CAIB 2 - Chapter 7

Importance of Business Interruption Insurance

• Business Interruption Insurance (BI) is often misunderstood but essential for businesses
• Clients may shy away from BI due to perceived complexity
• BI insurance protects businesses against loss of income

Risks of Not Having Business Interruption Insurance

• Physical damage to property vs. income loss
• Statistics show high failure rates for businesses without BI
• High profile examples like the Antwerp ethylene oxide plant explosion demonstrate the importance of BI

Why Selling Business Interruption Coverage is Essential

• Protects the interests and assets of clients
• Reassures confidentiality and privacy
• Gives clients confidence in business continuity planning
• Highlights the risk management role of insurance brokers

Obstacles to Selling Business Interruption Coverage

• Technical complexity and perceived difficulty in understanding BI
• Client reluctance to share financial information
• Lack of awareness about the importance of BI

Causes of Business Interruption

• Damage to business property:
  • Fire, including direct and secondary damage like smoke & water
  • Other natural disasters like floods, earthquakes, and windstorms
• Failure or breakdown of public utilities:
  • Utilities like electricity, water, and gas are critical
  • Historical examples of utility failures causing significant disruptions like the 1998 Quebec Ice Storm and the 2003 North Eastern Blackout
• Transportation-related accidents:
  • Accidents can prevent access to business premises
  • Dangerous goods spills, train derailments can cause evacuations
  • Historical examples: 1979 Mississauga Train Derailment (toxic gas), 1989 Elma Train Derailment (flammable gas)
• Physical damage to neighboring premises:
  • Damage can force closures of adjacent businesses
  • Example: damage to anchor tenants in malls or business districts
  • Example: 1986 Saint John Explosion that shut down the entire downtown area
• Loss caused to major supplier or customer:
  • Disruptions at key suppliers or customers can significantly affect a business
  • Examples: Supplier plant fire, major customer disruption
  • A fire at a sole supplier can halt production
  • Delays at a major customer can reduce sales and revenue
• Actions of regulatory authorities & ancillary causes:
  • Civil authorities may restrict access or mandate repairs, prolonging interruptions
  • Ancillary causes like strikes or lock-outs can delay rebuilding
  • Example: Construction industry strikes affecting repair timelines

Funding Options During Business Interruption

• Reduction of capital reserves:
  • Using retained profits for ongoing expenses
  • Can delay future investments and expansion plans
• Bank loan:
  • Additional operating loans to cover expenses
  • Increases financial burden due to interest and repayment obligations
• Increasing product prices:
  • Potential to generate extra revenue
  • Risks making prices uncompetitive, potentially reducing long-term income

Business Interruption Insurance Basics

• Purpose of coverage: helps cover ongoing expenses and profit loss during interruptions
• Policy structure:
  • Endorsement to property insurance, not standalone
  • Triggered by covered occurrences under property insurance

What Business Interruption Insurance Covers

• Operating expenses: costs that continue despite the interruption (e.g., utilities, salaries)
• Net profit: compensates for the loss of income due to business interruption

Coverage for Civil Authority Orders

• Provides indemnity if access to premises is restricted due to civil authority orders
• Includes closures caused by riots, explosions, fires or other disasters
• Coverage is subject to specific limitations outlined in Business Interruption forms

Myth 1 - Broker’s Need for Accounting Expertise

• Reality: understanding basic insurance terms is sufficient
• Key Terms for Brokers:
  • Income: total earnings from sales or services
  • Expenses:
    • Fixed: ongoing costs (e.g., mortgage interest, management salaries)
    • Semi-variable: costs that may vary (e.g., advertising, short-term salaries)
    • Variable: costs that fluctuate with sales (e.g., cost of goods sold)

Expense Categories in Business Interruption Insurance

• Fixed expenses: continue during the interruption (e.g., mortgage interest, salaries, property taxes)
• Semi-variable expenses: may or may not continue during the interruption (e.g., advertising, temporary salary continuation)
• Variable expenses: vary directly with the level of business activity (e.g., cost of goods sold)

Profit Categories

• Gross Profit: Net sales minus the cost of goods sold
• Net Profit: Gross profit minus all operating expenses
• Coverage Implications: insuring only net profit is insufficient as it does not account for ongoing expenses

