Business Interruption Insurance: Coverage Every Business Owner Should Understand

Aaron (00:00) Welcome back to Speaking of Insurance, brought to you by Bollinsure Insurance Services. I'm Aaron Bollinger, and today we're talking about a type of insurance that I think a lot of business owners don't fully understand until they actually need it. And that's called business interruption insurance. Now imagine this. You own a restaurant in SoCal. You've spent years building your business, you've invested inland kitchen, hired employees, developed a loyal customer base, and you finally reached a point where the restaurant is considerably profitable or consistently profitable. One night, an electrical fire breaks out. Aaron (00:30) Thankfully, nobody gets hurt, but the fire causes damages to the kitchen, smoke spreads throughout the building, and the fire department determines that the restaurant can't fully reopen until repairs are completed, which is very common. You call your insurance company, the good news is that you've got the commercial property insurance, right? For the physical damage, subject to policy terms, of course, on that covered loss. The damaged equipment, certain repairs, and other insurance property losses can also be addressed based off the specific types of insurance that you have. But here's the problem: your restaurant's now closed. Aaron (01:00) Now, this isn't like a contracting business where the operations have to stop and you've got the builder's risk side of things with the permitting issues and potential other issues. This is just that your business has just stopped. You aren't serving customers, you aren't bringing in your normal revenue, your employees are wondering when they'll return. Your landlord expects rent, and you have expenses that don't simply disappear because the doors are locked. So who's paying for these? That's where business interruption insurance comes into the picture. Aaron (01:29) And today we're going to talking about how it works, what it actually covers, what it doesn't cover, and why this is something that every business owner should at least understand, have a gauge on, have a grip on. Honestly, if you're a sole practitioner, if you work for any business, if you own a business, this applies to you. This could affect your livelihood. This could affect because everybody works for a business, whether you own one or you work in one. One of the biggest misconceptions in commercial insurance or business insurance is that if you're building an equipment are insured. Aaron (01:58) Your business is protected. If you've got your liability covered, if you've got the products completed operations, you've got everything else covered, what happens when your business actually stops? There's a type of insurance for that. And so it's not necessarily true that your business is fully protected if you do have the basic policies. What is business interruption insurance? Let's start with the basics. Business interruption insurance is commonly referred to in insurance policies as business income coverage as well. It's designed to help. Aaron (02:27) replace certain lost income, and of course they have to be qualifying, but also some continuing operating expenses when a business has to suspend or reduce or pause operations because of covered physical loss or damage to the property, to the situation that is covered. And I want to emphasize that specific last part is the covered physical loss or damage. Under a typical commercial property form, business income coverage generally requires a covered cause of loss. Aaron (02:55) For that insured property at the premises. And of course, this is subject to each individual policy's wording, but it has to be a covered physical loss or damage. So it has to be covered by the insurance policy on top of the business income coverage, generally speaking. So let's go back to your little restaurant that you own in SoCal. The restaurant experience is a covered fire, it has to close the kitchen. Aaron (03:17) While the kitchen is being repaired. During that period, the business loses income it would have otherwise earned. Business income insurance may help address the loss of the income. But it's important to understand that this does not necessarily give you insurance for all your gross sales because business income is calculated generally on the business's expected net income, along with other certain normal operating expenses that continue during the interruption. Think about that. Aaron (03:46) That can include rent, payroll costs, continuing obligations. Of course, it depends on how good your insurance company is and how good your coverages are. So if a restaurant normally generates 100K in monthly sales, that doesn't mean your insurance company is gonna be like, hey, we'll give you 100K, because you could just pocket more than that if your operating expenses are much less than that, if that makes sense. Aaron (04:09) They don't want you profiting off insurance. They want it to replace and help you get back to where you would have been financially had the loss not happened. So the actual call, so the actual calculation is more involved than that. And we'll walk through an example in a minute as well. The restaurant that closes for three months. So let's build out this example. Imagine a restaurant with the following monthly financials: a monthly revenue of 100K, food and other variable expenses of 35K, payroll of 30K. Aaron (04:39) Rent of 12K, operating expenses of 13K. And so if you do the math, unless you're, Einstein, I probably couldn't have done this in my head that quickly, it leaves you with 10,000, 10,000, 10K in monthly operating profit. For those of you who listen to me say K 10 times, thank