Study 9 – Business Interruption Insurance
1. Note the comments made in the introduction. (p. 3)
Business interruption insurance pays for income lost because of the interruption of business or the extra expense necessary to keep the business going after a loss. Many firms that do not have BII fail to survive a bad fire or other disaster, because they do not have the resources to draw on while their income gradually returns to normal.
2. Review each point discussed regarding the loss at Premier Door and Window Company. (p. 2-5)
3. What is the main point under “Perils to be insured”? (p. 6)
Many firms only buy BII against fire and extended coverage, and fire is certainly one of the main perils. However, an all-risks type of policy is wider and may not cost much more. Also, consider the possibility of interruption of outside electrical power or the water supply following damage to the electrical or water supply system. These risks can be covered.
4. What are the main types of BII coverages? (p. 6)
1. Profits
2. Gross Earnings
3. Extra Expense and Additional Increased Cost f Working
BII policies are written by attaching a BII wording to a property policy such as fire and EC or all-risks. This method adopts the perils insured in the property policy but has the disadvantage of including provisions that are inapplicable to BII and must be disregarded.
5a) What is the difference between Profits and Gross Earnings on the one hand and Extra Expense and Additional Increased Cost of Working on the other? (p. 7)
Profits and Gross Earnings are alternative types of income restoration policies whereas the Extra Expense and Additional Increased Cost of Working only pay the additional expense of continuing in business after a loss as occurred.
5b. Does the Profits policy cover gross or net profits? (p. 7)
Profits form is based on a British form and covers gross profits, not merely net profits.
Gross Earnings is based on a U.S.
5c. What are the three main differences between Profits and Gross Earnings? (table on p. 7)
See page 7.
1. Period of indemnity
2. Coinsurance
3. Stock
4. Bylaws
5.
6. How is the choice made between Profits and Gross Earnings? (p. 8)
The principle difference between the forms is the Period of Indemnity.
The question is: Will the result of the business return to normal as soon as the damaged property is made good? If they will, then gross earnings coverage is sufficient (and may cost less). Otherwise, profits is needed.
7. Explain how adjustable policies work. What is an important benefit obtained from an adjustable policy? (p. 8)
Both Profits and Gross Earnings policies are normally subject to coinsurance. The best way to prevent the insured’s being penalized by coinsurance is to provide an adjustable policy.
The insured choose a sum insured that he believes will be more than adequate and pays a deposit premium based on that amount. Then at the end of the policy year, he declares his actual figures and the premium are adjusted accordingly. There is a maximum return premium of 50% of the deposit, but the insured should be able to estimate his results accurately enough not to be penalized by this.
Under no circumstances does the adjustable policy provide more insurance than the limits stated in the policy.
8. Explain the need to forecast results well into the future. (p. 9)
Insured’s must forecast future results so as to adequately specify the amount of insurance required. Don’t forget also that although the insured may have compiled with the coinsurance requirement, the sum insured may not be enough to pay the entire loss caused by a prolonged interruption.
9. Do you consider the stated amount or adjustable basis the better method? Give your reason. (p. 9)
The stated amount basis is available for BII as for physical damage. When properly arranged it avoids the application of a coinsurance penalty. However, for BII the problem is not only coinsurance, but estimating an adequate amount of insurance for a possible claim that could affect a period well over a year ahead.
The adjustable basis which helps sole this problem is therefore usually better than the stated amount, that does not.
10. The Profits form uses the addition method of calculating the sum insured whereas Gross Earnings employs a deduction system. What is the difference? (p. 10)
The Profits policy uses an additional method for calculation. The net profit before tax is taken and this is added to the charges that do not reduce in proportion to the drop in revenue following an interruption of business. For example, interest on loans and advertising. The policy calls these standing charges. The total of the net profit before tax plus the insured standard charges constitutes the sum insured.
Gross earnings on the other hand, proceeds by a system of deducting items from a gross figure. To obtain the gross amount for a manufacturer, the net sales value of production is added to the other earnings derived from the business. For non-manufacturing businesses, the net sales/revenue is added to other earnings. From the gross figures, certain deductions are made.
11. How is insurance in respect of a manufacturer’s finished stock handled when the insured has a) a Gross Earnings policy b) a Profits policy? (p. 14)
One of the differences between the Profits and Gross Earnings form for manufacturers is that Gross Earnings excludes loss of earnings caused by damage to finished stock. On the other hand, the Profits form (and the Gross Earnings for non-manufacturers) does not exclude it.
The usual method of dealing with this is through the insurance on the stock against physical damage (fire and EC, etc). For manufacturers with Gross Earnings policy, the physical damage policy cover stock for its selling price. In all other instances where profits or gross earnings is bought, stick is insured for cost price.
12. How are ordinary payroll and the wages and salaries of key employees handled? (p. 14-15)
Both Profits and Gross Earnings policies insure in full the wages and salaries paid to key employees whose services would not be dispensed with the following an interruption of business.
It is usual to insure wages (except those for key employees) for a comparatively short period. In fixing the period, the insured should be guided by such factors as the ease (or difficulty) of obtaining replacement workers when the business gets back into operation, time required for training, and legal requirements such as union contracts.
The Profits form does not insure ordinary payroll at all unless a separate item is added and the Gross Earnings policy covers 100% payroll (and includes the amount in any coinsurance calculation).
13. What is the reason for insuring auditor’s fees? (p. 15)
Accountants are expensive to employ and it is wise to include an item in the policy to pay for the fees of the accountants employed by the insured. This item will not be subject to coinsurance.
14. What points arise about supplier’s and customer’s premises? (p. 16)
Suppliers: - Supplier’s premises – Contributing Property
Damage at a supplier’s premises can be insured under Profits and Gross Earnings forms. You should investigate the degree of dependence, which is rarely total and may apply to only one line of products leaving others in full production. It is not usual to change the sum insured, but the degree of dependence (% of total gross earnings) will affect the additional premium charged.