Understanding Policy Terms vs. Accounting Terms

• Insurance definitions vs. accounting definitions:
  • Gross Profit: different in insurance compared to accounting
  • Insurance terms may not align directly with accounting terms
  • Gross Earnings: unique to Business Interruption insurance, also applies to the Profits Form

Measure of Recovery

• Coverage Basis: Reduction in gross earnings directly resulting from business interruption less charges and expenses that do not continue during interruption
• Coverage Duration: Up to the time required to rebuild, repair, or replace damaged property, not limited by policy expiration but by actual loss sustained

Gross Earnings

• Insurance Definition: Gross Earnings are the sum of total net sales and other earnings from business operations less costs: merchandise sold, materials and supplies consumed, and services purchases from outsiders
• Important Note: The definition of gross earnings is specific to insurance and differs from accounting definitions

Income and Non-Continuing Expenses

• Income Includes: Net sales and additional earnings
• Deductible Expenses: Merchandise sold, materials and supplies, and outside services not continuing under contract
• Exclusions: Other expenses not directly tied to production or service delivery are not deductible

Coverage on "Actual Loss Sustained" Basis

• Principle of Indemnity: coverage is based on the actual loss sustained during the interruption period
• Income Loss: Insured receives payment for the income they would have earned if no loss occurred

Evaluating Loss of Income

• Pre-Loss Analysis: Assess past sales and income to estimate the loss impact
• Seasonal Businesses: Special considerations are needed for businesses affected by the timing of the loss

Evaluating Continuing Expenses

• Continuing Expenses: Only expenses necessary to resume operations with the same quality of service are covered
  • Examples: Salaries for specialized employees, but general payroll might not be covered if easily replaceable

Due Diligence and Dispatch Requirement

• Requirement Overview: Payments are based on the time required with due diligence and dispatch to restore operations
• Impact of Delays: Delays caused by various factors (landlord, insured, others) may reduce the period of indemnity
• Scenario 1: Expense Reduces Loss:
  • The expense allowed the business to resume earlier, reducing the overall claim by 25,000.Full25,000. Full 25,000.Full5,000 monthly rent was covered by the insurer due to significant savings.
• Scenario 2: Partial Reimbursement
  • 15,000rentalcostonlyreducedthelossby15,000 rental cost only reduced the loss by 15,000rentalcostonlyreducedthelossby10,000.
  • Insurer covered only 10,000asitmatchedthereductioninloss.Theinsuredbearstheexcess10,000 as it matched the reduction in loss. The insured bears the excess 10,000asitmatchedthereductioninloss.Theinsuredbearstheexcess5,000.
• Judgement and Coverage Limits:
  • Insured must evaluate whether expenses will effectively reduce losses
  • Expense Coverage Cap: Insurer covers only the portion of expenses that directly reduce losses
  • For additional protection, consider Extra Expense Insurance (IBC 4027).

Media Limitation - Coverage Details

• Coverage Limits for Media and Data Loss:
  • Clause (a): Maximum liability of 30 consecutive calendar days
  • Clause (b): Liability extends until the damaged or destroyed property is rebuilt, repaired or replaced if this period exceeds 30 days
• Application of Clauses:
  • Media-Only Loss: Coverage for business interruption due to media and data damage is limited to a maximum of 30 days
  • Loss Involving Other Property: If other insured property is also damaged, coverage for media and data continues until the other property is restored, potentially exceeding the 30-day limit
• Specialized Coverage: Electronic Data Processing (EDP) policies may offer broader coverage for media and data loss than standard property policies
• Best Practices: Regularly back up data and store copies off-site to mitigate potential losses

Interruption by Civil Authority - Coverage Scope and Purpose

• Coverage Scope:
  • Duration: Up to 2 weeks
  • Conditions for Coverage:
    • Access to the insured premises is prohibited
    • The prohibition is issued by a civil authority
    • The prohibition is due to damage to neighboring property
    • The damage is caused by a peril covered under the insured's policy
• Purpose of Coverage: To cover income loss when the insured premises are inaccessible due to external damage

This quiz explores the critical aspects of Business Interruption Insurance, including its importance, risks of not having it, and obstacles in selling coverage. Understand why this type of insurance is essential for protecting businesses against income loss and how it reassures clients about their financial stability.