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Business Interruption Insurance
Hurricane Katrina may prove to be most costly natural catastrophe in U.S. history. Estimates of economic losses continue to climb and insured losses will be in the billions of dollars — probably over twenty billion dollars if the insured losses from Hurricane Andrew are any guide.
Perhaps the greatest challenge to companies will be how to survive given that they will be out of operation for months. Luckily, many businesses had the foresight to take out business interruption insurance, which should replace their operating income for the period that they can't operate. If history is any judge, however, the insurance companies will deny many legitimate claims and will attempt to limit the payout on the claims that it honors. Unfortunately, many businesses will have to sue their insurers to force them to pay full and fair compensation for their business losses.
This paper addresses the basics of business interruption insurance and the various policy provisions and issues that need to be considered when evaluating a possible business interruption claim.
I. Overview
Business Interruption Insurance ("BII") provides coverage for income you lose as a result of an interruption in business due to the physical damage of certain covered property. Stated more simply, BII is designed to cover actual loss of income due to loss of physical property.
"Business income" losses include interruption of utility services, the inability of customers or vendors to reach retailers or distributors, and even damage suffered by a critical supplier or customer. Are these losses covered? It depends on your policy. A policy covering property damage loss will not necessarily cover a business income loss. Your commercial property policy must specifically include a BII endorsement. If it does, then the first major hurdle is overcome. However, BII provisions can be complex and business owners often underestimate the scope and extent of the coverage of the BII.
Moreover, courts generally interpret insurance contracts according to the law of the state in which they were executed. As such, the effect of certain provision can sometimes vary significantly from state to state.
II. General BII Coverage
Basic BII provisions are simple in theory. As always, however, the devil is in the details. The evaluation of a potential business interruption loss can broadly be broken into three questions: (1) Has there been a business interruption? (2) Was the interruption caused by physical damage to specifically covered property? (3) What is the compensable loss?
A. Has there been a business interruption?
The importance of this first threshold question is often overlooked. If you have simply experienced a slow-down in your business, even if it is related to physical property damage, your insurer will likely challenge your claim. Depending on the wording of the provision, some States' laws interpret "business interruption" to mean a complete cessation of business operations. Others, however, do not adhere to such a strict interpretation of the policy language, allowing coverage for "partial shut-downs" of operations.
The distinction between a "slow-down" and a "partial shut-down" is a nuance that, if applicable at all, will necessarily turn on the particular facts of your situation and the law governing your policy.
Another twist in thinking about this question is the fact that most States' laws impose a duty on a business owner to mitigate his or her damages. However, if you are in a state that allows coverage for partial shut-downs, your attempts at mitigating your business losses may well impede your ability to receive compensation for your loss.
B. Was the interruption caused by physical damage to specifically covered property?
BII provisions do not cover income losses resulting from physical damage to just any
property you own. Instead, the damage has to be to property that is specifically listed or referenced in the policy. This is generally a straight-forward issue, however, there are circumstances that add complexity.
One common scenario is that of a business owner having two or more business locations that are separately insured, or perhaps where one of the locations is uninsured. If a business interruption occurs at one location because of damage to property at another location, will the interruption be covered? Probably not under a basic BII plan, but the terms of the policy will govern. The common BII provision is usually tied only to the property named in the policy. However, as discussed below, you may have an additional level of BII coverage for this circumstance.
Most States construe BII provisions strictly since it is assumed that both parties to the insurance contract are fairly sophisticated. However, if the terms of the policy are ambiguous, the presumption is generally in favor of coverage.
C. What is the amount of the compensable loss?
Once you have established your entitlement to BII coverage in a particular circumstance, the amount of the payment to which you are entitled is obviously going to be the foremost issue in your mind. Answering that question, however, can be the most challenging part of your claim. The amount of coverage your policy provides is probably not going to be unlimited, so the analysis will start within the framework of your policy limits.
Unfortunately, the simple truth is that while you will want to maximize your recovery under the policy, your insurer will want to stay as far below the policy limits as he or she can. Of course, both of you will have to justify your positions with documentary support. However, even with solid evidence, there are still a myriad of issues that arise at this phase of a BII claim.
For example, does your policy entitle you to recover lost earnings or lost net profits? Most seem to focus on earnings, but you still need to know how that term is defined in your policy.
You will also need to know the starting point for calculating your lost earnings. Is it the date that Hurricane Katrina devastated your business. Perhaps, if your business income is immediately affected by the damage. However, consider the scenario where you have two weeks worth of inventory stored at a location different from where you manufacture your product. If your manufacturing plant is shut down for three weeks as a result of an explosion, you may not see a business income loss until two weeks after the event when your inventory has been depleted without being replaced.
