CHAPTER 1

Introduction:

  • Direct losses – building burning down
  • Indirect losses – loss of earnings. Less tangible.
  • Business interruption insurance protects commercial ventures against indirect financial loss.

Commercial Exposure:

  • From the income (revenue) earned, the business pays the expenses it incurs to earn that income.
  • Some typical business expenses:
  • The cost of goods or services sold,
  • Payroll, salaries, commissions,
  • Mortgage or rental payments,
  • Transportation,
  • Advertising,
  • Equipment,
  • Professional fees (legal and accounting services),
  • Bank loans,
  • Insurance premiums,
  • Telephone,
  • General office expenses,
  • When a business ceases, financial obligations continue.
  • If the business has a sizeable capital reserve, they could use that to maintain cost: profit ratios at or near their preloss levels and avoid increased loan costs.
  • All businesses needs some form of business interruption insurance (large and small).

Businesses That Can Use Business Interruption Insurance:

  • A business that can resume normal operations almost as soon as any loss or damage is repaired or replaced.
  • A business that may lose customers.
  • A business that must continue to operate because it provides a service or has a monopoly.
  • A business that requires skilled workers.
  • A business that relies on one supplier for a critical part of its product.
  • A manufacturer of a specialized component for a very limited market.
  • An apartment building used by multiple tenants who may need to move.

Business Interruption Insurance: Forms and Terms:

Forms:

  • Per diem form:
  • Requires insurer to pay the insured a specified sum per day for the loss of net profit and continuing expenses, for the period during which destruction or damage of the premises by an insured peril has partially or totally closed down the insured’s business.
  • Issued on a non-valued basis. This limits the insured’s recovery to the actual loss sustained on the per diem amount in the policy, whichever is less.
  • Accounts for only a small part of the business interruption premium.
  • Goss Earnings form (now Business Income form):
  • American version.
  • Provides coverage from the date of the loss until repairs or replacement have been completed with due diligence and dispatch.
  • Once the insured reopens for business, the coverage ceases.
  • Profits form (now Extended Business Income form):
  • British approach.
  • Recognizes that the interruption of business will continue to affect the business even after it has reopened.
  • Therefore, the business is interrupted not merely for as long as it takes to repair or replace the premises and contents but until the interruption has ceased to affect the level of business income – ie: the profit that would have been earned but for the loss.
  • Business Income / Extended Business Income:
  • Covers business income, rental income and extra expenses incurred.
  • Manuscript Wordings:
  • An agreed indemnity per day, week or month,
  • A limitation of the indemnity period,
  • A comprehensive description of the risk,
  • The normal policy details, such as full name of the insured, the location of the risk, and the perils insured against.

Terms:

  • Indemnity period – the duration or length of time for which indemnity will be provided under the policy.
  • Direct loss – the loss of economic value that occurs when property is damaged or destroyed. Ie: fire policy.
  • Indirect loss – the economic loss that arises from the direct loss or damage to property. Ie: business interruption losses.

Co-insurance:

  • Most fires cause partial losses.
  • Most insureds would choose to underinsure.
  • The purpose of the coinsurance clause is to encourage insureds to insure to value.
  • The clauses reduces the insured’s premium if the insured maintains an amount of insurance equal to at least a stated percentage of the total value of the insured property.
  • If after a loss, the actual amount of insurance is less than required by the coinsurance clause, then the insured will assume a proportionate part of the loss from the insurer, in effect becoming a coinsurer with the insurer.
  • Coinsurance formula: Amount of insurance carried/Amount of insurance required x Amount of loss.
  • The coinsurance clause applies at the time of the loss.

Financial Terms:

  • Income – money received by the business for goods sold or services rendered.
  • Expenses are the costs incurred by the business to function. These expenses are incurred either in supplying goods to be sold (the cost of merchandise or of materials used to make merchandise) or in running the operation (the operating cost expenses).
  • Variable expenses – vary in direct proportion to the amount of business. Ie: cost of merchandise.
  • Fixed expenses – continue regardless of the activity of the business. They must be paid even if operations cease completely. Ie: bank loans.
  • Semi-variable expenses – cannot be forecast in advance to cease or vary should the business be interrupted. Ie: cafeteria supplies.

Rating:

  • Basic rate is usually the building rate.
  • 80% coinsurance rate is normally used.
  • 90% rate if the building is sprinklered.

Benefits of Business Interruption Insurance:

  • Provides income.
  • Avoids further debt or capital drain.
  • Makes bankruptcy less likely.
  • Pleases banks – better financial security.
  • Keeps key personnel.
  • Enhances stock values.
  • Benefits government.
  • Provides employment.