As catastrophes mount, interruption insurance worth consideration
INSIGHT ARTICLE |
As thousands of American businesses continue digging out from recent devastating hurricanes, an increasing number of company owners are exploring business interruption insurance.
It’s important they do so: Many, if not most, of those in Houston and Florida who had business interruption insurance are on their way to recovering; those who did not have this type of insurance may never open their doors again.
As natural catastrophes increase across the country, businesses with inadequate insurance are at heightened risk. Even before Hurricanes Harvey and Irma made landfall, there were nine weather and climate disaster events with losses exceeding $1 billion each across the United States in 2017, according to the National Oceanic and Atmospheric Administration, including two flooding events, one freeze and six severe storms. Overall, these events resulted in the deaths of 57 people and had significant economic effects on the areas affected. Current estimates for losses from both Harvey and Irma exceed $300 billion.
More than basic coverage
In response, many business owners are seeking to bolster their basic insurance by adding business interruption coverage. Unlike basic insurance that covers damage to structures and equipment, business interruption insurance provides funds that a business owner can use to pay salaries and expenses during a period when normal business activities are temporarily suspended; it also covers the loss of business income during this time period.
It should be noted that many standard insurance policies provide for revenue reimbursement during a reconstruction period, but only for a limited time, such as a month, and often with relatively low caps. Business interruption insurance is different: Think of it as similar to personal long-term care insurance, or some other form of income replacement insurance for those who are suddenly disabled.
Construction is among the industries that stand the most to gain from business interruption insurance. With profit margins averaging around 3 to 4 percent, many contractors do not have the cash reserves to sustain long-term interruptions. But each situation will be unique and coverage can be dependent on a number of factors.
For example, suppose a contractor planning to start a project on Dec. 1 is devastated by a tornado in late November. If the project owner says it will be fine to start the project in January, the contractor may not receive business interruption insurance compensation for December because the project—and payments—have been postponed until January.
But if the project owner terminates the contractor because he or she is unable to start the project on time, business interruption insurance will likely pay for lost income from that project. In such situations, business interruption insurance can be especially important for the continued viability of the business.
Assessing the need
According to global insurer Allianz, natural disasters around the world have increased in number from 400 a year to more than 600.1 In addition, business interruption now accounts for a much higher proportion of the overall loss than was the case 10 years ago. The average large business interruption property insurance claim is now more than $2.4 million, which is 36 percent higher than the corresponding average property damage claim of about $1.8 million, according to Allianz.2
For contractors considering business interruption insurance, the process should begin by assessing worst-case scenarios and then analyzing how each would affect cash flow and subsequent profits. During this step, contractors likely will need assistance from their accountants as well as their insurance broker. To file a claim, contractors need to know exactly how much money needs to be replaced, and that figure needs to cover not just lost profits, but also fixed expenses such as rent and salaries.
At the same time, extra expenses need to be identified because these expenses may also qualify for reimbursement under the provisions of an insurance policy. An extra expense could be the cost incurred in renting a temporary storage shed due to the insured event, for example. These costs need to be determined and documented during the preparation of an insurance claim.
Depending on a company’s size, business interruption insurance policies cost between $750 and $10,0003 and the policies normally are combined with a company’s regular insurance. It is important that contractors make certain their business interruption insurance is broad enough to cover all necessary expenses, and this requires a re-examination of the basic insurance plan. If the basic plan does not include flood insurance, for example, then the additional business interruption insurance may not cover income lost because of a flood.
One aspect of business interruption insurance that is often misunderstood is valuation. Accounting gross profits do not necessarily equal insurance gross profits. It is important to be aware of your specific policy provisions regarding indemnity periods since one size does not fit all.
While it is common to opt for a standard 12 months in gross profits, that is rarely enough. Many policies pay until the property is reinstated. Policies should be evaluated to determine if there is a time-element period, and whether the policy includes sufficient funds for a true recovery of profits and reimbursement of expenses.
It’s important to remember that standard business interruption insurance can’t take care of every cost. For example, replacing a building may be more expensive than expected due to new codes and the cost of modern materials. To cover these extra expenses, contractors may need to add an “extra expense’’ rider.
Depending on a company’s geographical location, business interruption insurance may not be worth the cost. But as we are learning in painful fashion, few areas of our nation are out of reach of a natural disaster. Consequently, all contractors should consider this extra layer of protection.
Published In: December 2017 Texas Contractor.
1. “Managing disruptions: Supply chain risk: an insurer’s perspective” (2012) Allianz Global Corporate & Specialty AG
2. “Business interruption on the rise: growth in insurance claims highlights increasing risks for businesses worldwide” (Dec. 9, 2015) Allianz Global Corporate & Specialty AG
3. Understanding Business Interruption Insurance, Trusted Choice, Independent Insurance Agents