Customers: Buyer’s premises – Recipient Property
Similarly a firm may be selling much its products to one or perhaps a few customers and if the customers’ premises are damaged, they may not be able to buy the insured’s product for some time, cause loss to your insured.
Department store in mall – Leader (or magnet) Property
15. Discuss the advantages and drawbacks of the no coinsurance form. (p. 17)
This form is useful where the client has a limited BII exposure, wants a simple policy and wants to pay as little as possible for it. It is generally only available for non-manufacturing risks and is on the gross earnings basis in that it covers only for the time needed to restore damage, there is no cover for loss arising afterwards as in the profits policy.
Premium savings hardly makes acceptance of the restriction in the No-Coinsurance form worthwhile.
16. What factors need consideration in regard to extra expense type coverages? (p. 18)
Economical Extra Expense pays the extra expense of staying in business in so far as this does not exceed the loss of gross profit or gross earnings avoided. In other words, they will always pay 99 cents of extra cost to save $1 of loss gross profit/earnings but not $1.01.
An Extra Expense type policy, which will not pay any loss gross profit/earnings, will pay extra expense without regard to any saving in loss profit or earnings. There are certain limitations but basically the Extra Expense form covers the extra charges incurred to keep a business going.
Some businesses may need both earnings coverage and extra expense coverage since in some circumstances, they might need only restoration of earnings and in others, they could maintain their earnings if the extra cost of continuing can be recovered.
17. Give details of the limitation related to EDP media in BII policies. What should be done about this? (p. 20)
It limits the period of time for which the insurer must pay when the interruption results from damage to EDP media (discs, tapes, etc) and programming records.
The time period is:
· 30 consecutive days; or
· The time required to restore other damaged property, whichever is greater..
The insured can ask the insurer for an extension at an extra cost. The limitation does not apply to damage to hardware.
18. Review the information about interruption of access by order of civil authority. (p. 21)
It provides limited coverage where interruption of business is caused because access to the premises described in the policy is prohibited by order of civil authority. Coverage is subject to two important provisions:
· A time limit of two weeks;
· The prohibition must be the direct result of damage to neighbouring premises by a peril insured.
19. Note the important exclusions in BII policies. (p. 21-22)
The Gross Earnings forms have a section called Additional Exclusions. The Profits form specifies restrictions and extensions in a section called Provisions.
Gross Earning exclusions:
· Bylaws: can cause delays and prolong period of interruption
· Interference: increase in loss due to interference with rebuilding, repair or replacement at the insured’s premises or in the resumption of business by strikers or others
· Suspension, Lapse or Cancellation: loss of income resulting after the indemnity period from suspension, lapse, cancellation of a lease, licence, contract or order.
· Fire, Damages or Penalties: excludes fines, damages for breach of contract or non-completion of orders and penalties of any nature.
Profits form exclusions:
· Bylaws: include delay caused by the application of a bylaw and does not extend the period of indemnity beyond the time stated in the declarations.
· Fire, Damages or Penalties: excludes fines, damages for breach of contract or non-completion of orders and penalties of any nature.
20. What points arise from the examination of a client’s lease? (p. 24)
Leases are not standard documents and may contain special features based on the ingenuity of the lawyers who drew them up. There is no substitute for seeing the actual lease and summarizing the features that affect insurance matters.
21. When is a policy confined to coverage on rent adequate? (p. 25)
Where rent is only one item in a client’s operations, it is best covered as part of a Profits, Gross Earnings or Extra Expense (or AICW) policy. An example is a manufacturer who has more space than he needs and rents out part of his premises. There is no difficulty about insuring rent under a regular BII policy.
However, if rent is the only or chief source of income, rent insurance is usually sufficient. For instance, this is true of an owner of apartment block(s) whose income is derived from the rent they produce.
22. What is the main difference between the Profits and Gross Earnings approaches to separate rent insurance? (p. 25)
The two separate rent insurance are as follows:
1. Gross Rentals
2. Rent and Rental Value
The first follows the profits method of providing coverage until results return to normal, subject to a time limit.
Rent and Rental Value is based on gross earnings approach in which coverage stops when restoration has been completed. Obviously the gross rentals are preferable unless he/she can re-lease his premises as soon as the damage is made good. The words rental value refers to a situation where the premises of an owner/occupier are damaged and he has to rent elsewhere.
23. Review the comments about rent exposures in the case studies. (p. 26)
24. How does leasehold insurance work? (p. 27)
If the client has a bargain rent, he may have to pay considerably more should his premises be badly damaged by a fire. Many leases contain a fire clause which in effect says that if the premises are severely damaged by fire, the landlord may cancel the lease.
Leasehold interest can be arranged to provide cover. Claims are settled by a cash payment which is discounted at a rate of interest stated in the policy because payment is made immediately instead of at intervals as the increased rent is payable. Leasehold insurance is not cancelable except in a few situations specified in the policy.
25. What is meant by delayed opening coverage? (p. 27)
If a planned start-up date of a business is delayed because of damage during construction, expected earnings will not be achieved in time. Examples include a factory, department store, etc.
BII (Profits and Gross Earnings basis) can be arranged based on projected earnings.
It is important to realize that the same effect may result from damage at the premises of a major supplier and these risks can be insured.
26. Review the comments about insuring tuition fees. (p. 28-29)
Private schools, colleges, business and trade schools stand to lose tuition fees if, because of damage at their premises, they cannot provide instruction. If the premises are not ready when needed, a school can lose its fees for the entire year depending on when the damage occurs in relation to the start of the school year.
Neither the Profits nor the Gross Earnings form provide proper coverage unless modified.
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