Could Your Business Keep Operating After a Major Loss? Understanding Business Interruption Insurance

A fire, major water loss or other unexpected event can damage more than your building or equipment. It can also affect your ability to generate revenue, pay employees and keep up with ongoing expenses while your business gets back on its feet.

Property insurance may help repair or replace damaged property but what happens to the financial side of your business while operations are interrupted?

That is where business interruption insurance can play an important role.

Business interruption insurance is designed to provide financial protection when a business cannot operate normally because of an insured loss. Depending on the policy and coverage selected, this may include losses caused by events such as fire, water damage, flood or earthquake where those perils are insured.

What Can Business Interruption Insurance Cover?

Every policy is different, but business interruption coverage generally focuses on three key areas: loss of income, ongoing expenses and extra expenses.

Consider a business that has to temporarily close after a serious property loss. Even though customers are not walking through the door, many financial obligations may continue.

Business interruption coverage can be structured to help address the income the business loses during the shutdown, along with certain operating costs that continue while repairs are underway.

There may also be additional expenses involved in keeping the business running. For example, a company may need to temporarily relocate or take other steps to reduce the overall loss. Extra expense coverage can help with qualifying costs incurred to mitigate a business income loss and, depending on the coverage selected, can also be written more broadly to help a business continue operating.

Not All Business Interruption Coverage Is the Same

There are several ways business interruption protection can be structured. The right approach depends on factors such as the type of business, how quickly operations could realistically resume and how long it could take revenue to return to normal.

Gross Earnings

Gross Earnings coverage is intended to insure the loss of gross earnings, less expenses that do not continue during the shutdown.

The coverage period generally begins on the date of the insured loss and continues until the damaged property has been repaired, or reasonably should have been repaired, subject to the policy’s maximum indemnity period.

This approach may work particularly well for businesses that can recover relatively quickly, including some offices, manufacturers and wholesalers. One important consideration is that coverage may end once repairs are complete, even if revenue has not yet fully recovered.

Profits Form

A Profits Form takes a different approach. It can insure the loss of net profits plus continuing operating expenses.

Rather than focusing only on when physical repairs are completed, the coverage period can continue until income returns to pre-loss levels, subject to the maximum indemnity period.

That can make it particularly relevant for businesses such as restaurants and retailers where rebuilding the physical space may be only part of the recovery. Customers may take additional time to return and sales may not immediately rebound to where they were before the loss.

Profits Actual Loss Sustained

Another option is an Actual Loss Sustained form.

This type of coverage can insure the loss of net income plus continuing operating expenses without a preset dollar limit, although coverage remains subject to the applicable maximum indemnity period and the terms of the policy.

It may be useful for businesses where future revenues and costs are more difficult to estimate. Businesses still need good financial documentation to demonstrate the amount of the loss.

How Long Would Your Business Really Need to Recover?

One of the most important decisions when arranging business interruption insurance is the indemnity period, or the period of time for which coverage may respond following an insured loss.

It can be tempting to assume that a business will return to normal as soon as repairs are finished. In reality, recovery can take considerably longer.

Construction may be delayed by labour shortages, supply chain issues or permitting. Even once the doors reopen, sales may take time to return to their previous level.

When reviewing coverage, business owners should think beyond the best-case scenario:

• How long would it take to repair or replace your location and equipment?
• Are any critical parts, machinery or materials difficult to replace?
• Could permits or contractor availability delay reopening?
• Once you reopen, how long could it take customers and revenue to return?
• Would your current coverage period realistically give your business enough time?

A loss that takes 18 months to recover from can create a significant problem if the business only planned for 12 months.

Don’t Overlook Your Coverage Limits

The amount of coverage selected matters just as much as the type of coverage.

Business interruption limits should reflect the financial reality of the business. Depending on the coverage being arranged, businesses may complete a Gross Earnings, Profits or Extra Expense worksheet to help determine appropriate limits.

Revenue changes over time, which means the coverage that made sense a few years ago may no longer reflect today’s business.

Growth, new locations, additional employees, higher operating costs and changes to the way a business operates can all make it worth reviewing your insurance regularly.

What Happens to Your Employees?

Payroll is another important consideration.

Some business interruption policies distinguish between employees who are essential to continued operations and what is commonly referred to as ordinary payroll.

Ordinary payroll may include wages for employees such as hourly workers, clerical staff and general labourers who may not be considered essential to operations during a shutdown. Businesses that want to continue paying and retaining these employees following a loss may need to specifically insure ordinary payroll for a selected period, such as 30, 60, 90 or 180 days.

For many businesses, this can be an important part of recovery planning. Reopening is one challenge. Reopening with the experienced team you had before the loss can be another.

Business Interruption Insurance Is Really About Recovery

When business owners think about a major loss, the first concern is often replacing what was physically damaged.

That is only part of the equation.

A business still needs cash flow. Expenses continue. Employees may need to be paid. Customers may go elsewhere during an extended closure and revenue may take time to rebuild.

The right business interruption coverage is designed with that recovery period in mind.

Before your next renewal, consider how long your business could realistically operate without its usual revenue and whether your current limits, indemnity period and payroll coverage reflect the way your business operates today.

A Navacord insurance advisor can help you review your business interruption coverage, understand the options available and identify potential gaps before a loss occurs.