Business Income: Beyond the Basics – Part I
Section I – Four KEY Concepts
I. “Business Income”
A. Net income that would have been earned had no loss occurred PLUS Continuing Normal
Operating Expenses.
B. “Net Income”
1. This term used in the business income policy is not defined the same as it is
within the world of finance:
a.
Business Income Form: “Net profit (or loss) before income taxes”
b.
In finance/accounting, “net income” means: “Gross revenue minus all
business and production-related expenses”
c.
In reality, the business income form defines “Net Income” to mean:
Earnings Before Taxes (EBT)
2. If the risk is classified as a manufacturing operation, this amount includes the
sales value of production
C. “Continuing Normal Operating Expenses”
1. Normal operating expenditures that continue (in whole or in part) during the
time the operations are discontinued (the “Period of Restoration”) due to a
direct property loss.
2. Includes payroll, unless reduced or altered by endorsement (CP 15 10)
3. Non-continuing operating expenses are not included within the definition of
“Business Income.”
4. It is not necessary to know which operating expenses will or will NOT continue
when developing the business income limit
II. “Period of Restoration”
A. Time period beginning after the direct physical loss or damage and ending on the earlier
of (1) the date the property should be repaired, rebuilt or replaced with reasonable
speed and similar quality; or (2) the date when business is resumed at a new permanent
location.
1. Generally there is a time deductible – 72 hours unless altered by endorsement
(CP 15 56)
2. Policy expiration does not alter the period of restoration
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Business Income: Beyond the Basics – Part I
B. Important Requirements
1. Direct physical loss/damage to the insured property itself; and
2. The damage must be caused by a “Covered Cause of Loss”
C. Four Period of Restoration Objectives
1. Repair or rebuild the insured structure or find an alternative permanent location
2. Locate, purchase, install and have operational replacement machinery and
equipment
3. Replace or replenish stock
4. Return as quickly as possible to the same level of “operational capability”
existing just prior to the loss
III. “Operational Capability”
A. This term is not found in the business income policy, but it defines the end of the period
of restoration
B. An entity’s ability to operate at or as nearly as possible at pre-loss sales or production
levels
1. Manufacturing operations: when they are able to return to pre-loss production
and inventory levels (excluding the time necessary to produce finished stock)
2. Non-manufacturing operations: the point where they can operate with the same
level of inventory, equipment and efficiency as before the business-closing loss
C. Operational Capability can be accomplished by repairing or rebuilding the current
location; or by finding a new permanent location
IV. “Time Doctrine”
A. Not found in the policy, but the concept that best describes the purpose/use of business
income protection
B. “Business Income” losses are settled based on the coverage limit purchased
C. Coverage limit is based on two factors
1. The 12-month business income exposure; and
2. The worst-case “period of restoration”
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Business Income: Beyond the Basics – Part I
D. The Key to business income is the correct estimation of time
E. Time Doctrine: All business income losses are settled based on the coverage limit
purchased. An accurate business income coverage limit calculation depends on the
legitimate estimation of the worst-case period of restoration. Estimating the worst-case
period of restoration necessitates understanding the time required to accomplish the 10
steps within the four “period of restoration” objectives. The key to business income is
the correct estimation of time.
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Business Income: Beyond the Basics – Part I
Section II - Major Business Income Policy Provisions
I. Three Business Income Sources
A. Business Income including Rental Value: Used when insured receives income from many
sources, including rental income
B. Business Income other than Rental Value: Used when the insured receives NO rental
income
C. Rental Value: Used when the insured’s sole source of income is rents
D. “Rental Value” is captured on Line “G.” of the business income worksheet (CP 15 15)
II. Five Coverage Triggers
A. There must be a suspension of operations
B. Suspension must be caused by direct physical loss of or damage to property at the
insured premises
C. The damage must be caused by a covered cause of loss (based on the cause of loss form
attached to the commercial property policy)
D. If damage to personal property in the open is the reason for the suspension, the personal
property must be within 100 feet of the insured premises
E. Business income losses are only paid during the defined “period of restoration”
III. “Covered Cause of Loss” Exclusions Specific to the Business Income Form
A. Business income coverage does not cover the cost of damage to “finished stock”
 Damage to “finished stock” is covered by the commercial property policy.
B. The “period of restoration” does not include the time necessary to replace, replenish or
repair “finished stock”
 The value of “finished stock” paid under the commercial property policy is the selling
price, thus the insured has, in a sense, already been paid for the income lost from the
finished stock and including the time to replace the finished stock as part of the
“period of restoration” would be double recovery.
