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Business Interruption Insurance

By: Investor Solutions

By: The Financial Planning Association

Tens of thousands of New York City area businesses and many beyond the area suffered loss of income due to direct or indirect damage from the destruction of the World Trade Center towers. While nearly all of those businesses carried property/casualty insurance to compensate for direct physical damage, many didnt have insurance to replace lost income and cover continuing operating expenses.

Thats where business interruption insurance is helpful. Depending on the provisions of the policy, this type of insurance will pay for a firms lost profits, payroll, rent, taxes and other overhead expenses. It may even cover extra costs such as relocating to a temporary or permanent site or the cost of obtaining new suppliers. Some policies will cover these expenses even if the business does not sustain direct physical damage, yet suffers lost earnings due to property damage to associated businesses or even area-wide perils that reduce the firms revenues.

Business interruption insurance, sometimes called business income coverage or loss of profit insurance, is typically a rider or endorsement added to a businesss property/casualty policy. As such, whats covered under the main property/casualty policy will determine what is and is not covered for business interruption. For example, P/C policies typically cover fire, but not floods or earthquakes, so if an earthquake damages the business, your business interruption coverage wont kick in unless youve obtained additional coverage for earthquakes.

Scrutinize the policy to see if it will cover crimes such as theft or vandalism, particularly internal theft such as embezzlement. Also, see if it will cover loss of revenues as a result of cyber terrorism, computer viruses or disruption of business due to the loss of an Internet service provider. Many policies wont cover these losses.

Another coverage area that some businesses will need to examine is interruption due to losses suffered by a key third-party business, called contingent business interruption. For example, if you depend on raw materials from a supplier, and that supplier is put out of business because of a fire, your business will suffer if you cant quickly find an alternative supplier. Or you may be equally vulnerable if your business depends on a sole or major buyer of your product or services.

Business also may be interrupted due to civil or military authorities closing down or limiting access to your business, as happened to many businesses in the southern part of Manhattan immediately after the September 11 attacks. You also may be able to obtain coverage for losses due to the interruption of utilities such as power or communication.

Some policies may not provide coverage for such an event unless there is direct physical damage to your business. And some policies wont cover third-party interruption only direct damage to your property. Youll need to shop carefully if this is important to you and read the language of the policy closely. Business interruption policies also require coinsurance, and experts caution that policies frequently end up underinsured because the business owner accepts the wrong coinsurance factor.

How long the policy will pay for interruption expenses varies. Typically, it will provide benefits for the time it takes to rebuild the business and get it back on its feet, even if that extends beyond the original length of the policy. Some policies impose a time limit, and some policies allow extended time to be bought. Coverage for interruption by civil or military authorities is typically limited to a few weeks at most. Also, policies typically require a certain amount of time to pass (three days is common) before coverage begins, so consider whether you want to reduce that elimination period by paying an additional premium.

Examine the claims process carefully. What will the insurance company require to prove lost profits? Generally, this is based on your financial records and should show what you would have earned had the disaster not occurred. Will you be able to allocate losses to the different parts of the coverage, such as lost profits and suppliers?

Not every business will need interruption coverage. Attorneys or accountants, for example, can quickly set up shop again unless theyve lost records. But most businesses should at least do a careful review. According to the Insurance Information Institute, half of the 300 small businesses affected by the 1993 attack on the World Trade Center never recovered.

May 2002 This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Frank Armstrong, a local member in good standing of the FPA.