Interruption Coverage Can Protect Income

Mention business interruption insurance to many business owners and you get one of two reactions: a blank stare or a look of frustration.

The blank stare comes from the business owner who knows nothing about this important coverage. The look of frustration comes from the owner who carries the coverage and has no clue how it works.

Both are understandable.

Business interruption insurance is a necessity--and something of a mystery to business owners. You need help in buying it and, equally important, help in keeping it in force. Given its complexities, you may need help most of all in collecting on it.

In essence, business interruption insurance is as simple as the risk it covers: the threat that a mishap such as a fire will damage not only your plant but also the profit generated by the work you do there.

You cover the threat to your plant with simple fire insurance. You cover the threat to your income with business interruption insurance, which only sounds simple.

For starters, you buy a specific benefit with business interruption insurance, and that benefit must accurately reflect your net income. Thus, you must forecast net income for the coming year, and if your business is seasonal, you must specify upfront how you expect it to fluctuate.

You must also assess the worst-case scenario should something like a fire strike, exploring questions such as these:

* If a fire destroyed your plant, would you be out of business for a month? Two months? Three?

* For that matter, just how likely is it that a fire would destroy your plant? How good is your sprinkler system?

In addition, business interruption coverage comes with a coinsurance clause that can confuse you, mainly because it doesn’t work like coinsurance associated with health coverage.

With the latter, you share the costs of medical care with your insurer to a certain limit; for example, in any given year you may pay 20% of your medical costs and your insurer pays the rest until the total exceeds say, $10,000, after which your insurer pays everything.

With business interruption insurance, you share the costs of any claim with your insurer if you are underinsured at the time of loss.

That’s a big difference, and if you suspect that the coinsurance clause in your business interruption coverage can bite you, you’re right.

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Assume, for example, that you buy the coverage in January and forecast your net income to hit $1 million in September. But revenue grows faster than expected: In August you net $1.2 million and you expect to see $1.25 million in September.

A fire strikes your plant Sept. 1, putting you out of business for 30 days. You file a claim with your insurer for $1.25 million, and you send purchase orders and other records justifying the claim.

Your insurer, however, noting that you underestimated net income, tells you you’re underinsured. It invokes the coinsurance clause, which obligates you to pay 20% of any claim for which you are underinsured, and it cuts you a check not for $1.25 million but for $1 million--$1.25 million less 20%, or $250,000.

At the cost of a quarter-mil, you’ve just learned that you must keep your eyes open when buying business interruption insurance--and while you have it in force. You’ve also learned that it may pay to call for help from a public insurance adjuster or even a lawyer when filing a claim, given the fine print in any business interruption policy.

“Deciding how much coverage to buy is the most difficult thing to do with business interruption insurance,” says Mary King, a risk management consultant with Deloitte & Touche in Los Angeles who analyzes insurance and risk management problems for businesses small and large.

“You have to know your business. You have to know what your net income has been and what you project it to be. Then you have to know what your worst-case scenario is.”

King urges her clients to buy what insurers call all-risk coverage, which covers you for all risks except those specified in the policy--for example, a shutdown caused by earthquake.

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She also considers it important to buy:

* Extended business income coverage, which compensates you for losses to net income while you rebuild revenue following a shutdown.

* Extra expense coverage, which covers you against costs you would not incur short of a shutdown--for example, the cost of renting temporary quarters or restoring damaged client files.

* Coverage against losses attributable to civil action--for example, losses to your business caused by the construction of a subway or mass transit system down the middle of your street.

* Contingent business interruption insurance, which, for example, covers your losses should a fire shut down not your operations but those of your biggest customer.

“If your operations are interrupted by a direct loss to your own building,” King says, “business interruption insurance covers the loss of the income your business would have earned during the restoration of your premises.

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“But you can suffer losses to net income even after restoration is finished, while you get back up to steam. And you can suffer losses if you operate out of temporary quarters during restoration.

“You have to protect yourself against all the likely losses.”

And if you’re in business, you probably need the coverage, she adds.

“Any business owner needs it who feels that he or she could not survive a shutdown,” King says. “And it’s a buyer’s market for insurance today because insurers are better capitalized than they ever have been.

“I can’t imagine that anybody who’s in business to make money wouldn’t feel the need for this coverage.”

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How to get financing will be a topic of The Times’ Small Business Strategies Conference Oct. 17-18 at the Los Angeles Convention Center. Columnist Juan Hovey will be featured. He can be reached at (805) 492-7909 or via e-mail at jhovey@gte.net.