Business interruption insurance helps to replace lost business income if you are unable to open your business on a temporary basis due to a loss covered by the policy, such as a fire or theft.
Also known as business income insurance, it is one of the most common types of coverage most small businesses need. If a disaster strikes and your business is required to shut down for a period of time, it will help cover lost income or operating expenses like mortgage or rent, loan payments, taxes, and payroll.
Understanding business interruption insurance
Business interruption insurance helps protect against lost income after a covered peril affects a business. Covered perils typically include theft, fire, wind, falling objects or lightning. Coverage may help reimburse you in two ways:
- For lost income from the destroyed merchandise (minus expenses you may have already paid, such as shipping).
Your pre-loss earnings are the basis for reimbursement under business interruption coverage. Lost earnings, also known as the actual loss sustained, are typically defined as revenues minus ongoing expenses. - For extra expenses if you must temporarily relocate your business because of the fire (for example, the cost of rent at the temporary location).
Business interruption insurance is not sold as a separate policy but is either added to a property/casualty policy or included in a comprehensive package policy as an add-on or rider. Premiums (or at least the additional cost of the rider) are tax-deductible as ordinary business expenses. This type of policy pays out only if the cause of the business income loss is covered in the underlying property/casualty policy. The amount payable is usually based on the past financial records of the business.
Business interruption insurance coverage lasts until the end of the business interruption period, as determined by the insurance policy. Most business interruption insurance policies define this period as the date that the covered peril began until the date that the damaged property is physically repaired and returned to the same condition that existed prior to the disaster.
According to the Insurance Information Institute, the standard policy is 30 days; however, an endorsement can extend this to 360 days. There may also be a waiting period of 48 to 72 hours.
How does interruption insurance work?
Business interruption insurance works when a covered event occurs. You can file a claim with your insurance company and provide evidence of the damages incurred. Your insurer will review your claim, especially in light of whether the event is covered under your current business interruption coverage.
The idea is that your business will be no worse off than it was before the accident.
Generally, these policies work because they have what’s known in the trade as a ‘material damage proviso’. This clause is put in place so that any necessary repairs that need to be made or replacements of stock or equipment can be paid for by the insurance provider. It allows your business to get back up and running as quickly as possible so you can continue to trade.
Business interruption insurance can sometimes be offered as an add-on to your standard business insurance or it can be offered as a standalone policy. In many cases, you will also need to have valid building and contents insurance in place to make a claim.
Types of business interruption coverage
The most common forms of business interruption coverage include:
- Business Income Coverage: This form of coverage replaces lost income and pays ongoing expenses if your business is forced to close temporarily due to a covered loss. It can compensate for missed profits, payroll, rent, taxes, and other operating costs discussed below.
- Extra Expense Coverage: Extra expense coverage assists in covering the additional costs your company may incur to minimize or avoid a shutdown. This may include items such as renting temporary office space or equipment, paying non-exempt staff overtime, or covering the cost of temporary transportation or relocation.
- Civil Authority Coverage: Civil authority coverage protects your firm from damages caused by government-mandated closures or other limitations that prevent it from operating. For example, if your firm has to close due to a mandatory evacuation order or a curfew issued by local authorities, civil authority coverage may be able to compensate you for your lost income.
- Contingent Business Interruption Coverage: This protects your company from losses caused by a disruption in the operations of a supplier or other business partner on which your company relies. For example, if a fire prevents your supplier from delivering goods to your company, contingent business interruption coverage may help compensate for your lost income.
Note, though, that each type of expense may pertain to only a specific type of coverage or may only be included if you opt into that particular coverage.
Business interruption and restoration period
Your business interruption coverage likely has a “restoration period.” This is the length of time that your policy will help pay for lost income and extra expenses while you restore your business after a covered claim. It is important to read your policy documents to understand when your restoration period starts and how long it lasts.
Typically, there is a 48- to 72-hour waiting period before the period of restoration kicks in, but it typically lasts up to 12 months (this time period usually can’t be extended by the policyholder). That means if your business was damaged on June 1, you would receive business interruption coverage benefits until June 1 of the following year — even if your policy expires before then.
For example, 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 are not completed before the 12-month restoration period ends, your business interruption coverage will expire. This means you will stop receiving reimbursement for things like lost income.
Keep in mind that you will also need to make repairs to your business within a reasonable amount of time to help ensure reimbursement from your insurer. If you don’t, it could create potential issues with loss of income payments.
