Tag Archives: business income

Business Income: The Dreaded Coverage

Why do I say business income is “the dreaded coverage?” Based on my years teaching and decades of E&O audits, business income is the commercial coverage I have most often seen producers shirk. Many do not even try to sell it, or at least they do not try beyond whatever the throw-in coverage is. Yet business income is one of the most important commercial coverages. This combination of importance and silence equals a wicked E&O exposure.

Why do producers dread bringing business income to the attention of clients? In my experience, many producers do not know the coverage adequately. Others know it but dread the worksheet. Others know the coverage but are uncomfortable discussing it because they do not know how to discuss business income with clients. Business income is not an easy coverage.

The fact it is not an easy coverage is not an excuse to not discuss business income, much less should it be an excuse for not emphasizing to clients the need to purchase the coverage and to customize it to fit each client’s needs. And just because some companies have “Bopped” it does not mean a producer need not discuss the particulars. Avoiding the particulars is just being lazy or scared.

See also: Digital Solution for Income Protection

One of the main dreadful issues is the worksheet. A key practical reason no one likes dealing with business income is that worksheet. It seems almost everyone thinks the worksheet has to be addressed first. I’ve been told that many coverage instructors even state that. But focusing on the worksheet first is plainly bassackward. The coverage provisions need to be addressed first because, if a producer does not know an insured’s business income exposures, a producer cannot calculate the required limit.

Knowing the client’s exposures first also requires addressing the various time limits. The time limits are essential to addressing business income correctly.

Another factor is the need, availability and possible gaps. For example, if the cause of loss is a flood, the insured still has a business income loss, but if the business did not suffer physical damage from the flood, it may not have any coverage if the producer did not identify this potential and associated gap. Gaps equal E&O exposures. An agent can advise that the gap exists or can find a coverage solution. Many specialty business income gap products exist through specialized providers and almost never on standard forms. I find few producers know these gap products exist, which may be because so few are standard forms and most CE instructors stick to standard forms.

In particular, the civil authority gap is of special importance. The civil authority gap is further divided into specific types of civil authority actions, but a simple example will suffice here. An insured has a business income loss due to mandatory evacuation, but the business suffers no damage from any of the covered perils. From an insured’s perspective, they have a loss, and they want it covered.

Another cause of business income dread is not understanding how the limits versus claims settlement is made. Regardless of the worksheet, when a claim is submitted it has to be supported by the insured’s documentation. A simple example is the contractor who has a liberal interpretation of the tax code. He pays little in taxes because his deductions are high or because maybe he does not see the need to report all his revenue. Then he files a business income claim for the legitimate amount, but his documentation does not support that amount. The documentation supports a much lower loss. This is indeed a dreadful situation.

See also: The Case for a Hybrid Business Model  

The goal or premise of P&C insurance is to return the insured to the same balance sheet financial position the business was in the moment prior to the loss. To meet this promise, agents must improve their knowledge of business income in general and the options available, and their ability to communicate the associated complexities effectively to insureds.

To learn more, visit www.burandeducation.com/niche-program-business-income.

Checklist to Prepare for Business Interruption

Business interruption (BI) losses are among the most confusing types of claims in the insurance industry. As claim specialists, we are often asked for a “checklist” filled with action items for when a loss occurs. A “checklist” isn’t practical because there are too many variables and “if/then” scenarios to map out. When you have a significant property damage and business interruption claim, only experience can guide the way to a fair recovery.

However, there are actions that can be taken ahead of a loss to ensure you are prepared. The following seven items represent such a “checklist.” It will not only help with your next loss but can have an immediate benefit to your risk management program.

1. Prepare accurate ratable business interruption values

The annual ritual of preparing the business interruption worksheet is often treated as an administrative nuisance.  It should be looked at as an opportunity to accurately account for the insurable risk for which you pay your premium and to accumulate annual values for future trending.

The worksheet provided by the insurance company is woefully inadequate to explain the nuances of most businesses. Go beyond the worksheet and explain your business more completely to underwriters. For an effective BI values methodology, solicit help from the specialists, such as an experienced forensic accountant. The results will be appreciated by underwriters and should translate into more appropriate coverage and possibly a more favorable rate. Once a system is in place, accuracy, consistency and efficiency should be improved.

