Winter, 1998
CLAIMS LAW UPDATE
BUSINESS INCOME COVERAGE
[Ref: Commercial Property, Para. 715-719]
Business income coverage is an important form of insurance for commercial policyholders. Its intent is to provide the insured with a source of recovery for actual loss of business income when operations are interrupted as a result of a covered cause of loss. For an insured whose operations are suspended for a period of time, it can mean the difference between survival and extinction.
Business income coverage has taken different forms over the years. It has been referred to as time element insurance, at one time taking the name of business interruption coverage, and currently goes by the name of business income insurance under the commercial property forms. Coverage is available for loss of income and extra expense, or loss of income without extra expense. Similar coverage, for loss of income, is also available under the Business Owners Policy. The primary focus of this article will be on the ISO Business Income Coverage Form including extra expense.
BUSINESS INCOME
What is business income? Historically, coverage was provided for the insured’s reduction in gross earnings less any expenses which were not continuing. There did not have to be an actual loss of profit for an insured to recover. As long as the business would have generated earnings which would have covered its operating expenses, but for the operations being suspended, recovery was possible. The policy now provides coverage only for actual loss of business income. This is a clarification of the earlier policy language. However, it may not necessarily change the benefit realized by the insured. The policy now addresses business income as follows:
Since business income includes net profit or loss, before taxes, it may be possible for an insured to seek recovery for loss of business income where the business was not operating at a profit. For example, consider a business which generates a monthly income of $20,000 but incurs monthly expenses of $30,000 for a net loss of $10,000. The insured has continuing operating expenses of $25,000 during a one month period of business interuption. The insured has business income of $15,000 (a. net income of minus $10,000 and b. continuing operating expenses of $25,000).
The coverage considers not just the actual loss of income but also continued expenses. These continued expenses are a form of loss because the insured is still obligated to make these payments but realizes no income from business operations during the period of loss. For example, if an insured leases premises which were the subject of a loss and is obligated to continue to pay rent while operations are suspended, there is a continuing operating expense which the insured must now meet, at a loss, because the business is not bringing in any money. If an insured has payroll obligations which continue during the period of suspension they too become a covered loss. These expenses, during the period of suspension, are not being offset by the income which would otherwise have been generated. If, on the other hand, the insured is relieved of the obligation to pay rent or salaries, then these expenses, which otherwise would have been incurred in the course of operations, are not considered as part of the insured’s loss.
A business may realize income from different sources. Income may be generated through sales, the provision of services, ownership of rental property, or a combination of sources. The policy allows the insured to choose the type of business income to be covered. An insured who has no income generated from rental property may elect coverage for business income other than rental value. An insured whose income is from rental property alone can elect coverage for business income based solely on rental value. Coverage may also be elected for both business income and rental value.
PHYSICAL DAMAGE
AND
SUSPENSION OF OPERATIONS
Not all claims for loss of business income will be covered. The loss must have been incurred because of the necessary suspension of operations due to direct physical damage resulting from a covered cause of loss. Coverage applies for the period of restoration, meaning the time that it would reasonably take to repair or replace the damaged property. It is not enough that there was a suspension of operations or that there was damage resulting from a covered peril. The damage from the covered peril must be the basis for the business interruption. Furthermore, the suspension must be the result of damage to property at the premises described in the policy’s declarations, including personal property in the open or in a vehicle, within 100 feet of the covered premises. Damage to property off of the premises described in the declarations does not trigger coverage. If an insured factory burns and all inventory is lost there is a valid claim for the factory’s loss of income. If the insured has a retail store at a different location which suffers an income loss because of lack of inventory due to the factory fire, such loss is not covered unless the insured has blanket coverage applicable to both the factory and the retail store.
The Business Income Form is attached to the commercial property policy and coverage is determined by the perils covered by the form to which it is attached. Similarly, the exclusions for the form to which the Business Income Form is attached also apply to the insured’s claim for loss of business income.
The North Carolina Court of Appeals was called upon to consider the physical damage requirement in Harry’s Cadillac -Pontiac - GMC Truck, Inc. v. Motors Insurance Corp, 486 SE2d 249 (1997). In Harry’s, the insured’s business operations were interrupted for a period of one week as a result of a severe snowstorm. Coverage was under a Causes of Loss - Special Form, which provides open perils coverage and therefore covers damage from a snowstorm. The covered building had sustained minor damage as a result of the storm. The repairs took a short period of time and the damage to the building did not cause any interruption to the insured’s business. However, the business was closed because of the road conditions due to the snowstorm. The court found that the insured’s operations were suspended because of his inability to access the business due to the snowstorm and not because a covered peril caused damage to the business. The insured’s business income claim was not covered because there was no suspension of operations resulting from direct physical loss or damage to the described premises as a result of a covered cause of loss.
