Business Interruption Insurance: A Lifeline for Your Company
Most businesses have property insurance in place to protect themselves against severe losses from events like fires and explosions. However, the income lost during a shutdown after a loss can be even more devastating. Without business interruption insurance, the organization may suffer a blow from which it will be difficult to recover.
Business interruption coverage applies under four conditions:
- The named insured organization must suffer an actual loss of business income for a certain period of time;
- The loss of income must result because the organization had to suspend operations;
- The suspension must result directly from loss of or damage to the organization's premises;
- The loss or damage must be caused by a factor the policy covers, such as fire, lightning, or windstorm.
The term "business income" does not necessarily mean "profits." Rather, it means net income (profit or loss before income tax) that the firm would have earned, plus continuing normal operating expenses. The insurance will not provide profits for a business that was on track to lose money. If the firm was expecting a $100,000 loss and continuing expenses (including payroll) of $150,000, the most the policy will pay is $50,000 ($150,000 expenses less $100,000 loss).
To calculate the amount of the loss, the insurance company will look at the firm's most recent financial statements. It will separate costs into two categories:
- Fixed costs, such as debt payments, permits, and salaries;
- Costs directly tied to sales, such as the cost of producing goods not yet produced.
Expected profit or loss plus costs that must continue during the shutdown equals the actual loss sustained. The amount of time the insurance company will pay for may not be the same as the actual length of the shutdown. The company will pay for business income lost during the "period of restoration."
This period starts 72 hours after the damage occurs to the premises. It ends on the earlier of:
- The date the damaged property should be repaired, rebuilt or replaced with reasonable speed and similar quality, or
- The date when business resumes at a new permanent location.
The insurer will be reluctant to pay for the entire business income loss if it determines that the shutdown should have ended earlier. For example, if factors within the business's control delayed re-opening or if the business could have taken steps to shorten the shutdown, the insurer will reduce the amount it will pay.
The insurer will cover some of the business's costs to reduce the amount of lost income. However, the expenses must actually reduce the amount of the loss. For example, if the business can resume operations two months sooner by renting a building that carries a higher rent, the insurance will make up the difference between the old rent and the new. The insurer will not cover costs that exceed the amount of income the business would have lost.
Business owners should discuss this important coverage with their insurance agents. The right coverage may be the difference between surviving and shutting down permanently.