2.    Analyze exposure scenarios and calculate MFL and PML

Once the ratable BI values are calculated, policyholders should explore realistic loss scenarios. The BI value is an annual number that does not factor in real-life responses that would generally mitigate a claim. To get to the actual exposure to risk, companies should determine the maximum foreseeable loss (MFL) and probable maximum loss (PML) measurements. The MFL measures a “worst case scenario” in which all of the loss-control protections fail. The PML is the more realistic loss scenario, in which mitigation systems work and contingency plans are executed properly. In both cases, the property damage and business interruption effects would be calculated as if they had occurred.

Loss scenarios should be postulated in detail, e.g. by location and by occurrence, considering all factors. These numbers should not be measured by simply applying a daily “BI rate” to an engineered loss period. It is more realistic to prepare as if presenting a claim, exploring all “what if” possibilities. Insurers may offer some assistance in this process, but remember, their version will be from their perspective. As with any claim, you should always prepare your own scenarios and your own calculations according to your understanding of your operations. An independent forensic accountant will have prepared claims just like your scenarios and would be able to accurately value the losses.

3.   Analyze contingent risks

Concurrent with the MFL and PML analysis, you should work to understand contingent risks to your business. Knowing what your suppliers’ and customers’ exposures are is important. Policyholders should involve leaders in operations, procurement and sales to help identify contingent exposures. If you have a sole supplier, your contingent exposure may be greater than anticipated and should be examined.

It is important to understand how your current policy language would respond to the contingent loss scenarios you’ve identified. For example, if suppliers in your policy are referred to as direct supplier,” make sure you understand how this would be interpreted in a claim. If “direct” means only those suppliers with whom you have a direct contract, and an indirect supplier, i.e. a second-tier supplier, has a loss that affects you, would you be covered? These scenarios should be discussed with your broker and underwriter to ensure your policy will respond as expected.

Once the values and scenarios are updated, you will be better able to make informed decisions about your insurance coverage, limits and terms.

4.    Business interruption vs. extra expense

Another common discovery from performing an exposure analysis is which type of time element coverage is the best risk transfer solution. Considering each location, if the risk is a lost of sales, BI would cover the lost earnings. If sales are not the risk or they can be sustained at an extra expense, extra expense coverage would be more appropriate. If sales are at risk but can be mitigated to the degree contingency measures are enacted at an additional expense, it’s a combination loss exposure.

It’s of value to risk managers to know what the exposure truly is because, if an exposure can be covered by extra expense coverage, it may eliminate or reduce the need for BI insurance. For example, if you are a distributor with multiple warehouses whose inventory is insured at selling price, what’s at risk? If you have alternative space or can quickly secure temporary space, the likelihood of experiencing a sales loss that exceeds the sales value of your lost inventory is remote. How much BI coverage should you buy vs. extra expense? Exploring your loss scenarios and subsequent contingency plans would allow you to better quantify your risks and select the option best suited to your needs. Extra expense is a more “tangible” risk than BI, making it easier for underwriters to rate, and it generally will cost less.

5.   Gross earnings, gross profit and business income

The names are different, but the intent is the same – to protect earnings lost because of damage or loss of use of insured property. The history of each of these forms would take a separate paper to detail, but, in a nutshell, gross earnings is a form commonly used in the U.S. with a basis in manufacturing risks, while gross profit is used throughout the world and has its basis in mercantile operations. Business income is the term used for the current ISO forms. Today, all forms have been modified to accommodate almost any business — however, there are some situations where one form may be preferable. The terminology and the mechanics of calculating business interruption loss varies among the forms, but the answer should be the same, regardless.

The exception to this has to do with the period of indemnity — the gross profit form is usually limited to a specific time, while gross earnings will continue until repairs are (or should be) completed with “due diligence and dispatch”; there is the ability to add an extended period to recover sales. It is important to make sure the form you have would cover your potential loss period. For example, if you have a manufacturing company with specialized production equipment that have long lead times to replace — longer than the period that a gross profit form would cover — you should probably have a gross earnings form. If you do not see a scenario that would exceed the gross profit period and you cannot accurately predict an extended period required to add to gross earnings, the gross profit might be a better option. If there isn’t any scenario that would create a loss that exceeds the gross profit period of indemnity and you are comfortable that you can cover that time to recover sales, than either form would work. There are new options that allow you to pick which form you would like to use up until the closure of a claim — these forms eliminate the need to determine which form is right for your business. Just make sure you have a form that will cover your worst-case scenario.

