Protecting your business from unforeseen events is crucial. Business income and extra expense coverage are two vital components of your insurance policy that ensure your business can weather the storm of unexpected disruptions. Unlike some other common business insurance coverage such as liability and workers compensation coverage, this one primarily benefits you!
In this blog post, we'll explore this coverage in detail, discussing the options available and what you should consider when determining your insurance needs.
Business Income Coverage
Business income coverage, often referred to as business interruption insurance, compensates you for lost income if your business operations are halted due to a covered peril, such as a fire or natural disaster. This coverage is designed to restore your business to the same financial position it was in before the loss occurred.
Methods of Business Income Coverage
Actual Loss Sustained (ALS)
Overview: This option covers the actual loss of income sustained during the period of restoration, up to a specified time limit, typically 12 months. It is commonly available on businessowners policies (BOP) for smaller businesses.
Pros: Simpler to manage, as it doesn’t require you to select a coverage limit.
Cons: May not be sufficient for businesses with longer restoration periods.
Coinsurance Method
Overview: This method requires you to choose a coverage limit based on a percentage of your annual income, known as the coinsurance percentage.
Pros: Can be tailored to fit your specific business needs.
Cons: Requires careful calculation to avoid penalties for underinsurance.
Understanding Coinsurance
Coinsurance in business income coverage means you agree to cover a certain percentage of your business’s annual income. The coinsurance percentage is essentially the percentage of the year that you would insure your income in the event of a loss. Common coinsurance percentages are 50%, 80%, and 100%, but can be higher, for example 120%
For Example: If your annual income is $1,000,000 and you choose 50% coinsurance, your coverage limit would need to be at least $500,000. In other words, you are insuring 6 months worth of your $1,000,000 annual income. If you selected 120%, your coverage limit would need to be $1,200,000. This would indicate that it would take longer than one year to restore your operations.
If you insure for less than the required coinsurance amount, you could face penalties that reduce your claim payout. Because many claims may not result in a loss of your full annual income, many insureds may be tempted to purchase a smaller amount of coverage.
By implementing coinsurance requirements, the insurance company and you agree on an accurate expectation of annual income. If you only wish to insure 6 months of your income you may select a 50% coinsurance percentage. However, the cost of the coverage will be based on the likelihood that 50% of your true annual income would be at risk. This is as opposed to purchasing half the coverage on an annual basis and collecting it all in 6 months.
Coinsurance Penalty Example
The equation for determining a coinsurance penalty is simple:
(“How much coverage did you purchase”/ “How much coverage should you have purchased”) x Loss amount
Or
(“Did”/ “Should”) x loss.
Assuming a $1,000,000 annual income, a $500,000 coverage limit, a 100% coinsurance amount, and a loss that causes 6 months of restoration ($500,000), the equation would follow:
($500,000/$1,000,000) x $500,000 = $250,000 claim payout.
So even though you sustained a $500,000 loss and purchased $500,000 of coverage, only half would be covered!!
This is because the coinsurance limit selected was 100%. You agreed to purchase a limit of insurance equal to 100% of your annual income, but only purchased half of that amount; as a result, only half of the loss would be covered.
Monthly vs. Annual Maximum Indemnity
Monthly Limit: Provides coverage for a specific amount each month during the period of restoration. This can be beneficial for managing cash flow during the recovery process. This method is is best for businesses who risk a consistent amount of income continuously until operations are restored.
Maximum Period of Indemnity: This option is available for business income needs up to a maximum of 120 days. It is not suited for businesses that cannot restore their operations in a reasonably short time-line. However, there is no monthly cap. This option may be suited for businesses that would have front-loaded loss of income, but could be back up and running fairly soon. For example a seasonal business, may lose a large portion of their income in a short period of time, and may not operate more than 120 days per year.
Ordinary Payroll Coverage
When selecting your coverage, you must decide whether to include or exclude ordinary payroll expenses. Including ordinary payroll ensures that you can keep paying your employees during the restoration period, which can help retain staff and maintain business continuity. If you work in a business where talent is hard to come by, it may be worth your while to include ordinary income. You may specify how many days of ordinary income will be included, such as 90 or 180 days.
Extra Expense Coverage
Extra expense coverage reimburses you for additional costs incurred to minimize the interruption of your business. These expenses are above and beyond your normal operating costs and are necessary to get your business back up and running as quickly as possible. However, extra expense coverage is provided only to the extent that it helps prevent further loss of income.
Example of Extra Expense
Imagine your office is severely damaged by a fire. To continue operations, you might need to:
- Rent temporary office space.
- Lease or purchase new equipment.
- Pay overtime wages to employees working to restore your business.
These additional costs are covered by extra expense insurance, ensuring you can resume operations with minimal delay.
Planning Your Coverage Needs
When determining how much business income insurance you need, consider the following:
Restoration Time: How long would it take to rebuild or relocate your business? This affects the period for which you need coverage and the coinsurance amount that may be appropriate to select.
Recovery Strategy: Would you rebuild at the same location or move to a new one?
This decision impacts the amount of extra expense coverage you might require as well as the coinsurance amount you may want to select. A business that rents its location, may be able to move to another location and be up and running in less time that a company that would need to re-build.
Conclusion
Business income and extra expense coverage are essential components of a robust business insurance portfolio. Understanding your options and carefully evaluating your business needs will help you select the right coverage. Protecting your income stream and managing extra expenses ensure that your business can survive after an unexpected disruption.
If you have any questions or need assistance in determining the best coverage for your business, don't hesitate to contact us. One of our independent insurance agents can help search for a policy that meets your specific needs.
(Licensed in KS, MO, CO and AR)