When you’re in the thick of growing your business, the last thing many entrepreneurs think about is what happens if their business suffers a loss. Most people understand the need to insure their business property against loss but many forget about the second-order effects of lost income and productivity that come with it. Business Interruption Insurance helps you pay for lost income resulting from a loss interrupting your business.
What Is Business Interruption Insurance?
Traditional property insurance is fairly straightforward and easy to understand. You buy insurance for a certain amount or limit of insurance and when that property is lost or damaged, you get compensation from the insurance company in the form of cash or you get the property repaired or replaced.
But when it comes to business property, any physical loss or damage actually comes with more financial consequences than just the damage itself. Oftentimes, you will rely on physical assets like buildings and machinery to operate your business and generate income. If a key piece of equipment is damaged, the financial consequences in terms of lost income can easily be worth 10 or 20 times as much as the equipment itself.
Business Interruption is a key piece of your commercial insurance package that addresses this important exposure. When you suffer a loss to your property that causes an interruption to your business, the insurance company will indemnify you for the income lost.
What Does Business Interruption Insurance Cover?
Put simply, business interruption covers you for loss of income that you would have earned had the loss not occurred. The insurance company would calculate the amount of indemnity based on many factors including:
- Historical Financial Statements
- Trends and Seasonality
- Anticipated Growth
- Limit of Insurance
How Is Business Interruption Coverage Triggered?
For most business interruption policies, coverage is triggered when there is a physical loss or damage to your tangible property. Common examples include: theft, earthquake and fire.
For more complete coverage, you can also consider contingent business interruption insurance that extends coverage to interruptions to your business caused by losses to the tangible property of major suppliers or customers.
Will Business Interruption Insurance Cover Coronavirus?
This is an uncertain time for many small businesses. With the need to practice physical distancing, many Main Street businesses that form the backbone of the Canadian economy are forced to shut down completely or curtail operations.
While there are policies out there that have specific language meant to insure against pandemic-related interruptions, they’re mostly seen in policies for medical professionals like dentists. Unfortunately, that means most small businesses are not able to access their business interruption coverage during this COVID-19 pandemic as it doesn’t constitute a physical loss.
That said, there have been cases where businesses were able to access coverage under a “contamination” claim. For example, if you discover that a worker came in sick and you have to close for 1 week to perform a deep cleaning, you may have a valid claim. The legal argument here is that the contamination is a type of physical loss as it renders the premises unusable or uninhabitable.
Another avenue that small businesses can try to get coverage is under their “actions of a civil authority” clause. There is usually language in your policy that will give you 2-4 weeks coverage if your business is interrupted due to the actions of a civil authority. If you go down this route, check if your policy restricts this coverage to orders related to physical damage. There may also be restrictions against voluntary or partial shutdowns.
While I’m not in the business of providing legal advice, these are two potential avenues that you may want to explore. If that’s the case, make sure you review your policy wordings carefully with your lawyer and insurance broker. The courts tend to side with insureds whenever there is ambiguity so it may make sense to claim even if it’s unclear whether you’ll have coverage or not.
Even if your claim is ultimately unsuccessful, the information you’ve compiled regarding your COVID-19 related losses will help you apply for different government relief programs later on.
As an interesting side-bar, Wimbledon has been paying for pandemic insurance for the last 17 years and now is poised to collect a US$141 million payout due to COVID-19. This really shows the importance of having a comprehensive and professionally designed insurance policy.
When Does Interruption Coverage Start and How Long Does It Last?
This is commonly referred to in the industry as the period of indemnity. The indemnity period begins when a qualifying loss triggers coverage. How long it lasts depends on the type of business interruption coverage that was purchased but it typically continues until your property has been repaired or your income has been restored up to a maximum of 12 to 18 months.
Business Interruption Claims Example
Client: Bob’s Ice Cream Parlor Inc. Situation: An electrical fire started on site during work hours the day before Canada Day long weekend. Thanks to the quick action of their staff, the fire was quickly controlled and the only damage was to their commercial stand mixer.The insurer indemnified Bob’s Ice Cream Parlor Inc. $750 to repair the stand mixer. Outcome*: During the 3 days it took to repair the mixer, Bob was not able to sell one of their most popular products resulting in $5000 in lost income compared to similar periods in the past. As a result., the insurer also indemnified Bob for the $5000 in lost income he would have earned had the loss not occurred.
*Names and amounts have been modified to protect privacy.
How Much Business Interruption Insurance Is Enough?
There is no one-size-fits-all solution for something like this and it really comes down to working with a qualified commercial insurance broker to assess your business and the risk exposure involved. That said, there are some things you may want to consider on your own:
- Amount of monthly income and expenses that will continue during an interruption (ie. taxes, wages, mortgage/rent, and debt repayments)
- Personal and corporate cash reserves available to self-finance a loss
- Average period of interruption for your type of business
- Common losses experienced by your type of business
- Ability for you and your team to work remotely
- Ability to minimize interruptions by renting an alternate location, renting equipment, etc.
Even if you don’t intend to purchase business interruption insurance, going through this exercise on your own or with your insurance broker is going to help you with your business continuity planning.
Why Is Business Interruption Insurance Important?
“If a key piece of equipment is damaged, the financial consequences of lost income can easily be worth 10 or 20 times as much as the equipment itself.”
While everyone understands the need to insure their physical property from damage, many business owners and non-profit leaders I speak with still wonder why they need this type of insurance.
The key takeaway is that loss to physical property is just one part of the equation. Even though your property will be covered, it may take weeks or even months to rebuild everything in the event of a serious loss. As a result, you have the potential to suffer an even greater second-order financial loss in the form of lost income.