An unforeseen adverse event, such as a fire, can have a devastating impact on your small business's operations. Although standard property insurance may cover specific types of property damage, business interruption insurance (also known as business income insurance) fills in the gap, addressing lost income and other issues that arise when your business shuts down unexpectedly. Here's what business interruption insurance covers, how it works, and how to obtain this coverage for your small business.
What is business interruption insurance?
Business interruption insurance kicks in when a business can't operate normally because a specified peril caused physical property damage, rendering the business inoperable. It covers operating expenses and other lost income for a certain period of time after the business shuts down. The policy spells out the type of unforeseen events that qualify for coverage.
You can obtain this type of business insurance as a stand-alone policy from any of the best liability insurance providers. You can also find it as an inclusion in your business owners policy (BOP), or you can purchase it as a rider to an endorsement or property insurance policy or package.
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What does business interruption insurance cover?
Most business interruption insurance providers typically cover the following types of perils:
- Falling objects
Be sure to read your business interruption insurance policy documents so you know precisely which perils your insurer covers.
Here's an example of how a boilerplate insurance clause or endorsement might read (from Pacific Coast E&S Insurance documents):
"We will pay for the actual loss of business income you sustain due to the necessary suspension of your 'operations' during the period of 'restoration.' The suspension must be caused by the direct physical loss, or damage, to property at premises … The loss or damage must be caused by or result from a covered cause of loss."
Typical business interruption insurance policies include the following coverage areas (but note that these areas may deviate slightly according to a carrier's formula for calculating financial losses):
- Lost revenue based on prior financial records
- Mortgage, rent and lease payments
- Employee payroll
- Taxes and loan payments due during the covered period
- Relocation costs if the business must move to a new or temporary location due to physical damage to the business premises
Business interruption insurance example
Let's say a fire damages your warehouse, leaving the building uninhabitable and destroying merchandise already packaged to send to customers. According to Allstate, there are two main ways business interruption coverage can reimburse you:
- Reimbursements for lost income: Business interruption coverage can help reimburse your business for lost income from destroyed merchandise (typically minus prepaid expenses). Insurers, such as Allstate, may base reimbursement amounts on a business's pre-loss earnings. Lost earnings – the actual loss sustained – are equal to revenue minus ongoing expenses.
- Reimbursements for extra expenses: Business interruption coverage could reimburse your business for additional expenses during the restoration period that wouldn't have occurred without a physical loss to the business's actual or personal property due to the covered peril. For instance, if you must temporarily relocate your business because of the fire, the cost of rent at the temporary location could fall under this category. You can also use extra expense reimbursements to pay overtime, if necessary, to restore the operations.
Carefully review your business interruption insurance policy, since the insurer will have its own specifics on calculating lost income. Accounting criteria for lost income and expenses can include the following:
- Net income (net profit or loss before income taxes) that would have been earned or incurred by the insured party if the business were fully operational
- Normal operating expenses incurred, including ongoing payroll, vendor and lease obligations, that continue despite the operational shutdown
What is a restoration period?
Your business interruption coverage likely has a restoration period – the length of time your policy will help pay for lost income and extra expenses while you reconstruct or restore the property to its original condition.
Read your policy documents to understand when your restoration period starts and how long it lasts. To qualify for insurance reimbursement, the restoration period typically begins when the peril occurs and ends after a reasonable period of time for the property to be restored and operations to fully resume.
Here's an example Allstate provides: If your business was damaged on Oct. 1, you'd obtain business interruption coverage benefits until Oct. 1 of the next year, even if your policy expires before then. Your policy might end because your business was heavily damaged, and you may not have a business to insure.
If your business's building repairs aren't completed before the 12-month restoration period ends, your business interruption coverage will expire. This means you'd stop receiving reimbursement for lost income, for example. Check your individual policy for specifics.
Endorsements and extensions
When reviewing your business interruption coverage with a broker, you may want to discuss whether the following overages are included or can be added with an endorsement:
Extended period endorsement
Business owners experiencing difficulty during the restoration period can seek an endorsement that includes a 30-day extended restoration period provision.
Under Marsh McLennan's policies, for instance, if an insured business needs more time to restore the property beyond the 30-day limit, they can buy an extended period of optional indemnity endorsement for various time periods, ranging from as little as 30 days or any multiple of 30 days up to 720 days. Check with your provider for specifics.