you. For those of you who skip this little part, don't blame you. Now imagine a covered kitchen fire forces the restaurant to close for those three months that we just talked about. Aaron (05:07) The owner might say, hey, I lost $300,000 in revenue. That's that could be considered true depending on what you gross revenue, net, et cetera. But for insurance purposes, we have to look at what expenses the business would not incur during that period and what financial obligations would continue. So for example, the restaurant may not need to purchase its normal amount of food that it was purchasing to cook up the stuff while it was closed. Maybe some utility costs decrease or are eliminated entirely. Maybe you don't need your gas while, you know, your property. Aaron (05:36) ha is recovering from a fire. Maybe you do. Could be. Loan payments and other obligations still exist as well, too. The business has lost the profit it expected to earn. and so for this hypothetical situation, let's assume that the restaurant continues paying $20,000 per month in those operating expenses. And it also loses $10,000 per month in expected net income. Aaron (06:01) That creates an illustrative business income exposure to the insurance company that's $30,000 in. So it's a summation of those expenses that would linger on throughout the period, of course, subject to your insurance policy. Not gonna catch me saying something that'll get the E and O all amped up. But for three months, that's $90,000. So does your business interru interruption income coverage have three months worth of coverage? Does it have 12 months worth of coverage? Is there a time limit? Aaron (06:29) This is what we talked about last podcast. Most of these things have a time limit for the loss of income or the loss of rents on landlord insurance policies, for the rental income expense on the homeowners' policies. Same way with business interruption coverage. So this is a simplified illustration, not a promise, of course, what the insurance company would pay. But it shows why property coverage alone might not be enough for actually insuring your business that is so reliant on its consistent income. Aaron (06:59) To be financially stable. So let's add another layer to this. What if you didn't completely close down your operations? What if there's a way to keep a part of your business operat while the repairs are underway? Think about it like if you've watched The Bear on Hulu, great show. I don't know if I'm allowed to talk. I'm new to this whole podcast thing. Let's say that you're the bear. And let's say that you've got a Michelin star, really nice restaurant, and then you've got that beef sandwich place on the side. Aaron (07:28) That beef sandwich place on the side could potentially still be running if something happens to the bear and vice versa as well. And so you're not completely closed. And this is where the extra expense coverage can become truly valuable because there's a way to keep some of your business operating while repairs are still going on. Extra expense coverage addresses certain necessary additional costs incurred because of a covered loss. So let's say a restaurant's dining room is closed, but the Aaron (07:57) Owner finds a temporary commercial kitchen. That could work that way as well. They can continue preparing meals for delivery and catering to customers. But operating from that temporary kitchen, of course, could cost more. They might need to rent the facility, move the equipment, arrange temporary internet and phone services, pay additional delivery expenses and other things that they would not be otherwise paying, or spend money notifying customers about the temporary location, which is a great idea to retain customers. Aaron (08:27) extra expense coverage addresses qualifying additional costs associated with those continuing operations and reducing the level of interruption and financial burden that your insurance should be helping you cover and continue with. They work together: the extra expense coverage and the business income coverage. Again, business income coverage addresses qualifying lost income. Extra expense addresses qualifying additional costs to continue your operations. Aaron (08:54) For certain businesses, extra expense can make an enormous difference. Professional office, maybe an accounting firm, an insurance agency, hey. Or a consulting business. If their office becomes unusable after a covered fire, they might need to operate from another temporary location or transition to remote work. The additional cost of doing that could be much smaller than the financial consequences of shutting down completely. Of course, all of this depends on your insurance company and your policy and your broker, big broker, you know. Aaron (09:23) Gotta get a good broker, Bollinsure. It's definitely one of them that does have a level of expertise on their commercial risk management team that I'm kind of helping with, but don't worry, they're older than me and a lot wiser than me on our commercial risk management team. But this is where things get particularly important. A lot of business owners assume that if they're closed for six months, business interruption insurance will automatically pay for six months. That's what we were talking about before. That's not how it works. Just like Aaron (09:52) With the prior coverage or with the loss of rents and everything. Many commercial property policies use a concept of period of restoration. Generally speaking, this is the period beginning after the applicable waiting period and ending when the damaged property should reasonably be repaired, built, or replaced with appropriate diligence and similar quality, or when operations resume at a new permanent