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BUSINESS INTERRUPTION INSURANCE

Even though most retailers are careful to carry adequate amounts of property insurance to cover a loss in the event of fire, smoke, and windstorm damage, many retailers who do incur such a loss never reopen their doors for business.

This is due in many cases to the fact that the retailer failed to adequately insure against the financial loss that follows such a property loss as a result of business interruption.  Even when there is damage to the physical premises of a retail store and business cannot be continued, there are always on-going bills and expenses during the time the store is closed for restoration.  In order for a retail store to resume business when its premises are restored, these expenses will have to be met even though there is no profit being earned during this time.

There is a type of coverage known as business interruption insurance which will protect a company from such a financial loss.  Also known as business income protection, profit protection and out-of-business coverage, these types of policies are seldom sold as freestanding policies but as past of the “business owners policies.”

One way to describe business interruption insurance is to say that it will do for a retailer during a period of shut down what his business would have done if that shut down had not happened.  In other words, the function of this type of coverage is to replace the operating income of a business during the period when damage to property prevents this income from being earned.  Small businesses and those businesses which are not operating at a profit may be particularly hard hit at a time when there is a business interruption because they often do not have financial reserves strong enough to carry them through this period.  It is these businesses that are many times forced to shut down completely.

The Time Element
Business interruption insurance differs from property insurance in that it falls under the heading of “time element” insurance coverage. This is because time plays a very important part in determining the limit of liability that is covered  The duration of this type of loss for insurance purposes extends from the time of property damage until the time the store is ready to open for business again.

In order to provide for adequate business interruption coverage a retailer would need to estimate the length of time that would be needed to restore his premises to their original condition.  Your best resource for determining this construction time would be a reliable building contractor.  Keep in mind, however, that in a wide-spread disaster such as  the 9-11 terrorist attack in 2001 or hurricane Katrina in 2005, it may take much longer to complete your repairs and be able to reopen.  Consider both worst and best case scenarios and insure accordingly.

Continuing Expenses
A certain amount of confusion is associated with continuing and non-continuing expenses.  Some are quite obvious and others are misunderstood.  One expense which is frequently misunderstood is payroll expense.  Since the purpose of business interruption insurance is help the company in resuming operations as effectively as before the interruption, much of a retail store’s payroll should be counted as one of the company’s continuing expenses.

Naturally, management and other key office and sales personnel would be included among those who would be kept on the payroll in order to keep the company effective and have it functioning well when business resumes.  Key salespeople are valuable to a retail store especially if they have a following which will help bring customers back once the store does reopen.  Payroll expenses to be covered should include not only the wages and salaries but also the other costs relating to the employees who are kept on the payroll such as union contributions, retirement funds, insurance and, of course, taxes.  Bonuses would not necessarily be included in these expenses, however.

Other continuing expenses besides payroll costs are usually figured on an individual basis.  Rent may automatically be stopped in the event of business interruption and, if so, that amount may be excluded from continuing expenses.  (Check your lease carefully before disaster strikes so you can plan accordingly.)  If the retail business has delivery trucks or cars they would be considered on-going expenses.  Other on-going expenses to consider would be bank loans, taxes, insurance and so forth.

Take a good look at expenses before deciding whether or not they should be considered “on-going.”  Advertising is a good example.  A retailer might at first glance think that advertising would not need to be included as on-going, but in order to let customers know about reopening, advertising will be necessary.  Expenses caused by the loss itself should also be included.  For example, an extra buying trip to purchase merchandise to restock the store for reopening should be included.  So should rental costs of a temporary warehouse to store new merchandise.  A financial counselor or consultant would be more able to assist the store owner concerning the expenses he should consider.

Earnings
One of the biggest problems to be encountered with business interruption insurance is determining a business’ earnings.  What needs to be insured is the reduction in gross earnings less charges which do not continue, plus any extra expense needed to restock and reopen the store.  In the case of a retail operation, earnings is the difference in dollars between sales income and the cost of goods purchased.  It is essential that a retailer project at least one year into the future when estimating his store’s earnings; and ideally, he should project even two years into the future.  Next year’s figures can be substantially different from this year’s , especially in a period of inflation  A rental who based his earnings estimates for business interruption insurance coverage on past performance may find that he is grossly underinsured when a future loss occurs.

Insurance policies tend to be forgotten after they are purchased.  Frequently, a business owner purchases the coverage as soon as possible—but in the following years the business may grow.  If your policy still reflects values based on the start of your company, you may be sadly under-insured. 

Also, coverage changes may have affected your policy.  Excluded categories may include public unrest or riots; water damage or flooding (especially for businesses in a floodplain); firestorms, tornadoes, earthquakes and acts of war or terrorism.  This coverage is usually available, but may need to be purchased separately.  Ask your trusted insurance broker now to explain your coverage.  Keep asking the questions until you understand.  And read all the accompanying documents—the fine-print  is important.

One additional note about this type of coverage: If your business itself is not damaged but adjacent properties are and police and fire departments have closed all businesses near the damaged property, your business interruption insurance can provide coverage for the period of time your store is closed even though the interruption of business is not caused by actual damage to your own place.  Check your policy carefully.  Do not neglect to read the small pieces of paper that may be included with your policy statement!  They may, and many times do, contain language stating that something that was at one time covered is no longer covered unless you purchase a separate policy.  This happened to a retailer we know whose store was destroyed by Hurricane Katrina.

When business interruption coverage is established, all these elements (length of time business is interrupted, expenses that will continue and projected earnings) are all very important in determining and setting adequate liability limits for the policy.  However, more than in any other type of coverage, the amount the insured will actually receive from business interruption insurance is a negotiated value.  The retailer who has suffered this type of loss needs to be ready with facts to support his position as to lost profits and expenses caused by the interruption of his business.  Good recordkeeping and protection of those records is essential for this. 

Two Pieces of Insurance Wisdom
Business interruption insurance coverage can reap an additional benefit for the retailer who is wise enough to place it with the same insurance company who provides coverage for property damage.  Because the insurer is reimbursing for business lost while the store is closed, the insurer has a very powerful incentive to make speedy settlements to restore the property that was damaged.  To unnecessarily delay damage settlements will cost the insurer what he has to pay from the lost business. 

Correct and consistent record keeping is necessary when filing a claim.  Back-up data stored in file room at the back, which was blown away in a severe storm, cannot be submitted to prove a claim.  Be smart.  Back up computer systems regularly.  Then, store the back-up off site in a safe deposit box.  Check back-ups to make sure they are good.  And make sure you know the proper procedure to restore the information on a new computer should you suffer a total loss. 

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