PERIOD OF RESTORATION
The insured’s claim must be based on a loss of business income which was incurred during the period of restoration. A loss occurring at a later date is not subject to coverage, even though the insured may be able to establish that the loss resulted from the suspension of operations. The policy describes the period of restoration as the period of time that:
The policy further states that this time period will not include any increase due to the enforcement of any ordinance or law which:
Pennbar Corp v. Insurance Company of North America, 976 F2d 145 (1992), provides an example of a claim for loss of income which considers the requirement that the loss occur during the period of restoration. The insured was a manufacturer of manual typewriters. The insured’s subsidiaries had factories in foreign countries and the policy in question had been written to provide coverage for all of the insured’s related companies, including the foreign subsidiaries. The factory of the insured’s Italian subsidiary suffered earthquake damage on two occasions, the first on 11/23/80 and the second on 1/9/81. Operations were suspended as a result of physical damage for a period of five days following the first quake and for slightly over one month following the second quake.
The insured was able to utilize existing stock to meet its sales orders during the period of restoration. The insured was also able to locate an alternative source of typewriters. The insured’s claimed loss was based on the number of typewriters which the factory would have made, but for the earthquake, and which the company claimed it would have sold at a later time. Thus its claim was based on projected sales and not a loss which actually occurred during the period of suspension of operations. The U. S. Court of Appeals, applying New Jersey law, held the insured’s claim to be invalid. The court found that the policy was clear and unambiguous in providing coverage for only the loss of income which occurs during the period of restoration. This insured’s claim was for a loss which did not occur during the period of restoration.
A word of caution: In policies which do not provide coverage for extra business expense, there is a waiting period of 72 hours. This may also be referred to as a deductible period. It has the effect of eliminating coverage for situations where the suspension of operations for restoration is brief in duration.
ADDITIONAL COVERAGE
The Business Income Form provides for four additional coverages: Extra Expense, Civil Authority, Alterations and New Buildings, and Extended Business Income. These additional coverages do not increase the limits of liability. An insured with business income coverage of $100,000, for example, can not recover more than this amount. If the insured suffers a business income loss of $75,000 and an extended business income loss of $65,000, the insured’s total recovery will be for no more than the $100,000 coverage limit.
Extra expense coverage provides a source of recovery for expenses incurred in an attempt to avoid or minimize the suspension of business during the period of restoration. The coverage is for expenses incurred in an effort to continue operations, whether at the covered premises or by relocating the business to replacement or temporary premises. Coverage is also afforded for expense incurred in an effort to minimize the suspension of operations, if it is not possible to continue operations. Such expense is covered even if the result is that it does not minimize the insured’s loss of business income.
There is coverage for expense incurred in replacing or repairing property as well as expense incurred in researching, replacing, or restoring information on damaged records or papers. This is not coverage for damage to this type of property (repair or replacement of the property itself may be covered by the underlying policy), but is coverage to defray the expense incurred in mitigating the business income loss. The policy requires that the insured mitigate his loss and this coverage recognizes that the insured will incur expense in doing so. It allows the insured to recover the amount expended in mitigation to the extent the business income loss is reduced. If the insured incurs expenses of $2,000 and reduces his loss of business income from $7,500 to $3,500, the extra expense will be covered in full. If, on the other hand, the insured incurred $2,000 in expenses and only diminished his loss of business income by $1,000 the insured would recover only $1,000 of the $2,000 in incurred expense.
The additional coverage for civil authority applies to situations where the insured’s operations are suspended as a result of the act of civil authority, due to direct physical loss of or damage to property other than at the insured premises. The physical damage must be the result of a cause of loss which is covered under the insured’s policy. Coverage does not apply where the insured is denied access to his premises by act of civil authority which is in response to damage at the insured premises. For example, if a building neighboring the insured’s suffers a fire and the police evacuate the surrounding area, causing the insured to suspend operations, the insured would be covered for his loss of business income. Coverage is limited to a period of no more than two consecutive weeks from the date of the action. If, however, the insured’s building suffered a fire, which prompted the civil authority to act, the insured would look for coverage under the peril of fire and not the additional coverage for civil authority. Note that if the policy does not include coverage for extra expense, as with the deductible period applicable to loss of business income resulting from a covered peril, there is a 72 hour deductible or waiting period under this coverage. The insured must be denied access for more than three days before coverage applies, but the full two week coverage period is available, running from the date the 72 hour period ends.
