At least 30 percent of small businesses in the U.S. have been closed 24 hours or longer in the last three years due to a natural disaster, reports the National Federation of Independent Business (NFIB). FEMA, the Federal Emergency Management Agency, estimates that almost 40 percent of small businesses never reopen their doors following a disaster.
What Is Business Income Insurance?
Business income coverage (also known as business interruption coverage) protects your most valuable asset—your business income. It provides the cash you need to survive a shutdown or slowdown due to a covered cause of loss at an insured property. It can cover your payroll, continued operating expenses (such as rent), and lost net profits from the time your business shuts down until physical restoration of the property. Continuing to receive a near-normal income after a disaster helps you retain valued staff and maintain your financial stability during rebuilding.
The Limitations of Basic Business Income Coverage
Note the key phrases “insured property” and “covered cause of loss” above. To understand why these are important, let’s say that heavy snowfall caused your plant’s roof to collapse and forced a four-week closure for repairs. If your BOP covers this property, your business income coverage would apply.
Now let’s imagine snow damage closed a key supplier’s location. Even if you lost business as a result, your coverage would not apply, because the damage did not take place on your “insured premises.” Likewise, a shop in a mall would lose income if the mall had to close due to roof damage. If the shop itself (the insured location) didn’t have any damage, its business income coverage would not apply.
To cover these and similar situations, businesses can buy “contingent locations” coverage. This essential coverage protects businesses that depend on other businesses for their survival. These could be suppliers, key clients or even a neighboring business that draws customers to the area, such as an anchor store in a mall. If a covered loss closes or slows business at one of these “dependent properties,” contingent business interruption coverage will cover your lost income. You can buy this coverage on a named property basis, which would cover you for losses at specific locations, or on a blanket basis.
The “Time Element” in Time Element Coverage
Some insurance experts call business income coverage a “time element coverage” because it takes time for a loss to develop. Policies usually have a 72-hour waiting period, meaning they will not pay for income lost in the first 72 hours after direct property damage. You can buy additional coverage to reduce or eliminate the waiting period. Your “period of restoration,” or time the policy allows for rebuilding, begins after the waiting period. The policy covers your income lost during this time, usually 30 days.
After a major disaster, particularly one that affects a large geographic area, shortages of materials and skilled workers could make repairs drag on much longer than 30 days. To protect themselves from this risk exposure, businesses can buy coverage to extend the period of restoration for up to 360 days.
Most business income policy forms have a coinsurance provision. This requires the insured to buy insurance equaling net income and all operating expenses for a 12-month period, times the coinsurance percentage the insured selects. Coinsurance percentages range from 50 to 125 percent; the higher coinsurance percentage you select, the higher the premium credit your insurer will give.
Coinsurance percentages also affect how much your policy will pay at claim time. If Coinsurance percentages also affect how much your policy will pay at claim time. If you fail to maintain enough coverage, the insurer will pro-rate any claim payments, using the ratio of the insurance limit to the loss. Let’s say your business has an insured property damage loss and no income at all during the period of recovery, losing a total of $250,000 in income over three months. If you have $750,000 in coverage, your policy would pay a maximum of 75 percent of your loss, or $187,500, since you should have had at least $1 million in coverage ($83,334 in income per month times 12 months).
Insurers will waive the coinsurance penalty if your policy has an “agreed value” provision and you submit a business income worksheet to your insurer each year. In this case, your policy limit will be the agreed value, with no deduction for a coinsurance penalty.
Please also read How a Business Income Worksheet Helps You Rebuild after Disaster.
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