Business Interruption Insurance Explained
Only 37% of small business owners are familiar with business interruption insurance, which protects against financial losses when a business is unable to operate.
Unfortunately, many of them will need it one day. Consider these stats:
- The average number of major power outages occurring in the U.S. has doubled since 2003.
- After Hurricane Sandy, 52% of the small businesses surveyed in Connecticut, New Jersey, and New York reported lost sales and lost revenue. Roughly 75% had to close their businesses for a period of time following the storm.
- According to Chubb data, 50% of businesses never return to the marketplace following a major disaster. Of those that do, half go bankrupt within three years.
The following post looks at some common questions surrounding business interruption (BI) insurance. If you don’t see the answer you’re looking for, contact us directly. We’ll be glad to explain BI benefits and options.
What is business interruption insurance?
Business interruption insurance–also known as business income insurance– covers a loss of income and certain operating expenses if disaster ever forces you to close shop, temporarily. It is not a policy that can be purchased on its own. Instead, it’s either baked into your commercial property coverage or added as an endorsement to that coverage. Either way, it’s important to remember that business interruption insurance usually functions as an extension of your property insurance, which helps to explain some its terms and limitations.
NOTE: BI insurance can also be included in or added to commercial cyber insurance policies. More on this below.
When does business interruption insurance apply?
Not every type of business shutdown is covered. In most cases, three main criteria must be met:
First, the “interruption” has to be caused by a covered peril, a loss event that is listed in your commercial property insurance. In most cases, covered perils include fires, riots, wind storms, and other natural disasters. Floods and earthquakes are common exceptions. Because these disasters typically are not listed on standard commercial property policies (and require separate coverage), they wouldn’t qualify as triggers for business interruption coverage either. Be sure to carefully review the types of events that are and aren’t covered with your agent.
Second, the business has to suffer direct, physical damage. For example, a fire destroys your restaurant kitchen. Or a hurricane rips the roof off your store. In both examples, there is physical property damage that must be repaired. The physical damage component is important in starting the clock for your business interruption coverage. Coverage starts within hours after the damage happens (see Criteria #3), and ends when that damage is repaired (or reasonably should be repaired). The days in between are known as the “restoration” period. This is the timeframe that qualifies for lost income and operating expense reimbursement.
Third, the waiting period deductible (usually 24 to 72 hours) has to expire. Most business interruption coverage is designed to respond one to three days after the interrupting event occurs (though insureds can request that the length be decreased or even eliminated for a higher premium). This waiting period or “time deductible” replaces the dollar-amount deductible you might see in other types of policies.
Are there any exceptions to these rules? Of course! But the above conditions usually apply.
What does business interruption insurance cover?
Business interruption insurance is designed to cover the following categories:
- Lost income – Based on documented profits earned during a similar timeframe
- Operating Expenses – Fixed costs like your rent, mortgage, lease, or taxes
- Payroll – So you can continue paying employees as usual, even during a slowdown or shutdown
- A business interruption package might also cover things like temporary relocation costs (if you needed to move into a new facility during the restoration period) or training (if you needed to introduce new equipment or technology)–but only if the package included “extra expense coverage.” More on this below.
What does business interruption NOT cover?
This list is by no means exhaustive, but it highlights several of the common exclusions that business owners should be most aware of:
- Shutdowns caused by a pathogen, communicable disease, or virus (e.g. COVID-19)
- Shutdowns or slowdowns caused by government-issued capacity restrictions or lockdowns
- Shutdowns caused by flood or earthquake damage
- Losses or expenses that occur before the waiting period (24-72 hours) is over
- Losses due to utility service disruptions (in some cases; see below)
Who needs BI insurance?
Every business should consider BI coverage as a vital piece of its insurance planning and risk management strategy. In today’s world, business interruptions can result from a variety of events: storms, fires, break-ins, cyber attacks, etc. In fact, business and industrial risk experts say the severity and frequency of BI claims are on the rise.
What are the primary causes of business interruption claims?
Some leading causes of business interruption insurance claims, according to AGCS’s Global Claims Review 2015 Report, include fires, storms, strikes, riots, floods, equipment breakdowns, and power outages. Note that not all of these causes are covered by the standard scope of business interruption insurance. It’s a good idea to discuss these and other potential loss events with your business insurance agent so you can supplement with enhanced coverage, as needed.
Does business interruption insurance cover power outages?
As you may have noticed, we mentioned power outages as a common cause of business interruption claims. After a major storm, your access to electricity, water, telephone service, or Internet service could be cut off for weeks. And yet, power outages can happen without causing any physical damage to your property. (Criteria #2, remember?) So are utility interruptions covered by business interruption insurance? The short answer is maybe.
Some property policies do include coverage for utility “service interruption” caused by damage to a transmission line, power plant, transformer, or pump station. In other cases, businesses have to purchase a separate utility service interruption endorsement.
What is utility service interruption insurance?
This endorsement may also be called off-premises power coverage. Without going too far down the rabbit hole, it’s coverage that can be added to address potential gaps noted above.
But beware. Even when buying coverage specifically for utility disruptions, terms and exclusions still exist. For example, you will likely find distance limitations (i.e. how far from your property the damage can occur and still be covered). Outages caused by earthquakes or flood damage are often still excluded. Overhead transmission lines are often excluded. (You can opt to include overhead transmission lines, typically for a small increase in pricing.) Finally, like BI coverage itself, utility endorsements often contain a waiting period (ranging from 12 – 72 hours) before the coverage will kick in.
Here again, it’s important to ask your agent if/how your policy language addresses power outages/utility service disruption, and explore additional endorsements as needed.
What is extra expense coverage?
Extra expense coverage is similar to business interruption insurance, but they’re not exactly the same. And in many cases, it makes sense to carry both types of protection. After a business disruption, extra expense coverage kicks in to reimburse you for any out-of-the-ordinary expenses that crop up, as you attempt to work around the disruption. So for example, if you rent a new space or lease new equipment while your original stuff is repaired, extra expense insurance could cover those costs.
Extra expense coverage can be secured as part of your BOP or as an endorsement to your commercial property coverage.
What happens after business operations resume?
If you opt to select extended business income coverage, you may receive further protection against lost income even after your operation is restored.
How much BI coverage is enough?
BI coverage is no place for guesswork. Unfortunately, according to Chartered Institute of Loss Adjusters survey, 40 percent of BI coverage declarations were deemed too low by about 45 percent. To ensure your limit will be adequate, you’ll need to accurately project revenue for the upcoming 12-month period. Next, you’ll need to assess how long it would take to replace all damaged property and resume operations in the event of a worst-case loss. From there, you can work with your insurance agent to select a business income limit of insurance.
At the end of the day, you can’t afford to gamble your business’ future (or your employees’ livelihood) on the promise of smooth sailing. Arm yourself with a business continuity plan that includes paid protection for unexpected downtime. As always, feel free to reach out with your specific questions.