Business Interruption Coverage Too Complicated To Understand? Almost, But Not Quite.

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Last week, we promised to tell our readers more about what we reluctantly refer to as “Business Interruption Insurance.” We say, “reluctantly,” because it’s not a term you’ll find in an insurance policy – it may have been in years gone by, but now it is a business concept. So, that will be our jumping off point.

We’ll begin with a caveat or disclaimer. Today’s posting will be useless to anyone who is seeking to buy coverage. This form of coverage is conceptually simple but, in application, it is exceptionally complicated. That’s why insurance professionals were invented. Our goal is to get leasing and lending professionals to understand the “what’s” and “why’s” of “business interruption insurance,” not the “how’s.” Our objective to help non-insurance professionals “know what is going on,” not to turn readers into experts. Too many of us who are “doing deals” insist on asking for insurance coverages that don’t exist. Too many of us ask for insurance coverages that make no sense. And, too many of us don’t ask for insurance coverages that are really needed in the context of our deals.

So, let’s roll.

Business Interruption Insurance doesn’t insure that your business won’t be interrupted. All it (sometimes) does is pay money. One category of “sometimes” is when the interruption results from a “covered cause of loss” to “covered property.” These terms, found exactly that way in the most common forms of commercial property insurance policies, are CRITICAL ones. But, first, let’s do a quick recap.

Business Interruption Insurance is obtained in connection with a commercial property insurance policy, NOT a commercial general liability policy. It is obtained by way of an endorsement, rarely, rarely by way of a separate policy. [Don’t expect to find a lot of stand-alone business interruption policies, because only a handful of small companies write them. So, do not write your leases or other documents as if there will be a separate insurance policy.] When you are asking for business interruption insurance, you should be asking for what the insurance industry calls a “Business Income” coverage form or an “Extra Expense” coverage. These forms are available separately as well in a combined form, the one most commonly encountered. So, if you are going to require someone to carry this type of insurance, write that requirement into the section of your document that calls for property insurance and ask for Business Income coverage or combined Business Income and Extra Expense coverage. If you are looking at ISO coverage forms, these are the three you’ll be seeing: (a) Business Income (And Extra Expense) Coverage Form CP 00 30; (b) Business Income (Without Extra Expense) Coverage Form CP 00 32; and (c) Extra Expense Coverage Form CP 00 50.

[While we are at it, for new readers, we’ll cover some well-tread ground. Most commercial insurance policies are written using forms promulgated by the Insurance Services Office, Inc., called, for short, “ISO.” It is owned by its own employees and insurance companies. Even policies not written on those forms will frequently mimic ISO forms. The ISO forms are extensive and comprehensive. They are well-written, especially if you are an insurance company. Because they are ubiquitous, we will pretend that there are no other forms in use, thus allowing Ruminations to pretend that there aren’t even “manuscript” policies, ones made up from whole cloth for a particular insurance deal. So, when we write about what a commercial property insurance policy covers or doesn’t cover, please remember we are talking “ISO” form policies and endorsements. We are assuming that no insurance professional worth her salt will be relying on what this Ruminator is writing. So, in any given situation where you really want to know what a particular policy covers and, more importantly, doesn’t cover, find a really, really good insurance professional.]

Back to a “covered cause of loss.” Basically, this means physical damage to property caused by something the property insurance policy will pay for. The property that is damaged must be “covered property.” So, if your commercial property insurance policy will cover you for physical damage to your property, you have just seen a “covered cause of loss.” Basically, some causes of damage aren’t covered, such as war-caused damaged (to make a simple point). Not all property is “covered property,” such as currency (to make a simple point).

So, you ask: “Why do I care when I am looking to get insurance money to replace my lost business income? After all, if my business is interrupted by a fire down the block or at the other end of the building I rent, shouldn’t I start getting insurance checks?” Well, it all depends. If you only bought Business Interruption Insurance (actually Business Income coverage) to go with your commercial property insurance policy, don’t hold your breath waiting for the checks UNLESS your OWN property was burned in the fire. That’s because YOU didn’t experience a “covered cause of loss” – it wasn’t your loss of property that was “covered.” It was someone else’s.

That’s also why you don’t get a pay-out from your Business Income coverage when the utility company’s pole across the street is hit by a truck and you close down for a week for lack of power.

Yes, Business Income coverage is triggered by physical damage to your own property UNLESS you buy “contingent” coverage. And, coverage is only for physical damage that your policy will pay for. So, if you didn’t buy flood coverage and your property is damaged by floodwaters, your Business Income coverage isn’t going to get you any money. Your loss wasn’t “covered” by your property insurance policy.

No check for physical damage to your property (or to “contingent” property if you bought that coverage) MEANS no check for interruption of your business.

We hope that’s not too confusing, but that’s what insurance companies like to do – label their policies to make you think you are covered, and write them to limit their own exposure.

“Contingent” coverage? What is this thing called “contingent business income” coverage, or “CBI”? Basically, that’s coverage for interruption of your business caused by physical damage to someone else’s property, provided that your policy would have paid you had the damaged property been yours.

Huh?

OK, here’s an example. You buy (relatively expensive) Business Income coverage written to pay you if the convention center across the street has a fire because, if the convention hall is closed, you get very few customers. Or, you buy “supply line” coverage if a key supplier has a fire and you have to close because you need what that supplier sells to you.