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Business Income: Beyond the Basics – Part I
C. Neither business income nor extra expense coverage is available to if the business
suspension is caused by or the result of damage to or destruction of any part of a radio or
television antenna (unless the policy has been endorsed to provide this coverage using
the CP 15 50 “Radio or Television Antennas – Business Income or Extra Expense)
D. The “period of restoration” does not include any increase in building time due to the
actions of strikers or other like persons
E. The “period of restoration” is not lengthened due simply to the suspense, lapse or
cancellation of any license, lease or contract
F. No extra expense protection is provided to cover the costs associated with the suspense,
lapse or cancellation of any license, lease or contract
IV. Blanket Coverage
A. Substantial common ownership, actual management or operating control by the insured
is required at all locations to be blanketed
B. Coinsurance option must be in use
C. Warehouses, garages and offices are NOT considered additional locations for rating
purposes (if they are NOT the main business location)
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Business Income: Beyond the Basics – Part I
Section III - Calculating Coinsurance, Period of Restoration and Coverage Amounts
I. Calculating Coinsurance
A. Difference between Property Coinsurance and Business Income Coinsurance
1. Property coinsurance is based on the VALUE of the property at risk at the time of the
loss
2. Business income coinsurance is solely a function of time
 The actual business income exposure (“insurable” business income) is not
necessary to develop business income coinsurance
B. Information necessary to calculate business income’s coinsurance percentage
 A legitimate estimation of the time it would take the business to return to
operational capability following a worst-case scenario loss – the “Period of
Restoration”
C. How to calculate coinsurance
1. Estimate the worst-case “Period of Restoration.” How many months will it take to
return to “operational capability” following a worst-case scenario loss?
2. Divide the worst-case period of restoration by 12 (the number of months in a year)
3. The result is the recommended coinsurance
D. Importance of the coinsurance percentage
1. The business income coinsurance percentage is NOT dependent on the amount
subject to loss; it is dependent on and calculated using an accurate estimation of the
“Period of Restoration.”
2. Once the coinsurance percentage is calculated, it can be applied to the 12-month
business income exposure (“J.1’” or “J.2.” on the CP 15 15) to develop the limit of
business income coverage needed.
E. Acceptable coinsurance percentages: 50%, 60%, 70%, 80%, 90%, 100%, and 125%
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Business Income: Beyond the Basics – Part I
F. Example
Business Income Coinsurance Examples
Business Income Exposure for 12 Months (J.1.
$1,375,000
or J.2. from the Worksheet)
“Maximum Coinsurance Percentage”
Estimated Period of Restoration / 12
Maximum Coinsurance Percentage X 12“Estimated Loss of Income”
month Business Income Exposure (“J.1.” or
“J.2.”)
Example 1:
Estimated “Period of Restoration”
12 months
Maximum Coinsurance Percentage (12/12=)
100%
“Estimated Loss of Income”
$1,375,000 (Amount Subject to Loss)
Minimum BI Limit Purchased
$1,375,000
Example 2:
Estimated “Period of Restoration”
6 months
Maximum Coinsurance Percentage (6/12)=
50%
“Estimated Loss of Income”
$675,000 (Amount Subject to Loss)
Minimum BI Limit Purchased
$675,000
Example 3:
Estimated “Period of Restoration”
9 months
Maximum Coinsurance Percentage (9/12=)
75% - This is not an option, increase to 80%
“Estimated Loss of Income”
$1,031,250 (at 75%) (Amount Subject to Loss)
Minimum BI Limit Purchased
$1,100,000 at 80% coinsurance
Example 4:
Estimated “Period of Restoration”
15 months
Maximum Coinsurance Percentage (15/12=)
125%
“Estimated Loss of Income”
$1,718,750 (Amount Subject to Loss)
Minimum BI Limit Purchased
$1,718,750
II. Calculating the “Period of Restoration”
A. What must occur during the “Period of Restoration”
1. Four KEY objectives must be accomplished
a. Rebuild the building or find an move into an alternative permanent location;
b. Find, purchase, install and have operational new/replacement machinery or
equipment;
c. Replace and/or replenish stock (does not include the time necessary to replace
“finished stock” in manufacturing operations); and
d. Return to the same level of “operational capability” existing just prior to the loss.
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Business Income: Beyond the Basics – Part I
2. Ten factors directly affecting the length of the “period of restoration”
a. Time to adjust the direct property loss;
b. Building plans must be drawn and approved;
c. A contractor must be found and hired;
d. The insured must apply for an wait for building permits to be issued;
e. Site preparation must be scheduled and completed, including clearing the site of
damaged or destroyed property;
f. Time required to rebuild (may be adversely affected by “j.”);
g. Time required to restock;
h. Rehiring and hiring new employees;
i.
