When Business Income is Lost After Reopening – Extended Business Income

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by Christopher J. Boggs, CPCU, ARM, ALCM

Arriving at the end of the defined “Period of Restoration” does not generally trigger the insured’s immediate return to pre-loss “operational income” levels. The ability to generate revenues at the same level enjoyed prior to the suspension of operations may actually require several weeks or months following the insured’s returns to “operational capability.”

During the “period of restoration,” the insured’s customers and clients may find alternate sources for the goods, services or products the insured provides. In so doing they may have developed new buying habits or entered into a replacement contractual relationship with another entity. Regaining these customers and the revenue they represent takes time. Replacing these customers and clients with new buyers requires even more time.

Both business income coverage forms (CP 00 30 and CP 00 32) provide a small amount of “automatic” coverage to indemnify the insured for the income/revenue “lag” experienced once operations are resumed. Additional Coverages 5.c. Extended Business Income provides up to 30 days of “difference in income” coverage following the insured’s return to “operational capability.”

How Does the Coverage Extension Apply?

“Extended Business Income” protection is divided into two parts. Part “c.(1)” extends business income to policies covering “Business Income other than Rental Value.” Part “c.(2)” provides the same protection but to policies protecting against the loss of “Rental Value.” “Rental Value” is covered whether it is included as part of the business income protection or provided on a stand-alone basis.

Protection for “Business Income other than Rental Value” begins upon the actual resumption of the entity’s operations. Coverage ends: 1) when the insured is generating the same amount of business income that would have been earned had no loss occurred; or 2) in 30 consecutive days; whichever occurs first.

Likewise, “Rental Value” protection commences on the date property is actually repaired, rebuilt or replaced and tenability is restored. Coverage ceases when the tenant occupancy COULD be restored to pre-loss levels or in 30 consecutive days following tenability; whichever comes first.

Note that “Extended Business Income” protection will not allow and is not designed to help the insured to recover income lost due to externally poor economic conditions present following the insured’s return to operations. If the insured’s ability to return to pre-loss income levels is stunted by the surrounding community’s economic condition, the coverage extension does not apply.

For example, assume an insured is located in an area devastated by a hurricane. Six months following the damage, the insured is able to return to “operational capability.” However, the remainder of the business community and its residents are unable to return for several more months, causing the insured major income loss. The loss of income attributable to this lack of customer base does not qualify as a “business income loss” under this coverage extension.

How Much Will the Insured be Paid During the Extension?

Both business income forms (CP 00 30 and CP 00 32) state that the insured will be paid the amount of “Business Income” lost between the resumption of “operational capability” and the earliest of: 1) the return to its pre-loss “operational income” level; or 2) 30 consecutive days.

Presumably some income is earned during this extension period, but likely not as much as would have been earned had no business-closing loss occurred. Calculating the “extended business income” amount requires knowing (or estimating) both revenue levels. The insured is paid the difference between the “business income” that would have been earned had no loss occurred and the actual “business income” earned during the extension period (however long it is).

Remember, “business income” is the net profit or loss that would have been earned PLUS continuing normal operating expenses. During the defined “period of restoration,” there is likely NO or only minimal revenue and the normal operating expenses are reduced as per the term “continuing.” Once full “operational capability” is reached, income levels increase, to some extent, AND there is an increase in “operating expenses.” Some expenses that were lowered or discontinued during the business shut down are reestablished once operations are begun again.

Basically, the unchanged business income coverage form pays the insured for up to 30 additional days following its return to operational capability (subject to coverage limits). However, this period and its representative amount of business income is not part of the “period of restoration” and are not used in the application or calculation of any coinsurance penalty.

Does the Insured Need to Increase the Business Income Limit?

“Extended business income” limits are not in addition to the limit of business income coverage purchased; the income lost during this extended period is paid out of the business income limit. However, the insured does not necessarily need to increase the coverage amount to fund this 30-day extension!