Continuing with this hypothetical, what would be the end date of your business interruption? Would it be the day that your manufacturing plant comes back on line? Obviously it depends on how quickly you can regenerate your inventory. If it takes two weeks to manufacture your product, you will continue to suffer a loss of income even though the causal property damage has been repaired.
Lastly, the seemingly simple act of proving the amount of your business loss can often be complex. If you are a well-established business with a well-documented income stream, you will likely have less of a problem quantifying your loss. However, many new businesses have little or no history of earnings, making this exercise much more challenging. In either event, you will want to be armed with as many supporting documents and as much relevant data as you can muster.
III. Additional Coverages
Having examined the operation and limitations of basic BII provisions, a brief discussion of additional coverages that may be included in your policy is warranted. These supplemental provisions, if available, may operate to fill some of the holes that often exist in basic BII plans.
A. Contingent Business Interruption
This coverage extension is intended to insure loss of income you may incur as a result of a property loss by a critical supplier or customer. For example, if a key supplier experiences a flood at its plant and is unable to deliver parts or goods necessary for the continuation of your business, you may have a claim for a contingent business interruption loss.
B. Utilities/Services Interruption
If you suffer a business loss due to property damage at the facility of one of your utilities providers (e.g. electric, water, gas, sewer, telephone, etc.), this additional coverage may protect you. One of the more often cited examples is the spoiling of food at a restaurant that experiences a power outage due to physical damage suffered by the power plant. Such provisions are often written broadly enough to cover more than just public utilities. As usual, however, the precise scope of the coverage will be governed by the terms of the policy.
C. Interruption by Civil or Military Authority
This type of additional coverage protects against business losses that occur when you are denied full access to your property by civil or military authority because of some event such as a natural disaster, act of terrorism or other local, state or national emergency.
D. Ingress/Egress
Ingress/egress coverage protects against business losses suffered when, as a result of some damaging event, you, your customers and/or your suppliers cannot reach your business. This coverage is similar to the Interruption by Civil or Military Authority provisions, but does not require an authoritative order to initiate the restricted access to your business. Instead, the restriction is often caused, for example, by events such as the blockage of a tunnel or a bridge. Of course, it goes without saying that such a blockage would have to be fairly severe and of a duration sufficient to cause a business loss.
E. Extra Expense Insurance
This important additional coverage provides protection from the additional expenses you may incur if you need to relocate your business as a result of property damage. If your facility is flooded, for example, and you need to rent space in another location to continue your operations, this provision, if available, should cover you. Extra expense insurance also generally applies to the purchase, rental and/or installation of substitute office equipment, telephone lines, etc.
F. Extended Period of Indemnity
Your basic BII policy may not reimburse you for losses that occur after your business has re-opened, even though, as discussed above in § II. C, you may continue to suffer financial losses past that point. Extended Period of Indemnity provisions are designed to address that situation. Depending on the policy terms, these provisions often provide you extra protection for sixty to ninety days past the end date of your basic plan.
IV. A Few Other Things to Consider
A. Co-insurance Clauses
Most policies are subject to co-insurance, but it can be waived if the amount of coverage that you're buying is sufficient. Co-insurance clauses can create penalties if you are not insured to an adequate value at the time of a loss. Suppose you own a building that is valued at $1 million. If you have a co-insurance value of 90%, that means you must insure the building for at least 90% of its value, or $900,000, in order to collect on any loss in full. If you only insure the building for $450,000 -half of the required co-insurance amount - then you can only collect on half of any loss. So if you had a loss of $10,000, and had only insured the building for $450,000, then you could only collect $5000--half of the total loss amount--since you had only insured the building for 50% of the co-insurance requirement.
B. Limitations on How Claims are Paid Out
Read the fine print on your policy and screen carefully for any mention of limitations on how your claim will be paid out. If you experience significant losses, you're probably going to need to get as much of your claim in hand, as soon as possible. But some policies specify a schedule of payments such that you only get a small percentage of the full amount up front. For example, there may be a payout schedule where you only get 40% of the payment the first month, 40% the second month, and 20% the third month.
C. Waiting Periods
Examine your policy for any "waiting period" that applies to business income losses. Waiting periods are fairly common, and can last from a few hours to a few days — or more. That means that any losses incurred during the period of time directly following an event will not be covered. Sometimes, you can exchange waiting periods in your policy for a fixed deductible. If you have a dollar deductible instead of a waiting period, you won't be covered for the first losses up to that amount, but will immediately be covered in full for any amount above the deductible.
CONCLUSION
Business owners with business interruptions need to aggressively pursue the insurance payments to which they are entitled. Do not accept a denial of BII and do not accept underpayment of your issues.
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