By Michael Rouse ,
US Property Practice Leader
The COVID-19 pandemic has resulted in unprecedented disruptions for businesses and the economy. Compounding the challenges for businesses are recent civil unrest in major cities along with the early days of what may be an active Atlantic hurricane season. These trends mean it’s vital for risk professionals to know how their property insurance policies — including business income or business interruption coverage — may respond to potential losses.
Many insurers’ property policies include business interruption or business income either as a coverage within the form; others, including those insurers that use Insurance Services Office (ISO) forms for their policies’ content, add this coverage via endorsement. A business interruption clause or endorsement is designed to protect the insured for losses of business income it sustains as a result of direct physical loss, damage, or destruction to insured property by a covered peril.
While many such clauses are in use today, a typical business interruption insurance clause might read as follows:
We will pay for the actual loss of business income you sustain due to the necessary suspension of your “operations” during the period of “restoration.” The suspension must be caused by the direct physical loss, damage, or destruction to insured property. The loss or damage must be caused by or result from a covered cause of loss.
Although the contents of individual policies and endorsements may vary slightly, many use relatively consistent language to describe business interruption coverage. To better understand this coverage and how it might respond to potential losses, it’s important for risk professionals to focus on eight key concepts.
Business interruption coverage protects against an actual loss sustained by an insured as a result of direct physical loss or damage to the insured’s property by a peril not otherwise excluded from the policy. The insurer is only obligated to pay if the insured actually sustains an interruption of business leading to a business income loss. This loss, however, is subject to the policy limit or sublimit that is applicable to the specific location where the loss occurs or the type of peril that leads to the loss.
Usually, an insurer is responsible for the reduction in net income that results from suspension of operations — whether wholly or partially — due to a physical loss at an insured’s premises. Generally, insurers consider business income to include:
Insurers are liable for the loss of business income only during the period of restoration, which is often defined as the length of time required to rebuild, repair, or replace damaged or destroyed property. The period of restoration begins when the physical loss or damage occurs; it ends when the property should, with reasonable speed, be repaired or replaced and the location is made ready for normal operations to resume.
Expiration of the policy does not end the period of restoration; as long as the insured’s physical loss occurs during the policy period, a business interruption endorsement will provide coverage for the duration of the period of restoration.
An endorsement published by ISO includes a 30-day extended period of restoration provision beyond the standard period of restoration, as do some insurers’ forms. This provides additional coverage after an insured business resumes operations following the date of repair or replacement of the damaged property, which can be crucial since it may take time for the business to return to pre-loss income levels. However, if an insured requires more than this 30-day limit, it may be able to increase this limit — from 30 days to any multiple of 30 days up to 720 days — by purchasing an extended period of indemnity optional endorsement.
A business interruption clause in a property policy or added endorsement can provide additional coverages, including for extra expense. This extension covers necessary expense sustained by an insured during the period of restoration that would not have been incurred had there been no physical loss to real or personal property caused by a covered peril.
When a business income loss occurs, an insured is obligated to take reasonable steps to prevent or minimize it. Any expenses incurred to reduce the loss are covered as part of the business income loss, as long as they do not exceed the loss itself.
An insurer will typically not pay any part of the expense that is more than the claim itself. For example, an insurer will reimburse an insured $100 to reduce the business income loss of $200, but will not reimburse the insured $100 if the claim is only reduced by $50. Any additional expenses above this $50 amount that are incurred to continue the business may be recoverable under an extra expense provision in an insurance policy.
Business income clauses or endorsements may also include “extensions of coverage” wherein the insured’s policy will insure against business income losses resulting from certain specified events. These include service interruption, contingent business interruption, leader property, and interruption by civil or military authority. A sublimit typically applies for each additional coverage.
If included within the policy, a service interruption extension typically provides business income coverage arising from direct physical loss, damage, or destruction to electrical, steam, gas, water, sewer, telephone, or any other utility service’s transmission lines and related plants, substations, and equipment supplying such services to an insured business. The owners, managers, or operators of such utilities or services are not named insureds under the policy.
A physical loss, damage, or destruction at the location of the utility or service typically must be the result of a peril similar to those covered under the insured’s policy. Some restrictions on coverage may apply, however, including:
A CBI extension is designed to cover an insured’s business income loss resulting from physical loss, damage, or destruction of property owned by others. These typically include direct “suppliers” of goods or services to an insured and direct “receivers” of goods or services manufactured or provided by the insured. The physical damage to these suppliers or receivers usually must be of a type that would be covered by the insured’s policy had the damage happened to the insured’s property.
A CBI extension typically provides coverage for the “direct” relationship between an insured’s “suppliers” or “receivers” of its goods or services. Coverage can sometimes be extended for suppliers of a direct supplier — typically known as “indirect” or “second tier” suppliers. Such coverage may require, among other things, that indirect suppliers are specifically identified.
A leader property endorsement provides coverage to an insured for direct physical loss, damage, or destruction — of the type insured by the insured’s property policy — to property not owned or operated by the insured, located within a stated distance to the insured’s property or business, that attracts business to the insured. Examples would include a nearby amusement park, casino, mall, or destination retail store.
This extension provides coverage to an insured for the actual loss of business income it sustains during the length of time when access to its premises is prohibited by order of civil authority as a direct result of physical damage — as insured against in the policy — to property of the type insured. An interruption by civil or military authority extension is commonly found under most policies insuring business income or business interruption.
The coverage time period most commonly specified in this extension is 30 consecutive days. An insurer may also impose a waiting period — typically 48 or 72 hours — that must be reached in order for coverage to apply.
Familiarity with these critical terms and specific relevant policy language is crucial to any organization’s understanding of how business interruption coverage may or may not apply to a loss, the preparation of potential claims, and future purchasing decisions. Risk professionals — working with their advisors — should carefully review their specific policy language and other coverage options that may be appropriate given their companies’ individual needs.