Replacement machinery and equipment must be found, purchased, installed and
made operational; and
j.
Federal, state or local government may involve themselves following a loss. This
includes investigating the loss or facts surrounding the incident for legal or safety
purposes or enforcing building codes (ordinance or law issues).
3. The 10 factors above are not necessarily linear or in order of importance. Several
steps may be able to be completed simultaneously.
4. Remember, we want the insured to estimate the worst-case loss and period of
restoration.
B. Building codes and the “Period of Restoration”
1. The unendorsed business income policy excludes any increase in the period of
restoration that results from the enforcement of ANY ordinance or law.
2. Building codes (ordinances or laws) can increase the time required to complete the
rebuilding process (also increases the cost to rebuild).
3. Jurisdictional enforcement of building codes fall under one of two broad categories:
a. The Jurisdictional Authority Rule: The authority having jurisdiction decides when
a structure must be brought into compliance with current building codes.
1) Subjective in its application
2) Jurisdictions may base this decision on some percentage of square footage
damaged, the perceived safety of the undamaged part of the structure, how
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Business Income: Beyond the Basics – Part I
“out of code” the building was, or any other method that they deem
reasonable
b. The Percentage Rule: Buildings damaged beyond a certain percentage of their
value must be brought into compliance with current building codes.
1) Different definitions of “value”: Replacement Cost vs. Actual Cash Value vs.
Market Value
2) Different percentages used: Can range from 40% to 60%
4. Business Income policy must be endorsed to account for any increased building time
attributable to an ordinance or law.
a. Attach the CP 15 31 – Ordinance or Law – Increased Period of Restoration
b. Remember to adjust the business income limits to account for this increased
period of restoration
c. Endorsement covers the extended time to bring the building into compliance with
applicable building codes even if the ordinance or law deals with a cause of loss
not covered by the commercial property policy.
1) Flood plain management codes are a prime example. If an insured structure is
located within a Special Flood Hazard Area (“A” zone or “V” zone) it is subject
to codes related to flood losses. If the building suffers major damage by a fire
such that the local jurisdiction requires that it be brought into compliance
with current building codes (including flood plain management requirements),
the increased time required to bring the structure into compliance with the
local flood plain management code (likely being raised above the base flood
elevation) will be covered by the endorsement; even though flood is an
excluded cause of loss.
2) Why? The damage leading to the enforcement of the building code was a
covered cause of loss (fire); AND the endorsement does NOT limit which
ordinance or laws are covered.
III. Calculating Coverage Amounts
A. Required information
1. 12-month Business Income Exposure - Taken directly from the business income
worksheet (“J.1” or “J.2.”)
2. The worst-case period of restoration – Necessary to accomplish the four key
objectives considering all that has to be done (10 duties during the POR)
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Business Income: Beyond the Basics – Part I
3. The chosen coinsurance percentage
a. A function of the period of restoration
b. Estimated POR÷365 days = Coinsurance Percentage
c. If the developed coinsurance percentage falls between two available numbers,
go to the next higher percentage and increase the business income coverage to
correspond
B. Worksheet for calculating: 1) Period of Restoration; 2) Coinsurance Percentage; and 3)
Coverage Amount to Purchase
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Business Income: Beyond the Basics – Part I
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Business Income: Beyond the Basics – Part I
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Business Income: Beyond the Basics – Part I
Section IV - Non-Coinsurance Options
I. General Information
A. Three non-coinsurance options
1. Business Income Agreed Value
2. Monthly Limit of Indemnity
3. Maximum Period of Indemnity
B. All three options suspend the application of coinsurance for 12 months
C. Provisions for each option are found in the policy form – no endorsement required
D. Business Income Agreed Value option is triggered off the Business Income
Report/Worksheet (CP 15 15) as the insured must attest to the information on page 1 of
the worksheet. Can also be noted under “Valuation” in the ACORD 140 or under “Forms
and Conditions to Apply” in the ACORD 140
E. Monthly Limit of Indemnity and Maximum Period of Indemnity options are triggered
from the ACORD 810 (Business Income Supplemental Application)
II. Business Income Agreed Value
A. Although coinsurance is suspended, the insured must still complete the Business Income
Report/Worksheet (CP 15 15) and attest to the information by signing the first page
B. The underwriter and the insured agree on the 12-month exposure and amount of
coverage
C. All coinsurance options are still available. The amount of coverage agreed to and the
coinsurance percentage chosen is still a function of the “Period of Restoration”
D. If the insured fails to carry the amount of Business Income coverage agreed upon, there
is a penalty
1. Not a “coinsurance” penalty
2. It is a “contractual” penalty for failure to live up to the requirements of the contract
3. Penalty formula is the same as the coinsurance penalty: Did/Should x Loss
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Business Income: Beyond the Basics – Part I
C. The Agreed Value option cannot be combined with the Business Income Premium
Adjustment endorsement (CP 15 20)
D. Using the Agreed Value option increases the Business Income premium about 10% (but
the lowest rate per $100 of exposure of the three non-coinsurance options)
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Business Income: Beyond the Basics – Part I
E. Business Income Agreed Value example:
Agreed Value vs. Traditional Coinsurance Loss Payment Calculation
Estimated 12-Month Business Income
Exposure (BI Exp.)