But, even with CBI, you still need a “covered cause of loss.” If the reason the convention center is damaged or your supplier’s facility is damaged would not have been covered by your own property insurance policy (had the damage been caused to your own property), you don’t get paid.

Got it? We hope so! We’ve spent a lot of ink on the “covered cause of loss” requirement because it is so basic and so unknown or so misunderstood. Now, we’ll move on.

One clue you get from knowing that the insurance policy’s form is called “Business Income” coverage is that this form of insurance replaces “lost income,” what a business would otherwise have earned while its damaged property is being restored. [Astute readers may be getting the connection between the required “covered cause of loss – physical damage to insured property” and getting proceeds from a property insurance policy that includes “Business Income” coverage.] Since a business might not be able to resume immediately after physical damage has been repaired, or might not get up to “full speed” for a while, you can buy coverage for a period after repairs have been made.

For rental property, here’s a very practical example of the “timing” issue raised above. Suppose a landlord is carrying Business Income coverage and a fire damages part of the rental property such that the tenants are unable to operate. Also suppose that the leases are properly written to say that the rent abates when a tenant can’t operate because of a fire. Further suppose, that a fair deal was struck when the leases were written and it gave the tenants a reasonable time to reopen – perhaps to move back in, fixture, restock, rehire, etc. That time period might reasonably be the same number of days as when the premises were initially delivered to a tenant.

As you would expect, the Business Income coverage will “replace” the landlord’s lost rent while restoration is taking place, at least for the time restoration should reasonably take (up to some specified limit, say 12, 18 or 24 months). But, if the coverage ended when the repairs were completed and the tenant has another rent-abated three months, the landlord will be missing some meals (or possibly some mortgage payments). So, that’s why you buy an extended period of indemnity endorsement beyond the 30 days already built into the ISO forms.

For a tenant, the calculation is a great deal more complicated. Here, the tenant will want to replace expected profits and also to cover continuing expenses. There are worksheets to aid in this process. That’s all we want to say about it.

In our effort to “simplify” what Business Income coverage will pay, we haven’t been exactly straight with readers. Technically, you get: (a) the net income (profit or loss before income taxes) that would have been earned or incurred; and (b) continuing operating expenses incurred, including payroll. So, now you see why a landlord’s situation can easily be simplified, but why it is a different kettle of fish when it comes to a tenant’s situation.

There are even circumstances where the insured isn’t even in business, but might want to have business interruption coverage. Again, here’s an example to illustrate the point. Consider a building under construction. There is no rent being paid. Thus, if it burns, the owner (landlord) doesn’t really lose anything. Well, that’s not exactly true. It was expecting that within a certain number of days after completion, rental income would appear at its door. Business Income coverage will pay for the lost rent during the “delay” in completion.

OK, OK, enough about “Business Income” coverage. What is this thing the insurance industry calls: “Extra Expense” coverage? For an answer to that question, we’ll steal from the ISO form, where it says:

Extra Expense means necessary expenses you incur during the “period of restoration” that you would not have incurred if there had been no direct physical loss or damage to property caused by or resulting from a Covered Cause of Loss.

We will pay Extra Expense (other than the expense to repair or replace property) to:

(1) Avoid or minimize the “suspension” of business and to continue operations at the described premises or at replacement premises or temporary locations, including relocation expenses and costs to equip and operate the replacement location or temporary location.

(2) Minimize the “suspension” of business if you cannot continue “operations”.

We will also pay Extra Expense to repair or replace property, but only to the extent it reduces the amount of loss that otherwise would have been payable under this Coverage Form.

Give me an example, you ask. Here’s one you’ve heard before. Suppose the landlord of a now fire-damaged property had its own business office at the property (for which it wasn’t paying itself rent). It still need a business office, so while restoration is taking place, it rents one down the street. This rent, something that it wouldn’t otherwise be paying, is covered as an extra expense. Similarly, suppose a retail tenant had its regional office in the back of the store. It, too, will incur extra expense to rent substitute space until its store is again usable.

We’ve saved the best for last. Here’s what Ruminations thinks. Leases should abate rent when the property is damaged. Landlords should carry the Business Income (And Extra Expense) coverage. The coverage should be for 18 months (at least). Tenants should pay their proportionate share of the cost of this coverage. Why? Here’s an example. Part of a building is damaged by fire, but tenants in undamaged portions can’t operate because of the fire. Those tenants have no damaged property of their own. Thus, there is no loss to their covered property by a covered cause of loss. Consequently, their Business Income coverage isn’t triggered. They can’t pay rent, even if their leases require them to pay rent. They go out of business. Since they go out of business, the landlord’s judgment for breach of lease damages will be uncollectable. Now, does our suggestion make sense?

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Comments

  1. Richard Belthoff says:

    You wrote above that rarely are there separate policies and then recommend that you write your leases to require separate policies. Is this correct? Or did you leave out a “not”, as as “not write your leases” to require separate policies? Thanks.

  2. Richard, thank you. This demonstrates two scary things. First, it demonstartes that when you read your own writings, you see what you think you wrote. The second scary thing is that people, like yourself read these things all the way through and I have a responsibility to get it right the first time. For those who go to look for the missing “not,” you’ll find it right where I just put it.

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