How Business Interruption Insurance Works
An overview of all BI forms: (including Profits, Rental Income & Extra Expense)
Intangible: Unlike Property Damage Insurance, where material or “tangible” property is insured (such as buildings, equipment, office contents, stock etc.), Business Interruption, (or Loss of Income) Insurance insures an “intangible” products like future expenses and future income.
What is insured? Business Interruption Insurance begins where Property Damage Insurance ends, covering the loss of earnings attributed to a disaster. While operations are completely, or partially, stopped during the replacement or rebuilding of the property. This coverage assures the business of funds to help return it to the financial position it would have been in if no loss had occurred.
Business Interruption reimburses a business owner for lost profits and continuing fixed expenses during the time that the business must stay closed while the premises are being repaired following an insured loss, such as a fire.
What are continuing expenses? Mortgage payments, taxes, utility bills, phone bills, accounting and legal expenses, the cost of advertising, interest on loans, salaries of executives, other key employees, and even the cost of insurance.
**Ordinary payroll can be included as well, this is a judgment call on your part as to how long you would carry your employees if your business was unable to operate - as it could take months to rebuild or replace damaged property. You have to determine if you want to include the cost of ordinary payroll during this time of unemployment. Profits form - determine who is key and who is ordinary and payroll coverage starts at 90 days. In Alberta where employees are difficult to hire we recommend giving consideration to all employees being key and insuring your full payroll limit.Actual loss sustained includes payroll not exceeding 90 consecutive days following the date of loss. (If more than 90 days coverage is required this should be reviewed by your Armour Insurance professional)
How does coinsurance affect the profits limit? Profits is subject to a 100% coinsurance clause, therefore it is critical that the value insured be adequate to avoid a coinsurance penalty being applied. As advised, we always recommend the Profits Worksheet be completed by a chartered accountant, who is versed in completing such forms. The accountant will complete the form based on your prior, current and interim financial statements and will make a liberal estimate of your future “Gross Profit” to ensure the sum insured is enough to pay losses at least two years from the policy inception.
Why is the profits value trended 2 years into the future? The coinsurance clause is calculated when the loss occurs. As a rule of thumb, calculations estimate the company’s revenue 24 months into the future to ensure the business is insured to value and will not be subject to a coinsurance penalty. A worst case scenario is the loss occurs on the 364th day of the policy. The limit carried on that day is compared to the profits level of the company on that day. If the accountant has done the worksheet correctly, the value insured will be sufficient to provide indemnity for up to 12 months after the loss. It is recommended that a liberal estimate of your future Gross Profit is made. Co-insurance and indemnity are based on the period subsequent to the date of loss. In choosing your limits we recommend working with an accountant familiar with these forms. A quick way to look at your coverage limit is Sales less cost of sales.
PROFITS (BUSINESS INTERRUPTION) COVERAGE
Commercial coverage that reimburses a business owner for lost profits and continuing fixed expenses during the time that a business must stay closed while the premises are being restored because of physical damage from a covered peril, such as a fire.
Business interruption insurance also may cover financial losses that may occur if civil authorities limit access to an area after a disaster and their actions prevent customers from reaching the business premises. Depending on the policy, civil authorities coverage may start after a waiting period and last for two or more weeks.
EARNINGS (BUSINESS INTERRUPTION) COVERAGE
This form of insurance provides loss of income coverage (i.e., "disability income") for your business by replacing your operating income during the period when damage to the premises or other property prevents income from being earned.
It is by means of your operating income that your business meets its expenses of payroll, light, heat, advertising, telephone service, etc., and from which your profit is derived. If you suffer a business interruption and have to close for several months or operate at a reduced pace because of fire or other perils covered by your Earnings insurance, this income will cease or be reduced.
For the purpose of this insurance coverage, "earnings" are defined as the actual loss sustained by the insured as a direct result of business interruption necessitated by damage or destruction of real or personal property. The damage or loss must be caused by the insured perils.
Furthermore, "business income" is defined as the sum of total net profit, payroll expense, taxes, interest, rents, and all other operating expenses earned by the business.
The amount of coverage your Earnings insurance provides is established on the basis of either amount of insurance or actual loss sustained for each 30-day period of necessary business interruption caused by damage or loss from covered perils. There are several ways to set up Business Interruption depending upon your particular business. Monthly limitations, coinsurance, maximum time period to be paid, etc.
In addition to Earnings insurance, it is also advisable to carry Extra Expense insurance (see below).
EXTRA EXPENSE COVERAGE
This can be a stand-alone coverage OR purchased in addition to another business interruption insurance.
What does this insure? Following an insured loss to your building it may be necessary for you to secure other quarters to continue your business operations (at least to some degree). This coverage pays for expenditures over and above your “normal monthly expenses” necessary to allow you to continue your business as promptly and efficiently as possible (on an emergency or temporary basis) following disaster, until your premises are restored.
Examples: Rent of a temporary office location – or rent of an entire unit similar to your existing facility; the cost to rent temporary office equipment, phones, computers etc., the cost of overtime paid to employees to re-create accounts receivables/payables or other critical operating data or other extra operating costs incurred in one form or another necessary to continue your operation to some degree and help to minimize your loss.
EXTRA EXPENSE COVERAGE
If your building becomes empty of tenants because of any insured peril, it would probably be necessary to secure other quarters to continue your business operations.
The use of such buildings would require many extra expenses, such as rent, installation of telephones, etc. Extra Expense insurance covers such expenditures over and above your normal monthly expenses.
The amount of insurance is limited to 40% when the period of restoration is not in excess of 1 month.
70% when the period of restoration is in excess of 1 month but not 2 months.
90% when the period of restoration is in excess of 2 month but not 3 months.
100% when the period of restoration is in excess of 3 months but not 4 months.
RENT COVERAGE (LOSS OF RENTAL INCOME)
This insurance coverage protects building owners against loss of income when rentals have been interrupted or rental value has been impaired by the occurrence of any of the insured perils.
This is Business Interruption insurance for the landlord. It assures continuous income while an insured building is empty.
After a loss to assist in settling your claim we recommend setting up a new accounting code for all receipts related to increased costs due to the claim. This will make assessment of the loss easier to quantify. Items that you are not sure of should be put into this account - it is easier to delete items from the account that trying to find items that should be added later on.
After a loss you will likely be asked for the following to help quantify the loss:
- Financial statement for the last fiscal year prior to the loss
- Monthly Sales Journal for two years prior to the loss and for the loss period
- GST remittance forms for two years prior to the loss and for the loss period
- Bank statements for two years prior to the loss if not GST registered
- Lease agreement for insured premises
- Payroll Journal for two months prior to the loss and the loss period
Expert advice. We will make recommendation and suggestions based on your needs. One size does not fit all and at Armour we work to find the perfect fit for your insurance needs. Whether you own, rent, have a payroll, or leasehold improvements we will work with you to on ways to address each hazard.
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