6.   Professional fees coverage

Most policies now include professional fees coverage. Insurers recognize the need for dedicated claim preparation experts and are willing to pay for it as part of the claim. Often, this coverage is subject to limits that can be negotiated. If you are not familiar with this coverage or do not have it, you should discuss with underwriters. For the most part, this coverage can be included at some level just by asking. The benefits of having specialized claim preparation experts available as a resource for a claim can make the difference between a successful claim and a headache.

7.  Organize your claim team

In addition to forensic accountants, a claim may include forensic engineers, attorneys and others. It is a good idea to know those you want to use before needing their services. Meet with the various providers beforehand and select those that fit best for your organization. Typically, paperwork associated with hiring someone can be completed before needing their assistance (i.e. non-disclosure, purchasing, W-9, etc.) so that if something happens they can begin work immediately. Additionally, there may be an opportunity for the provider to help with reporting issues on business interruption values.

While no business wants to suffer a loss of earnings, the more prepared you are the better the results will be. The steps shown above may take years to fully develop and should be evaluated annually to account for changes to your business.

If these recommendations are incorporated into your insurance program, there’s no need for a claim checklist. Your risk management team will be prepared for any worst-case situations with the best-case solutions.

Business Income And Dependent Property From A Secondary Location

There was a lot that changed with the Commercial Property Forms in the 2013 series. In fact, most forms underwent some sort of modification. One of the most interesting of the changes was the introduction of an optional coverage available on the Dependent Property Forms for Dependent Properties in the Supply Chain (Business Interruption).

By way of background, the Business Income and Extra Expense forms require that there is direct damage at the premises described by a covered cause of loss that gives rise to a loss of income or need to pay extra costs to operate during the period of restoration. In providing this form of coverage, we have been aware of the exposure to a loss of income due to a physical loss at a location that our insured depends on for various reasons. Recognizing that a loss to a dependent location could cause financial harm to our insured, ISO created Dependent Property Endorsements (CP 1508, CP 15 09, CP 1534) provided on a scheduled basis. What this means is that, for our insured, we identify what company(ies) they are dependent on and schedule those locations on the Dependent Property Form attached to their business income policy.

For example, we could be insuring a winery that is dependent on a single manufacturer to manufacture their distinct wine bottle and provide them with their customized cork. If that bottle manufacturer had a loss to their manufacturing facility by a peril insured against on the winery's policy and the winery now has no bottles and the winery can demonstrate they are losing money or incurring an Extra Expense by going to a more expensive alternate supplier then the Dependent Property Endorsement could respond.

What we learned, when losses such as this arise, is that oftentimes the physical loss did not occur at the dependent location we scheduled on the policy but rather to a “location” that the dependent property was dependent upon to supply them a product or service. So to expand on the winery example — the bottle manufacturer is dependent on a single cork manufacturer to supply them with the blank corks they customize and the cork manufacturer has a loss (covered peril) and cannot supply the wine bottle company with the product. We never identified the cork manufacturer on our insured's policy as there was no known or direct relationship.

The new language on the Dependent Property forms have an option for “secondary contributing locations” and “secondary recipient locations.” Secondary locations are limited to direct suppliers and recipients of the dependent property's materials or supplies.

On the form, secondary contributing location and recipient location are now defined terms. There are some important clarifications of the coverage:

  1. The secondary location is not identified in the schedule. However, there is a box on the schedule that has to be marked identifying that a secondary location has been included.
  2. The secondary location cannot be owned or operated by the “contributing” or “recipient” location that is identified in the schedule.
  3. There is clarity that a secondary location is not a road, bridge, tunnel, waterway, airfield, pipeline or any other similar area or structure.
  4. There is clarity that any source of “services” in the area of water, power, wastewater removal or communication supply cannot be a secondary dependent property. These would be covered under Utility Interruption endorsements.
  5. Lastly, there is clarity that the secondary dependent property coverage is subject to the territory of the policy and is not worldwide.

This additional coverage under the Dependent Property Endorsements is very important to consider, especially for manufacturing accounts. This all gets back to our identifying exposure and providing solution.

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