location, depending on the policy. Aaron (10:20) Notice something really important here. The coverage period may be based on how long repairs should reasonably take, not simply how long the business owner actually remains closed. The business property remains closed. Let's imagine the restaurant, the SoCal restaurant that we all want to open up. Personally, it would be ooh, what would I open up? Aaron (10:44) no. Aaron (10:46) Box pasta. If you've been to Italy, hopefully if not, some nice Italian pasta. But for me, it'll be my SoCal box pasta restaurant. Let's say that I decide to redesign the entire restaurant, upgrade the dining room, and add a new outdoor patio to my super nice restaurant. The renovation now takes six months instead of three, let's say. That doesn't mean the insurance company's gonna be like, you know what, Aaron? We love these designs. It looks like Venice on the walls, it looks like Rome on the ceiling. Aaron (11:16) This is beautiful. We're willing to cover you for the millions of dollars it's gonna take to repaint Michelangelo. Nope. The additional time associated with the elective, elective meaning the ones that I'm choosing to add, the elective improvements may fall outside of that covered restoration period. So the restoration of that property could have taken three months, but because I wanted to add my paintings and upgrade my dining room, it takes six. Aaron (11:46) Insurance company's not gonna like that. That's why maybe having a custom insurance company who you can talk to these sort of things about, they won't help you paint your place back up, but they might be able to upgrade some of the furnishings if you do have that covered on that policy of yours. Of course, subject to exclusions. That's why understanding your policy wording and the language in it is so important. Crucial, those of you who listen, loyal podcast members, crucial. Word of the podcast. Aaron (12:14) You also need to consider the waiting periods. Certain policies impose a waiting period before business income coverage begins. A commonly encountered waiting period is 72 hours. Although the actual period depends on the policy, that's just to confirm hey, the loss is super meaningful and we need to file a claim and go through the insurance company for this because we waited 72 hours. Don't ask me why it's 72. Maybe that's somebody's lucky number. Maybe three days is substantial enough to determine whether or not a loss needs to go through the insurance company. Aaron (12:43) Course, there are going be separate limits, sublimits, or time restrictions on this as well, changed by the policy. Could be 24 hours, could be 48 hours, could be a million hours. Doesn't really matter. All that matters is that you understand how many hours that is, and then you move if it's a million hours. So it's important to review your actual coverage structure rather than just assuming that that policy is going to have the exact same functional way that the perfect insurance policy would have. It's just a thought. So what happens after you reopen? Aaron (13:11) Now, here's something the business owners might not anticipate, and that's what if you reopen, but your customers don't immediately return. Maybe you've been closed for three months, and everybody went to my SoCal restaurant, my pasta place, instead of going to yours. Customers have developed these new habits of going here. Some people assume you're still closed. Your catering relationships have been disrupted by me and my business operations. Your revenue takes time to recover. You might reopen at 50% of your previous sales. Aaron (13:39) Then reach seventy-five, maybe then reach eighty-five, and finally you return to normal. Does business interruption coverage continue after reopening? Sometimes there might be coverage for this through an endorsement or policy provision, commonly called extended business income. Extended business income coverage can provide a limited period of additional protection for qualifying income losses after operations resume subject to policy terms. So if everybody's going to my box pasta place before Aaron (14:09) The insurance company tells me that I have to go pay everything out of pocket for my paintings that I wanted to add to the walls, then in that meantime, while I've got all your customers, you know, you would have hopefully some sort of endorsement or policy provision that would cover you for that additional lost income. The duration and conditions do, of course, vary policy to policy. And it's not unlimited protection against permanently losing customers or market share. This is just usually temporary. So for a restaurant or retail store or hospitality business. Aaron (14:37) This is definitely worth discussing, worth explicitly getting in writing from your insurance broker that this is covered. If not, then BOR broker of recording it over to Bull Insurance. So our specialty commercial insurance team can get that coverage for you. Because reopening your doors doesn't automatically mean that the revenue returns back to normal. Trust me. if you've talked to any business owner who who's ever had to close down, it's it's tough getting back up on your feet. So let's let's bring California into this. Aaron (15:07) So we brought my California pasta place, but let's talk about California as a whole. We think about wildfire losses, usually when it comes to physical property losses, homes destroyed, commercial buildings damaged, smoke damage, the way the insurance companies deal with the smoke damage, entire neighborhoods evacuated. But there's another financial consequence that can easily be overlooked, and that is the businesses can lose income even if their own buildings are not destroyed. Really? Coffee