Business Income Insurance

By Norbert Schechter

All too often, business owners rely on their insurance broker as a risk manager, paying premiums with little understanding of how indemnity coverage relates to their particular needs. Reading the language in the policy is an essential first step. The insured is often aware of the need to insure its asset replacement value, which covers real and personal property, but has little understanding of business income (BI) indemnity for asset loss resulting from peril.

BI insurance is intended to compensate the insured for income lost during the “period of restoration,” a defined term during which BI coverage applies. It begins when the direct physical damage occurs and ends on the earlier of the date that the damaged property should be repaired, rebuilt, or replaced, or at such time as stipulated in the policy declarations.

The principle of BI insurance is to put the insured in the position she would have been had the peril not occurred. Without specific endorsements, physical damage to the insured’s property must occur for properties listed in the declarations. BI insurance pays for the anticipated net profit and ongoing expenses during the period of restoration. While the standard BI policy limits the period of restoration to 30 days, this period can be extended to 360 days by endorsement.

The concept of underinsurance with respect to real and personal property is self-evident. Not so with BI insurance. A business purchases BI coverage by completing a worksheet forecasting net income and expenses for the future period and selecting the amount of BI required for the anticipated period of restoration (the maximum indemnity period). Deductibles are an option. Unfortunately, hindsight can prove the business owner’s selection unsatisfactory. To avoid the coinsurance trap, policies can be written with reporting forms or agreed value. With the use of reporting forms, premiums can be returned
at year-end, avoiding payment for overinsurance.

A BI policy pays for only the “actual loss of business income sustained” during the period of restoration. A restaurant was denied BI payment because none of the continuing expenses had been “earned” prior to the fire; the fire served to reduce continuing losses. A men’s retail clothing chain that shifted inventories from other stores was found by a court not to have sustained BI losses.

The standard BI policy will pay for restoration expenses only if they reduce loss; the contract will not cover additional expenses. A rider for extra expense coverage will pay for restored telephone service, substitute space, the expense of moving, additional advertising, purchase or rentals of computers, and more.

Special exclusions for BI policies include power failures that occur outside covered buildings, losses arising from direct physical damage to radio or television antennas, and interruption of computer operations. If a computer crash causes suspension of operations, the additional coverage endorsement provides for payment of up to $2,500. This limited payment is restricted to any one policy year for all losses sustained and expenses incurred, but not beyond the period of restoration. Additional endorsements can be purchased to insure these exclusions.

What are the consequences in the event civil authority requires discontinuance of operations for buildings that are left undamaged? Standard indemnity policies provide coverage limited to loss of BI for periods extending to three weeks should ingress to premises be denied. A recent case, 54th Street Partners L.P. v Fidelity Guarantee Ins. [Co. App. Div. (June 10, 2003)], resulted in a decision unfavorable to the plaintiff. Although the street where the restaurant was located was closed to vehicular traffic for a full two weeks, access to pedestrian traffic was reopened after two days. The court ruled that access to the restaurant had not been denied after the restriction for pedestrian traffic was lifted.

The calamity at the World Trade Center illustrates the issue. ABM Industries was responsible for the cleaning and maintenance of 97% of the World Trade Center. ABM claimed BI indemnity for damage to real and personal property, including property owned, controlled, used, or intended for use by ABM. The United States District Court, Southern District of New York, opined: “ABM cannot recover under the Policy for any business interruption loss as a result of the destruction of the World Trade Center premises it served but did not otherwise occupy.” ABM had paid its insurer an annual premium of $224,591, which included coverage for extra expense, off-premises utilities, civil authority, and leader locations. Leader locations are those that attract customers to the insured’s business.

Unfortunately for ABM, endorsement coverage did not include dependent properties, formally known as contingent BI insurance. Dependent property coverage expands BI coverage to the following circumstances:

• Key suppliers that cannot produce goods or services on which the business depends;
• Key customers that cannot receive the business’s goods or services; and
• Manufacturers that cannot provide products for delivery to customers under contracts for sale.

ABM almost certainly understood the errors and omissions coverage carried by the broker. One can only speculate as to how the lack of time-element coverage affected proximate businesses.

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