Estimated “Period of Restoration” (POR)
“Maximum Coinsurance Percentage” (MCP)
(MCP = POR/12) (Remember, all coinsurance
options are available)
“Estimated Loss of Income” / Agreed Amount
(BI Exp. x MCP)
ACTUAL 12-month Business Income
(Insured is experiencing a better year than
planned)
Loss from 3-month shutdown (based on
actual)
Coinsurance Calculations
Traditional Coinsurance Calculation
(Calculated using the actual business income)
Agreed Value Calculation
(Calculated applying the “agreed” upon
business income)
$1,375,000 (“J.1.”)
12 Months
100%
$1,375,000
$1,620,000
$405,000
Amount of BI Purchased (DID)
Actual BI x Coinsurance %
(SHOULD)
Amount of BI Purchased (DID)
BI Agreed Amount x Coinsurance %
(SHOULD)
Traditional Coinsurance Loss Payment Calculation
Amount of Business Income Purchased (DID)
$1,375,000
Actual Amount of Business Income (SHOULD)
$1,620,000
DID/SHOULD x LOSS = Payment
Calculation
(($1,375/$1,620) x $405,000)
Amount of Payment
$343,750
Uninsured Amount (Due to Coinsurance
$61,250
Penalty)
Business Income Agreed Value Loss Payment Calculation
Amount of Business Income Purchased (DID)
$1,375,000
Business Income Agreed Value (SHOULD)
$1,375,000
DID/SHOULD x LOSS = Payment
Calculation
(($1,375/$1,375) x $405,000)
Amount of Payment
$405,000
Uninsured Amount
None – Loss is Fully Covered
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Business Income: Beyond the Basics – Part I
III. Monthly Limit of Indemnity
A. Although the term “indemnity” is used in the name, this option does not necessarily
indemnify the insured.
1. Payments for each 30 days is limited (may not be enough to cover the total amount
of business income loss)
2. Total amount of coverage is not based on a calculation of the insured’s actual
exposure – only a guesstimate
B. Insured chooses the limit of coverage with no worksheet required
C. Insured picks an extra expense limit, if such coverage is desired
D. Insured chooses the maximum payout for any 30 day period by use of a fraction
1. 1/3
2. 1/4
3. 1/6
(Note: These are ISO’s options; some carriers offer other options.
E. The denominator (the bottom number) does NOT indicate the maximum number of
months the insured can get paid. All it does is limit the amount of coverage in any 30
day period to the chosen fraction times the total limit.
F. The fraction does not apply to extra expense losses, but the total of extra expense
payments do deduct from the limits of coverage
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Business Income: Beyond the Basics – Part I
G. Monthly Limit of Indemnity Example:
Monthly Limit of Indemnity Example
Business Income Limit (BI)
Extra Expense Limit (EE) (Only available if the CP 00 30 is used)
Total Limit (TL) (BI+EE=TL)
Monthly Limit of Indemnity (MLI)
Maximum Business Income each 30 Days (TL x MLI) (Does not apply
to Extra Expense losses)
Example Using Above Data
Business
Extra Expense
Total Paid in
Month
Income Loss
Loss
Month
$300,000
$90,000
$390,000
1/3
$130,000
Running Total
#1
$90,000
$10,000
$100,000
$100,000
#2
$150,000
(Limited to
$130,000 by
fraction)
$5,000
$135,000
$235,000
#3
$50,000
$10,000
$60,000
$295,000
#4
$50,000
$10,000
$60,000
$355,000
#5
$40,000
$5,000
#6
$30,000
$5,000
$35,000 (all that is
left)
NONE (Limit used
up in 5th month)
$390,000
$390,000
IV. Maximum Period of Indemnity
A. Not an indemnity option
B. Business Income and Extra Expense coverage is limited to 120 days (essentially 4
months) or until the limit is spent – whichever comes first
C. Amount of coverage is chosen by the insured
D. No worksheet required – only an estimate by the insured
E. Only suitable for insureds with very short periods of restoration
1. Does not require any specialized facilities to operate (able to run the business from
practically any location.
