Is Your Business Income Truly Covered?
’Tis the season of frozen pipes, lost electricity, sliding vehicles, and other potential mishaps…but your business is covered, right? If you have business interruption insurance you might think you’re all set, but the contents of your policy still need to be considered.
For example, do you opt for production-based or sales-based business interruption coverage? In the case of the former, coverage typically provides for the actual loss sustained of gross earnings you would have had if the insured physical damage had not occurred. It’s based on the length of time needed to repair or replace destroyed or damaged property. It usually benefits those who might experience extended production or operations downtime (think: manufacturing).
Sales-based business-interruption coverage generally provides for the actual loss of gross profit you would have earned if the insured physical damage had not occurred. It might involve limited production loss, but usually protects against a protracted loss of sales.
While the subset of coverage as described above might be geared to the type of business you operate, there are some commonalities that you need to account for, no matter what your company does. According to Bill Kelly, Senior Vice President at Salem Five Insurance, any determination of business-interruption coverage starts with the completion of a business income worksheet.
“We use a formula of gross sales, minus cost of goods sold, minus non-continuing ordinary expenses in determining what should be covered,” he says. There are three things that business income should cover:
- Fixed overhead expenses. When you put the key into the door at the first of the month, how much money is already committed? That’s rent or mortgage payments, taxes, and all fixed overhead expenses.
- Net profit based on current operations.
- Payroll. You want to make sure that your upper-management staff and key employees are paid during the period of time that you’re closed.
Within the policy are three basic subsets of coverage type:
- Monthly earnings form - allows the business to collect up to a certain dollar amount in each 30-day period that it’s closed. “But if you run out of money on day 28, you’re out of luck, period,” Kelly states. “On the 30th day, we reset the meter and start again.”
- Gross earnings form - primarily designed for businesses with considerable fluctuations and seasonality. “Obviously, in the retail business, most places do north of 50 percent of their business between Thanksgiving and New Year’s,” he explains. “So if they were closed for any appreciable period of time during the holidays, that spells real trouble.”
- Actual loss sustained - In this case, it’s not about any specific dollar loss or time frame. The policy calls for forensic accounting after a loss and for subsequent payment based on the actual dollar loss.
Essentially, there is no “one-size-fits-all” business interruption policy solution. Every operation needs to be approached based on its specific needs. Often, business owners think in terms of the value of what’s being insured. Thinking “my building is worth $5 million, so I want to make sure we’re covered to that level” doesn’t address the $5 to $10 million in sales your business pulls in, covering cash flow is just as important as your property insurance, and the coverage needs can be just as—if not more—complex.
You and your agent need to take a fairly deep dive to make sure all aspects of your business and income are covered.
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