Finishing up the Business Income Worksheet – The Expense Section made it a point to clarify that it is not necessary for the insured to know or even consider which operating expenses will or will not continue, nor at what level any of these expenses will continue, following a business-closing loss. Non-continuing sales and production-related expenses are the only expenses subtracted from gross sales (or gross sales value of production) when completing the business income report/worksheet (CP 15 15). All other operating expenses are included in the insurable/ratable business income exposure (the “J.1” or “J.2.” total), not just those that continue during the “period of restoration.”

Insurable business income, as developed by the CP 15 15, is actually greater than the payable (compensable) business income – leaving the insured enough for the additional 30 days of protection. Thus, the business income limit does not need to be increased to provide the 30-days of additional protection.

Continuing vs. Non-Continuing Expenses Related to Extended Business Income

Many operational expenses are reduced or disappear completely during the “period of restoration.” However the insured is not charged with deciphering which operational expenses will be affected by the loss.

No hard rule or method exists to gauge the difference between pre-loss operational expenses and the continuing operating expenses during the “period of restoration.” Much of the difference depends on the endorsements used (i.e. the Ordinary Payroll Limitation or Exclusion) and the nature of the operation.

Even a 20 percent difference between pre-loss operational expenses and continuing operating expenses during the “period of restoration” generates a wide gap between the insured and compensable amount of business income. Click here to view an example.

The difference between the insurable business income and the payable business income in this example is $200,000. Applying the information in the referenced example, only $113,014 is required to pay the 30 day extension. Some income should be realized once operations resume, so it is unlikely that the entire “surplus” amount will be required to pay this 30-day extension. (Warning: The 20 percent is for example purposes only and not intended to be used as a rule.)

Explaining the difference between insurable and compensable business income is the goal of the next post. Here’s a warning in preparation for the upcoming discussion, do not consider lowering the business income limit due to the “insurable/compensable difference;” the coinsurance condition prevents such action.

What if 30 Days is not Enough?

Insureds have the option to increase the limit of extended business income coverage if the automatic 30 day extension is insufficient. Simply by activating the “Extended Period of Indemnity” optional coverage on the declaration page and paying an additional premium, the insured can increase the time limit in 30 and 90-day increments up to a maximum of 720 days (nearly two years beyond the return to “operational capability”).

If the insured decides to increase this time span of coverage, they must:
1) Decide how much additional coverage they need (beyond 30 days); and
2) Place this number in the “K.2.” line of the Business Income Report/Worksheet (CP 15 15).

Calculating the necessary amount of additional coverage is needed is surprisingly simple. First, the insured divides the “J.1.” (or “J.2.” if applicable) amount by 12 and multiplies the product by the number of 30 day increments the insured needs beyond the original 30 days. If the insured feels six months of coverage is required and his “J.1.” amount is $1,375,000, the additional amount of coverage is developed as follows:

• ($1,375,000/12) X 5 = $572,917

Remember, the product does not need to be multiplied by six months as the insured already has 30 days of coverage granted by the form. Only the additional months need be calculated.

But why use the full “J.1.” amount in this calculation rather than some percentage of that total? Because the insured is assuming a crippling loss of income during this extended period PLUS the operational expenses return to pre-loss levels even if/though the revenue stream doesn’t (making all expenses “continuing normal operating expenses”). The insured may not need the full limit purchased, but slightly over-insured is better than slightly underinsured.

This amount is transferred over to “K.2.” on the CP 15 15. Once the Extra Expense limit is added (as discussed in a future post), the CP 15 15 will be complete.

Coming Up!

The next post, as promised earlier, will detail the difference between the amount of insurable business income and the amount of compensable business income. Once done, the following commentary will turn its attention to the non-coinsurance business income options.

For all the information on Business Income coverage, take a look at Insurance Journal’s book, “Business Income Insurance Demystified: The Simplified Guide to Time Element Coverages.”

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