Remmie Butchko, CIC
Georgetown Insurance Service, Inc.
Silver Spring, MD
When it comes to building an effective business insurance program, a very important consideration is the determination of Business Interruption (BI) Insurance, also commonly known as Business Income and Extra Expense Coverage.
Determining an adequate limit of insurance for BI is exceptionally challenging because it is intangible—there are many unknowns and assumptions that need to be considered in the process. It is difficult enough to determine how much insurance on tangible assets is enough. For example, how much will it cost to reconstruct a building? With BI insurance, the questions relate to how long a catastrophe would keep the business down, what the financial consequences would be, and how much money it would require to restore operations to the level of functionality prior to a major loss.
Let’s outline an example to help illustrate some of the areas of consideration. Assume the business is a manufacturer with annual sales of $12,000,000, or $1,000,000 per month. While there are far too many variables to address in a brief summary, some areas of difficulty and oversight commonly include:
Period of Restoration (Extended Business Income)
Suppose that after deliberation, it is been determined that approximately 6-months will be required to rebuild and re-equip the facility following a major loss (fire, explosion, tornado, etc.). Six months would equate to a total of $6,000,000 of BI coverage in order to replace the lost revenue.
But then the question remains; how long will it take to restore production to the $12,000,000 level it was running prior to the loss? This is called the Period of Restoration. The business’s income could remain impaired for many weeks—or even months—before it restores to its level prior to the loss. The amount of impaired income over the restoration period is an important consideration in choosing an adequate limit of BI insurance.
The continuation of payroll needs is another aspect to consider when determining adequate BI insurance coverage limits.
If a business is shut down, it is unrealistic to think that the current staff will simply wait around for the business to re-open before seeking another form of employment. In order to help ensure that existing trained and experienced employees are still around once the business is ready to resume operations, these employees must continue to receive pay.
There is a variety of methods to address these “ordinary payroll” needs from an insurance standpoint. Depending on a business’s needs, payroll can be: (a) fully included in the BI limit of insurance, (b) included for a limited period of time (commonly 120 days), or (c) excluded altogether if payroll expense is not a major concern. Obviously, the more money that is needed to continue the current payroll expense, the higher the BI limit of insurance will need to be as well.
It isn’t uncommon for businesses to have seasonal peaks and valleys in their revenue. Unfortunately, it is impossible to forecast when a loss might occur in the course of a business’s annual cycle.
If a business has seasonality, this should be factored into the structure of the BI insurance limit. If there is a predictable seasonal cycle, higher limits of insurance should be procured for the months having typically higher revenue.
This can be done by either: (a) selecting a higher dollar amount of coverage during the busier months, or (b) selecting a higher percentage of increased income coverage during peak seasonal months. For example, if a business averages $1,000,000 per month, but runs $1,500,000 for several months during peak season, the limit of insurance could be an additional $500,000 per month or include 50 percent peak season coverage.
Failure to procure adequate BI insurance can be as deadly to a business as failure to adequately insure the tangible business assets. It isn’t unusual for businesses to ultimately fail following a major loss for being underinsured (or uninsured, altogether) for lost revenue and ongoing expenses.
Often there is enough insurance money for the building to be rebuilt, the machinery and stock to be replenished, and the office to be re-equipped, but there simply is not enough cash readily available for the business to weather the storm of lost revenue and continued expenses.
The intention of these points is not to make insurance even more confusing than it already can be. The intention is to prevent businesses from thinking that they are “fully insured” only to discover in the aftermath of a catastrophe that they, in fact, were not.
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