For an insured whose physical plant is expanding, the additional coverage for alterations and new buildings could be a blessing. This adds coverage for: losses involving new construction, whether finished or not; alterations to existing structures; and machinery, equipment, supplies or materials within 100 feet of the described premises used in conjunction with the construction or alteration project or incidental to the insured’s occupancy of the new building. The new construction and alterations have to be on the described premises. Coverage applies where the insured is delayed in starting operations at the new or altered building as a result of a covered loss. The period of indemnity (period of restoration) will be considered as starting from the date that operations would have begun, but for the loss.
The final additional coverage provides recovery for extended business income. This coverage is for loss which is incurred after the repairs are complete and operations are resumed. This coverage recognizes that the insured operations may not immediately realize the level of productivity which would have existed had the loss not occurred. The initial suspension of operations must be the result of damage caused by a covered cause of loss. Consider, for example, a restaurant. If the restaurant was shut down for repairs for a period of two months, many of its customers would find other places to dine. After reopening, the insured restaurant will need to rebuild its client base as it may be some time before people are aware that business has resumed or they may have found new restaurants which they now frequent instead of the insured’s. The loss of income which occurs while the restaurant becomes re-established is covered until such time as operations reach the level which would have existed, or thirty consecutive days after operations are resumed. The shorter of these time periods applies as the period for which indemnification may be sought. It is possible to increase the period of indemnity beyond thirty days. Any increase will be noted in the policy declarations.
CONDITIONS
The Business Income Coverage Form is subject to the Common Policy Conditions and the Commercial Property Conditions. It also contains its own loss conditions, many of which are similar to the conditions found in other property forms. The condition applying to loss determination, in particular the language addressing resumption of operations and operations which are not resumed as quickly as possible, is of interest. This policy language addresses how the insurer will treat the steps taken, or not taken, by the insured to resume operations. For instance, loss of business income will be reduced to the extent that operations are resumed through the use of damaged or undamaged property at the insured premises or elsewhere. This only makes sense because, if an insured can generate some income through, for example, the sale of damaged goods, then this income should be used to offset the loss of income which otherwise would have occurred. Remember, insurance is intended to make the insured whole and not to be a source of profit. If the insured does not resume operations or does not resume them as quickly as possible, then the insurer should adjust the loss based on the time it would have taken to resume operations as quickly as possible.
An insurer might believe that there was no suspension of operations and thus no coverage, where the insured resumes operations despite the damage and need for restoration. The issue of coverage where operations are resumed was considered in Maher v. Continental Casualty Company, 76 F3d 535 (1996). The insured owned and insured a furniture store which sustained fire damage. The building and stock were damaged by fire, smoke, and residue from fire extinguishers. Cleanup and repair took approximately two weeks to complete, during which time the insured resumed operations by selling damaged stock at reduced prices, as directed by the insurance company’s adjuster. The insurer denied the insured’s claim for loss of business income because the insured did not completely shut down operations. The insurer’s denial was based on policy language which stated that payment would be made for loss of business income the insured sustained due to necessary suspension of operations during the period of restoration. The court found that this argument was contrary to the policy language which reduces the business income loss to the extent the insured is able to resume operations by the use of damaged or undamaged property. The court found that this reduction language clearly indicated that there is coverage for lost income, even where the business continued to operate at a reduced level following the covered loss. The insured was entitled to recover damage for the actual loss of business income incurred during the period of restoration, taking into consideration the income generated from the sale of the damaged stock.
The policy places limitations on loss of business income resulting from physical loss or damage to electronic media and records. This is significant in this computer age. Coverage ends sixty days after the date of actual physical damage or the end of the period necessary to repair, rebuild, or replace other property at the described premises due to loss caused by the same occurrence. If the insured suffers a fire which destroys its computers, the insured has coverage for loss of income related to the loss of the computers for sixty days. If repairs to the building are completed in thirty days then this becomes the maximum time for which the loss of income related to the computers will be compensable.
CONCLUSION
Business income coverage is a complex area of insurance. Many fact questions will exist when you are faced with a claim for loss of business income and care must be taken in review. The insurance professional needs to consider the premises covered and the loss location, the type of business income claimed, the cause of the loss, the period of restoration and any additional or continuing expenses to which the insured may be entitled. One also needs to keep in mind that it is the insured who has the burden to prove the loss of income claim.
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