“Time element” is a term used to describe the group of coverages that, rather than covering direct physical damage to property, apply to loss of income, loss of profits, increased costs to sustain operations, loss of rental income, and similar losses, when premises are damaged by an insured cause of loss. Our concern within this article is with “business income” (formerly known as “business interruption” and before that as “use and occupancy”) and “extra expense” insurance.
It is a fairly simple matter to arrange appropriate time element coverage for a typical small or medium-sized business, normally with one location — a store or factory, an office or perhaps a warehouse. As we shall see in a moment, however, that procedure becomes a bit more complex when comparable protection must be arranged for a firm operating multiple sites. But before we get to that, let’s look at the fundamental valuation and coverage issues that should be taken into consideration in establishing a sound program at any level.
A frequent disappointment experienced by insureds following a business income loss is the imposition of a coinsurance penalty. The coinsurance clause requires the insured to carry an amount of business income insurance equivalent to a stipulated percentage (most commonly 50 percent – 80 percent with ordinary payroll excluded) of the insurable business income value for the policy year. For an expanding business, the insurable value may quickly outgrow the amount of insurance established as adequate at the start of the policy year. Unless the amount of insurance has been increased during the year, a loss later in the year will result in inadequate insurance. Even with a modest loss, a coinsurance penalty (i.e., reduction of the payment of the loss in proportion to the deficiency) would result.
Note also that in the gross earnings business interruption forms, which preceded the business income forms and are still used by some insurers, the basis for coinsurance is the value for the 12 months following start of the business income loss (as opposed to the 12 months of the policy year defined in the business income form). For a growing business, unless the values are reviewed throughout the year and adjusted as needed, an even greater coinsurance penalty can result than under the business income forms.
An alternative to insuring with a coinsurance clause is the agreed value option, which waives the coinsurance clause for one year if agreed statements of business income values are filed each year and the appropriate amount of insurance is carried, based on these values. In effect, this coverage option will avoid a coinsurance penalty, but not without its own potential drawbacks: