to 120 days (four months). Thus, this method is not good if the business income stream cannot be restored quickly. Coverage stops once business income is restored, even if less than 120 days. The main benefit of this method over a monthly limit option is that it does not provide a per-month cap. Thus, if expenses are front-loaded, this coverage is flexible enough to adjust. It usually costs more than 1/4 business income monthly limit. Coinsurance penalties do not apply.
Example: A restaurant estimates that if they lost their building, they would be out of business for 4 months and would lose $20,000 month 1, then $10,000 per month for the remaining 3 months. Thus, the total loss would be $50,000. The proper way to insure using a maximum period of indemnity would be $50,000.
Co-insurance
Protection under the coinsurance option for business income coverage, unlike the previous two methods, does not stop after a specified time following a claim. If a claim occurs while the policy is in affect, the resulting loss of income can occur over months or even years. Instead, coverage stops once repairs can be made. As the name suggests, this option is subject to coinsurance and thus penalties can apply if adequate coverage levels are not maintained. Because this method gives the insurance company good insight into coverage needs, it can be the least expensive of all options. Even so, we suggest requesting a quote for this option along with actual loss sustained (below) for comparison.
Example 1: A restaurant estimates that if they lost their building, they would be out of business for nine and a half months (approximately 80% of a year) and would incur a loss of $100,000 of business income and extra expense during that time. The proper way to insure using a coinsurance option would be at $100,000 with 80% coinsurance.
Example 2: A restaurant estimates that if they lost their building, they would be out of business for fifteen months (approximately 125% of a year) and would incur a loss of $200,000 of business income and extra expense during that time. The proper way to insure using a coinsurance option would be at $200,000 with 125% coinsurance.
The above examples are simplified for clarity and the coinsurance option for business income coverage can be nuanced, so we recommend you discuss it with your insurance agent. Coinsurance penalties are calculated in a similar manner, whether applied to buildings, contents, business income, equipment, or vehicles. Reference Coinsurance Explained for more information on this topic.
Actual Loss Sustained (ALS)
The actual loss sustained option for business income coverage is the easiest method to understand. It pays for all business income and extra expense loss without specifying limits. Coverage is available for twelve months, but some insurance companies offer options of eighteen or twenty-four months. It contains certain restrictions for extra expenses, such as dependent properties, so consider it carefully. The cost for this protection can vary, so request a quote to know how it compares to other methods.
Agreed Value
An often overlooked option for business income coverage is agreed value. This option is calculated in a similar manner as coinsurance explained above, and even states a coinsurance percentage in the policy. It requires financial information for the prior twelve months be submitted each year, along with projections for the future twelve months. The insurance company and the client then agree upon the level of coverage needed and the insurance company waives the coinsurance requirement. Thus, if a claim occurs, the limit stated on the policy is the amount of coverage the client has available – simple as that. No coinsurance penalties apply, hence the name “agreed value”. However, if financial information is not resubmitted at the renewal of the policy, coverage will default to the coinsurance option. This is a great choice for businesses with special business income needs, or for those that like the assurance an agreed value provides.
For each of the options above, coverage stops once repairs can be made given reasonable effort. However, business income coverage can be extended to allow for operations to ramp back up and resume normal levels. To do so, an Extended Period of Indemnity must be purchased. This allows up to sixty extra days for the business to recover, but more can be purchased.
Resources
Use the below two tools to help determine how much business income insurance coverage is needed and which methods are available.
Business Income Insurance and Extra Expense Calculator, Simple
Business Income Insurance and Extra Expense Calculator, Thorough
Questions on business income insurance? Contact your Bankers Insurance agent. Not a client of ours? Let us compete for your business! Each client is assigned a personal agent in our office, given their email address, and provided a phone number that rings right on their desk.
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