shop near a major wildfire. Aaron (15:36) Your building survives and it's like right on the edge. Roads are closed, customers can't reach your location. The people who would have been or are your existing customer base are now moved to the temporary housing from their loss of use, homeowners insurance coverage that they increase because they listen to my prior podcasts. But what happens to you? The surrounding community experiences that major disruption. All the businesses there. Your revenue collapses on your coffee shop. Aaron (16:04) Here's the question: Does your business interruption insurance cover that loss? It depends. Traditional insurance and business income coverage generally require covered physical damage or loss, like we discussed, to insured property at the described premises. So simply experiencing a few customers or all your customers because of wildfire doesn't necessarily trigger coverage. However, there is a cool little thing called civil authority coverage. Some policies, very some, very, very, very some, V-E-R-Y, very some. So Aaron (16:33) Very rare to find this. Civil authority coverage may apply in certain situations where a government authority prohibits access to an insured premises because covered damage to other property. So that could qualify. Could. There's important conditions. The damage generally must be involved near or because of a covered loss. The order must meet the policies requirements. And there also might be geographic restrictions. So you might be just ten feet away across the street from where it would have otherwise been covered. Aaron (17:04) That's a part of this game, is that it's uncontrollable. So control the controllables should brand that. And there are many waiting periods and limits on how long coverage can apply for as well for this. If the homes are all being built back up and again, nobody's still coming, maybe that extra business income that we had talked about doesn't trigger. Some specific policy level wordings are crucial to understand. Aaron (17:33) course is all policy specific. And an evacuation advisory, a road closure, or a general decline in tourism does not establish coverage. Let's say the people realize that Santa Monica is overrated. I'm in right next to it. And it's fun, but it's not fun, you know? I mean, as an adult, I mean, don't know. I mean, obviously there's some cool things that go on there. It's pretty nice to bring family to, but like, I don't know if it's like the best of the best. Aaron (17:59) Just because tourism declines there, because everybody listened to this podcast and realized, maybe Santa Monica's overrated, doesn't mean that maybe I get sued. Sorry, Santa Monica. Don't sue me. But regardless, it doesn't mean that there's going to be an insurance policy that's going cover for that loss in tourism. And so this raises a broader question. When business owners purchase insurance, are we only thinking about the building? Or are they also thinking about the events that could prevent the business from operating or prevent Aaron (18:28) The habitability of the building, not just the building coverage, but the implications of that coverage. And those are two completely different exposures and ways of thinking about things. So what if your supplier has the fire? Aaron (18:39) Now let's move away from the restaurant, my dream restaurant, for a moment. Imagine you own a manufacturing business. You rely on a specialized supplier for a critical component in your manufacturing process. Without that component, you cannot complete your products. Think about David Barr and the one ingredient that we discussed in UCLA business class that is exclusive to them almost pretty much. And so they actually bought it. So they kind of own that and then they got sued because of some sort of like monopoly scheme, but I don't know if that actually went through. Aaron (19:09) Can't confirm or deny, but it's really interesting to think about owning your supply chain would be awesome if it's not a monopoly. Nonetheless, a lot of people do not own their supply as a manufacturing business. And so let's say that you don't, and your supplier's factory experiences a major fire. Your own building is perfectly fine, your equipment works, employers, employees are ready, raring to go, but your supplier can't give you the materials. You need to actually create the product. Your production slows down or just stops completely. What happens to your business income coverage? Aaron (19:38) Do you have insurance company to help you? Not necessarily. Standard business income coverage generally focuses on the covered physical loss or damage involving your premises, your location. So certain policies can, depending on the insurance policy, add coverage called contingent business interruption, which is really cool. It can help address the qualifying income losses resulting from cover damage at certain suppliers, customers, or other dependent locations. Aaron (20:07) Especially important for businesses that rely heavy on a small number of suppliers, restaurants that the supply, require the supply, consistent supply of specialty food providers, manufacturers that require unique components, retailers that rely on a particular distribution center, businesses whose revenue depends heavily on one major customer. If that supplier or customer experiences a covered physical damage loss, your business could suffer even though your own property is completely undamaged. Dependent property coverage is designed to address. Aaron (20:37) Certain situations like these. But it needs to be included or structured appropriately. And it of course will have its own limitations depending on the type of dependent properties caused, cover of