Don’t Let A Disaster Destroy Your Company’s Income

Al Miller, CPCU
KeenanSuggs
January 3, 2012


In 2011, news of unbelievable disasters flashed across computer and television screens: tornadoes that ripped through Alabama and Missouri, taking out entire towns; a raging inferno that incinerated vast portions of Arizona and New Mexico, and a very active hurricane season.

Most South Carolinians shook their heads in disbelief and went about their business. Why? Mainly because of the belief that such disasters won’t happen here.

Wait a minute! Remember Hurricane Hugo and the havoc it caused in Charleston and across the state? The thousands of acres in Horry County destroyed by wildfires in 2009?

The truth is that disasters, natural and man-made, occur with regularity. If you own a business—a law firm, restaurant, retail store, manufacturing plant, hospital or medical practice, distribution warehouse, or financial institution—you should have business interruption and extra expense insurance as part of your disaster preparedness plan.

Business interruption and extra expense insurance are different from property insurance in that they are designed to protect a business’s financial well-being rather than its physical assets in the event of a disaster. Specifically, business interruption insurance covers:

1)    The net profit your business would have made during the period your business location is unusable.
2)    The costs and continuing expenses incurred by your business even though the location is unusable. This includes employee salaries.
3)    The costs incurred having to move and operate at a temporary location.
4)    The costs and extra expenses incurred by keeping the location open such as furniture or equipment rental.

Most businesses cannot operate without income so business interruption and extra expense insurance serves as an invaluable safety net. But before jumping on the bandwagon, understand this coverage is complicated. There isn’t a “one size fits all” plan; many variables are involved such as type of business, type of disaster, ability to function during the restoration period, the length of the interruption coverage, and of course, cost.

To further complicate matters, if you have business interruption and extra expense insurance, claims have to meet three criteria to be covered.

First, your business must lose income during the downtime period. Sounds easy, but it is possible that a business won’t lose income. Typically a forensic accountant will review historical income data, current income data, and operating costs to determine if income was lost. The best advice is to keep complete records, preferably with offsite electronic backup in the event of total destruction of your business.

Second, your operations must be suspended during restoration. This doesn’t mean a complete shutdown. Some policies cover slowdowns caused by disasters. So if your business is able to relocate to a temporary location and maintain a level of business, your income loss is still covered. The restoration period applies to the time following the loss until damaged property is replaced or restored so that the business can operate.

Third—and this is a biggie—the loss of income must be a direct result of direct physical damage by a covered peril to premises described in the policy. Here is an example. You own a popular restaurant in Five Points. A tornado sweeps through the area and destroys many buildings. Power is wiped out for days and perhaps weeks. Fortunately, your restaurant has been spared, except for spoiled food. News of the disaster spreads fast. Customers stay away, thinking Five Points is closed for business. Your income potential goes down the drain.

Unfortunately, business interruption insurance and extra expense insurance may not help in this case. Even though you met points one and two, your premises were not damaged by the wind, a criteria of coverage. And unless your coverage was structured to include off premises power failure, you would not have coverage for this loss.

This gets us back to the question of should a business have business interruption and extra expense insurance? The answer is yes; most businesses should have it in one form or another. And this is where having a knowledgeable commercial insurance broker is critical. A knowledgeable broker will help you understand your potential exposure and discuss options for a variety of natural and manmade disasters.

For example, if you are located in tornado alley, the risk and probability of a natural disaster is high and business interruption insurance is a sound decision. If you operate a food processing plant, coverage that protects you in the event of power outages—and food spoilage—also is a good decision.

(It is interesting to note that acts of terrorism used to be covered by commercial insurance policies. After the 9-11 attack, coverage for acts of terrorism is a separate and optional coverage. Careful consideration is required to determine if it is necessary.)

Of course, you can’t insure everything; the cost would be prohibitive. That’s why a good broker will help identify economical solutions and determine what is essential to cover and what level of risk the business owner can assume.

The best advice is to recognize that every business has some exposure. Know what coverage you do and don’t have so that if and when a disaster strikes and limits your company’s ability to generate income, you are protected and remain in business during the recovery period.