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Business Income: Beyond the Basics – Part I
2. Can operate using other locations to absorb the loss of production (a very rare
situation)
F. Highest rate among the three non-coinsurance options – but this is offset by the lower
limits
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Business Income: Beyond the Basics – Part I
Section V - Extra Expense Coverage
I. Extra Expense Defined
 “Necessary expenses you incur during the “period of restoration” that you would not
have incurred if there had been no direct physical loss or damage to property caused by
or resulting from a Covered Cause of Loss.”
II. Goals of Extra Expense Coverage
A. Maintaining at least partial operational continuity at the insured location following a
major property loss. If some level of income can be produced during the period of
restoration, the overall business income loss will be lower
B. Continue operations somewhere
1. Businesses, like people, can become “lazy”
2. Not being operational (or at least working towards operational) might delay the
insured’s return to “operational capability”
III. Expenses Included as “Extra Expense”
A. The additional costs necessary to speed-up real property repairs to possibly avoid or
minimize the suspension of operations at the insured location. For these costs to be
covered, they ARE required to reduce the amount of business income loss;
B. The cost to relocate to another location either temporarily or permanently to avoid or
minimize the suspension of operations. Additional costs may include: facility rental
costs, utility hook-ups, furniture and equipment rental costs, advertising costs, etc. For
these costs to be covered, they are NOT required to reduce the amount of business
income loss;
C. Any increased operating costs related to a new, temporary location. For these costs to
be covered, they are NOT required to reduce the amount of business income loss; and
D. Expediting expenses necessary to speed the replacement of machinery, equipment or
other personal property. For these costs to be covered, they ARE required to reduce the
amount of business income loss.
E. In essence, reducing “business income loss,” as required by “A.” and “B.” above,
amounts to reducing the “period of restoration.” For these expenses to be paid under
extra expense, they must reduce the “period of restoration.”
Example: A manufacturing operation suffers a business-closing loss. It is estimated that
nine months will be required to rebuild the structure; however it will take 12 months to
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Business Income: Beyond the Basics – Part I
get a replacement for a key piece of machinery. The business cannot operate without
this machine so to avoid 3 months of an unproductive building, the insured asks if the
replacement can be expedited. The manufacturer states that delivery can be expedited
and made within 9 months for a 25% “up charge.” Because the cost to expedite the
machine reduces the “period of restoration,” it is covered under extra expense
(provided there are adequate limits).
IV. Sources of Extra Expense Coverage
A. Business Income (and Extra Expense) Coverage Form – CP 00 30
1. Limit of coverage is chosen by the insured and entered in line “K.1.” of the
worksheet
2. The entire limit is available from the beginning of the period of restoration
3. There is NO waiting period (Business Income has a 72 hour waiting period, unless
endorsed down)
B. Extra Expense Coverage Form – CP 00 50
1. Also Known As: “Pure” Extra Expense because the policy provides ONLY extra
expense protection
2. Limit of coverage is chosen by the insured and entered in “K.1.” of the worksheet
and placed in the Extra Expense box of the supplemental ACORD application (ACORD
810)
3. No waiting period
4. Insured is limited on how much of the limit will be paid in any 30-day period
a. Amount available is indicated by a percentage. The percentage is a “rolling total”
meaning that up to the stated percentage amount can be used during the
specified period
b. Common limits:
1) 100/100/100 – means that the entire amount is available immediately (the
most expensive of the options)
2) 40/80/100 – means the insured has up to 40% of the limits during the first 30
days, up to 80% of the total limits can be used up during the 31st to 60th day
and the entire amount after the 61st day. No limit on the length of payout
except running out of limits. (This is the most frequently chosen option)
3) 35/70/100 – The least expensive of the commonly available options
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Business Income: Beyond the Basics – Part I
c. Non-standard options (allowed by ISO CLM Rule 53) – Use the Expanded Limits
on Loss Payment (CP 15 07) endorsement to trigger these (or other allowable
variation)
1) 35/60/90/100
2) 25/50/75/100
3) 20/40/80/100
5. Buying pure extra expense may be more expensive than purchasing the CP 00 30
with a non-coinsurance option
V. Who Needs Extra Expense Protection
A. Entities that cannot be shut down for any period of time due to operations or services
offered
1. Banks
2. Insurance agencies
3. Newspapers
4. Healthcare providers
B. Entities that can operate from nearly any location
1. Contractors
2. Consulting operations
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