What business interruption insurance covers
Most business interruption insurance packages cover the following items:
- Fixed costs: These can include operating expenses and other incurred costs of doing business.
- Profits: Based on prior months’ performance, a policy will provide reimbursement for profits that would have been earned had the event not occurred.
- Employee wages: Coverage of wages is essential if a business does not want to lose employees while shutting down. This coverage can help a business owner make payroll when they cannot operate.
- Commission and training cost: In the wake of a business interruption event, a company will often need to replace machinery and retrain personnel on how to use the new machinery. Business interruption insurance may cover these costs.
- Temporary location: Some policies cover the costs involved with moving to and operating from a temporary business location.
- Extra expenses: Business interruption insurance will provide reimbursement for reasonable expenses (beyond the fixed costs) that allow the business to continue operating while the business gets back on solid footing.
- Civil authority ingress/egress: A business interruption event may result in government-mandated closure of business premises that directly cause financial loss. Examples include forced closures because of government-issued curfews or street closures related to a covered event.
- Loan payments: Loan payments are often due monthly. Business Interruption coverage can help a business make those payments even when they are not generating income.
- Taxes: Businesses are still required to pay taxes, even when disaster hits. Tax coverage will ensure a business can pay taxes on time and avoid penalties.
What business interruption insurance does not cover
According to the Insurance Information Institute website, you will not be covered for:
- Damaged property, which would be covered under commercial property insurance.
- Flood or earthquake damage, which are covered by a separate policy
- Undocumented income that’s not listed on your business financial records
- Utilities, as they are usually shut off when a business is under repair.
- Pandemics, viruses, or communicable diseases
Cost of business interruption insurance
The cost of business interruption insurance depends on a number of factors. This includes the size of your company, the industry in which you operate, and the coverage levels you choose. Other factors that can influence the cost of business interruption insurance include your company’s location, revenue, and claims history.
Business interruption insurance can cost anywhere from a few hundred to several thousand dollars each year. However, the actual cost of your insurance will be determined by the specifics of your business and the coverage options you select.
A business interruption insurance policy costs between $40 and $130 per month, or $480 and $1,560 per year, according to Insureon.
Who needs business interruption insurance?
While business interruption insurance is a good option for most small business owners, it can be a crucial coverage type for businesses that rely on a physical location (like your building) or assets (like machinery or equipment) that could be affected by problems, such as fire, theft, wind, lighting and falling objects. This includes businesses, such as:
- Restaurants
- Retail stores
- Salons & spas
- Dog groomers
- Yoga studios
How much business interruption insurance coverage do I need?
Every business interruption policy generally has a coverage limit. This is the maximum amount your insurance company will pay toward a business interruption claim. Choosing a good coverage amount is essential because you’ll have to absorb any financial losses above your coverage limit.
Consider these factors:
- How long would it take to get the business up and running after a disastrous problem like a fire?
- Are the security and fire alarms for your business up to date?
- How much would it cost to rent new office space in your area, and is space readily available?
Look at your gross earnings and earnings projections as guidelines for the right amount of coverage. You want the insurance to cover the costs of operating expenses while repairs are being made to the business.
What triggers a business interruption claim?
Business interruption coverage typically only activates after a direct physical property loss arising from a covered event occurs. You may only make financial claims if this event has caused damage to your physical location
Do business interruption claims have a limit?
Yes.
Your coverage for business interruption coverage is often limited to an amount based on a certain amount of activity over a certain amount of time. For example, some coverages may restrict business interruption coverage to a 12-month financial period. In addition, there may be limits to the types of expenses that can be claimed or the types of revenue lost that may be claimed.
How to make a claim under your business interruption insurance
Making a claim on your business interruption insurance can be done through your insurance provider. There should be details on their website that tells you how to do this. A claim can usually be made by filling in an online form or emailing the right department to let them know of a problem. Your insurer will then get back in touch with you to find out more details about how you want to proceed.
Is business interruption insurance necessary?
Whether you need business interruption insurance or not depends upon a number of factors.
If you are sure that a fire burning your premises down or a flood would barely affect your ability to trade, it may not be necessary for you. However, if you carry a lot of stock, or require substantial premises in order to operate, business interruption insurance could be the only way to stay in business long enough to get back on your feet.
You also have to consider factors such as customer loyalty. Even the most loyal customers will find new suppliers when you can’t help them, and while you might be trading again after a couple of months, the consequential cost of lost customers and sales in the long term could be insurmountable.
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