A coverage extension provides insurance for business income losses resulting from certain specified events, such as service interruption, contingent business interruption, leader property, and interruption by civil or military authority (for example, if a state, local or federal governmental entity restricts access to your property). A sublimit typically applies for each additional coverage, according to Marsh McLennan.
You can include a service interruption extension in the policy, so ask your insurance provider for details. A service interruption extension typically provides business income coverage arising from direct physical loss, damage, or destruction to any utility service's transmission lines and related plants, substations, and equipment supplying services to an insured business.
Restrictions may apply, such as waiting periods, distance limitations, the exclusion of certain perils such as earthquakes, and exclusions for overhead and transmission lines. The owners, managers, or operators of such utilities or services are not named as insured under the policy, Marsh McLennan says. Again, check your policy specifics.
Loss limits and exclusions
Marsh McLennan notes that when a business income loss occurs, an insured business is obligated to take reasonable steps to prevent or minimize this loss and any further losses. Expenses incurred to reduce that loss may be covered under the policy as part of the business income loss, as long as these expenses don't exceed the actual loss.
For instance, if there is a business loss of $200 associated with the interruption of business operations, the insurer could reimburse $100 to reduce the loss, but it will not reimburse the business $100 if the claim is reduced by $50. If the business incurs other expenses above this claim amount to continue to operate the business, those could be covered under an additional expense provision if one is included in the insurance policy.
Coverage varies across businesses interruption policies, although policy specifics are key, and policy verbiage is important to note. CNA's policy details require "a direct physical loss" or damage that interrupts your business to qualify for coverage. Terms and exclusions may also limit or preclude coverage.
This "direct physical loss" and exclusions verbiage may determine whether or not the policy is upheld or denied in court.
Other areas to note, particularly in light of COVID-19, are exclusions for microbes. Manufacturers should take note of exclusions for losses associated with pollutants and contaminants, as well as information about any deductibles, waiting periods and policy limits. This information is on the declarations page or within the section detailing your coverages.
Temporary shutdowns due to COVID-19 restrictions have been a recent notable issue in business interruption insurance. For instance, a Pennsylvania state court judge ruled that a dental office was owed business interruption coverage under its business interruption policy with CNA Financial due to temporary shutdown orders in 2020 in the midst of the COVID-19 pandemic.
The courts determined that the specific policy verbiage of "direct physical loss of or damage to property" was a key factor in ruling for the insured.
The Pennsylvania case is one example of the 1,000-plus COVID-19 coverage claims businesses have filed against insurers. Many cases have been ruled in favor of the insurers, but policyholders, usually small businesses, have also won several rulings. In many of these cases, the main legal issues are either allegedly direct physical loss or damage to property, or whether the policy's communicative disease coverage is associated with insurance policy stipulations of direct physical loss or damage to property.
When to consider business interruption insurance
Retailers and businesses within the manufacturing and service industries should consider business interruption insurance. Any business that provides a service or goods should also consider this type of coverage.
Speak with an insurance representative or agent about your specific business. According to Allstate, there are several factors to consider when opting for business interruption insurance. Think about any potential risk associated with your building's location, safety protections, and any added precautions made to secure your premises, such as cameras, sprinkler systems and fire alarms. Be aware of comparable real estate space availability if you need to move to a temporary location as well.
How much does business interruption insurance cost?
As with any business insurance policy, costs depend on underwriting standards, the size of your business, and numerous other factors. Those include the following:
- Number of employees
- Amount of coverage
- Prior loss experience
Contact an insurance broker or agent for specific business interruption insurance quotes. Your location can also impact your policy's price, according to Chubb (read our review of Chubb for more information). Similar to homeowners policies, if the geographic area is at higher risk for claims, the premium will be higher.
According to business insurer aggregator site Insureon, business interruption insurance premiums usually range from $40 to $130 a month. Rates can be higher for businesses with high liabilities.
Where can I buy business interruption insurance?
You can purchase business interruption insurance via major insurers that cover commercial liability. Before purchasing a stand-alone policy for business interruption insurance, find out if you have existing coverage.
If you already have a BOP with your insurance company, check the policy details, since these usually include business interruption coverage. Also, see if your general liability policy has an endorsement for business interruption insurance.
Allstate notes that business interruption insurance typically has a coverage limit, the maximum amount your insurer will pay toward a covered claim. You'll pay out of pocket for any financial losses that exceed your coverage limit, so make sure the coverage amounts you elect are appropriate for your business, and speak with your insurance agent if you need additional coverage.
As always, discuss any concerns with your insurance agent and refer to your company's risk management plan to make sure you obtain adequate coverage.