An estimated 70 percent of companies that undergo a major loss eventually go out of business, because they failed to plan for the disaster. Proper planning includes completing a business income/extra expense worksheet.
Business property policies usually include business income and extra expense coverage. This valuable coverage reimburses you when a property loss (covered by your policy) causes you to lose income due to a shutdown or slowdown. In other words, if a fire (an insured loss) gutted your building and you had to close for four months to rebuild, your business income coverage would reimburse you for lost income. The extra expense portion of the coverage will reimburse you for any unusual expenses you incur to get your business up and running again after an insured loss, such as renting space while your building is under repairs.
How Much Coverage?
Businesses typically buy insurance to replace six to 12 months of lost income and extra expenses. Ideally, you will want to buy coverage for the “period of restoration,” – the time it takes to repair or rebuild the property (or to resume business at a new location). While it is possible to over-insure, most businesses underestimate the time and expense they will incur. When calculating lost income, be sure to factor in compensation for your projected growth — not last year’s income.
What Is a Business Income Worksheet?
Completing a worksheet may seem like a hassle, but it will help you estimate recovery costs and give you a blueprint to follow during the restoration period. It also documents your organization’s pre-loss income and expenses when you submit a worksheet as part of your application for coverage. This is important if you want “agreed value” coverage.
To calculate your income, use the formula: Net sales minus costs of goods and services.
This will give a figure that’s accurate to within 3 to 4 percent of the actual claim, if a loss should occur. Try not to fill out a generic worksheet, which will have cells that are not relevant to your industry. Your insurer should have worksheets specific to your industry sector available.
After a disaster occurs, the costs of rebuilding and replacing new equipment represent only a part of your costs to restore your business. You might have to incur unusual expenses to speed the restoration and avoid losing business to competitors. This could include the cost of renting temporary premises, expedited shipment of equipment or goods, hiring public relations counsel to do “damage control,” and more.
You may also have to pay the cost of moving to your temporary premises, advertising the new location, not to mention heating, lighting, and insuring the new site. You will likely have to pay employees overtime, incentives, and perhaps increased transportation costs. Consider all these factors when completing your business income/extra expense worksheet and your recovery plan.
Why Is the Worksheet So Important?
Typically, business income coverage has a coinsurance provision. Like the coinsurance provision in your health policy, it requires you to pay a certain percentage of covered losses out of pocket, which lowers your monthly premium and gives you an incentive to control your healthcare costs. Unlike your health policy’s coinsurance, the coinsurance provision of the business income policy acts as a penalty for not having enough insurance.
For example, let’s say your business has annual net income and operating expenses of 5 million. Fortunately, you have business income coverage, with a coinsurance of 80 percent. Unfortunately, you haven’t updated your policy in a few years, and your business has grown. You have only 2.5 million in coverage, where you should have 4 million in coverage (80 percent of 5 million).
If you have a business income claim, your insurer will reduce your claim payment by the amount for which you are uninsured. In this example, that would be 2.5 million/4 million = .625. Let’s say a fire closes your facility for six months and you lose 1.7 million in income. At claim time, then, you’d recover 62.5 percent of the covered loss, or 1.06 million (your 1.7 million loss times .625, less any deductible).
Unfortunately, under-insurance occurs fairly often. You can avoid this problem by making sure your policy has an “agreed value provision,” which your agent can add by endorsement. This provision eliminates the coinsurance penalty, so the insurer will use your worksheet as the basis of your claim payment.
After a disaster is the worst time to discover you don’t have enough insurance. Business income and extra expense factors are fairly complex topics. If you need assistance in estimating your business income/extra expense needs, please contact Barker Phillips Jackson.