losses, locations, and coverage limits. This is where the nuances of insurance come in and they kick us and say, hey, there is a coverage for this, but, but, but, but, B-U-T. But keep it in mind. Now I want to address something that is especially important. Aaron (21:04) That is that business interruption insurance isn't designed to protect a business against every possible reason that a revenue might be going down or declining or stopping. If sales drop because customers stop buying a product, that is not a covered loss immediately. It has to be considered. If a new customer opens up across the street, if a new competitor opens up across the street, that's not typically covered either. Business experiences an economic downturn, that's generally not covered. Business closes because of an event that doesn't satisfy the triggered coverage. Aaron (21:33) Requirement, you shouldn't assume the business income insurance will respond. Distinction depends on the insurance coverage and whether it's caused by a covered event and the ordinary financial risks of operating a business do not get covered. That's why business owners need to think carefully about what they're trying to protect against. It can address, that's insurance. Insurance can address certain unexpected losses, but it doesn't replace business planning, cash reserves, diversification, or sound financial management and decision making. Aaron (22:03) So, how much business income coverage should you carry? Let's talk about the practical numbers side. How do you determine the appropriate amount? The first thing is understanding your business's financials. Please, you need to consider your historical revenue, your net income, continuing expenses, things like your payroll, seasonal flunction, seasonal fluctuations, fluctuations, and how long it could realistically take to recover from a major covered loss. For example, think about a retail business and how Aaron (22:31) might earn most of its revenue during November and December. A fire in October could be way more disruptive than a fire in February, because the interruption could affect the most important sales period of the year. Da-da. And now imagine a manufacturer that relies on specialized machinery. Even if the physical building can be repaired in two months, replacing a custom machine might take considerably longer, even if the physical building can be repaired again. That specific component that's needed, whether it's from the manufacturer Aaron (23:01) And they own it, or it's from a supplier, can be the difference between a consistent steady income stream. Or my restaurant that requires health department inspections. Don't look at the paint. It does not have mold. Equipment installation and permits before reopening. Just a disclosure: I do not have an Italian restaurant and I don't plan on owning one. That was just a dream of mine that I came up with right now. As an example to you guys, so there is no health department inspection that needs to be done. The actual recovery process may take several different steps depending on all these. Aaron (23:31) Different exposures. One of the most valuable things a business owner can do is work with their accountant and insurance professional to estimate a realistic business income exposure. Coverage decisions are then based on the actual business instead of just an estimation or guess, a guesstimate. So let's talk about five questions every business owner should ask as a way to wrap this up. If you own a business, I want you to ask yourself these. Aaron (23:59) If my business had to close tomorrow because of a major fire, how long could I survive without normal revenue? Number two, does my commercial insurance policy actually include business income coverage? Number three, what events would trigger the coverage? Number four, how long would it realistically take to reopen? And number five, what happens if my revenue doesn't immediately recover after reopening? Hopefully this was a bit insightful for y'all. Aaron (24:29) Final thoughts, I'd say when most people think about insurance, they think about replacing damaged property. They think about fixing a building, fixing a car, maybe the auto liability side, replacing equipment, maybe the roof, paying for damage after a fire. Those things are obviously important. But for a business owner, the financial consequences don't necessarily just stop when property damage is repaired. You can lose income, continue to pay rent, employees that depend on you financially. Aaron (24:59) And you can experience a very, very, very difficult recovery period after you opening as well. That's why business interruption insurance deserves its attention. If you already have it, great. But how much of it do you have? Under what circumstances do you have it? Understanding these provisions before something happens can make a significant difference. If you are a business owner in California and you're not sure whether your commercial insurance includes business income coverage or whether your actual existing coverage reflects your actual operations. Aaron (25:29) That's something we can help you with with Bollinsure Insurance Services. Whether you're operating a restaurant, retail office, store, contracting business, or another commercial operation, the goal is to understand where your financial exposures are and what insurance options may be available. Because the question isn't just whether you can afford to rebuild after a disaster. It's whether your business can afford to be closed while you're rebuilding. I'm Aaron Bollinger. This has been speaking of insurance brought to you by Bollinsure Insurance Services. Thank you for listening. Aaron (25:59) And I'll see you all inland next episode.