It's every family business owner's worst nightmare: You receive a call in the middle of the night notifying you of a devastating fire at your business. All is lost.
Hours later, as you walk through the smoldering embers, you're relieved that the disaster happened when your facility was closed. Your employees — perhaps including members of your own family — are safe. But then your thoughts turn to the future. There's nothing to worry about, right? You have insurance.
Not so fast. Although most family businesses have some type of property insurance covering physical assets, they may have no way to generate revenue while they're rebuilding. From where will you operate? How will you pay employees? How long will it take you to fully recover?
These are all difficult questions to answer — especially in times of crisis. Family-owned companies with business interruption insurance generally have an easier time answering them.
Business interruption insurance provides financial relief to your company if it's forced to shut down temporarily because of a covered disaster, such as a fire or storm. The policy helps cover fixed operating costs — such as rent, utilities and payroll. It may also replace lost profits based on historical performance. Coverage typically kicks in after a short waiting period and continues for a set time, often until your family business can resume normal operations.
This type of insurance is commonly available as a rider to commercial property or fire insurance policies. Some insurers offer standalone options as well. Certain events, such as floods and earthquakes, may require separate coverage.
When applying for business interruption insurance, you need to weigh many factors. A rational, well-written business interruption strategy can help substantiate your coverage amounts if a loss occurs.
Typically, each policy is time sensitive and bought in 30-day or one-year blocks. Among the first choices you'll have to make is the length of time you need the coverage. This is inherently difficult because you must essentially imagine the worst possible disaster that could befall your company and estimate its aftereffects. How long would it take to get your family business up and running again after that happens?
You'll also need to establish the insured amounts based on your operating history and decide whether to include ordinary payroll expenses. Choosing the wrong coverage could lead to being underinsured and unintentionally forced into self-insuring — that is, covering your own costs (if that's even possible).
Your insurer will generally provide a worksheet to help you calculate business income, which is typically described as "sales less cost of goods sold." These figures are based on the most recent information from current financial statements and estimates for planned growth.
As mentioned, when applying, you must decide whether to include ordinary payroll expenses and indicate that on the worksheet. Most basic policies automatically cover certain employees — such as officers, executives, department managers and other key staff. However, you need to choose between full, limited or no coverage for rank-and-file workers on your established payroll.
Along with the cost of insuring such employees, factors to consider include:
As you can see, completing the worksheet and getting the right amount of insurance is more than a dollars-and-cents decision. You must think strategically as well.
Insurers generally don't want to be fully liable for a loss. They're wary of businesses not taking out an adequate amount of coverage, so many require a certain amount of coinsurance. This is a percentage of costs that the insured company must pay after meeting its deductible.
For business interruption policies, coinsurance is typically applied by "penalizing" losses when an insured has inadequate coverage. Coinsurance is usually expressed as a percentage. It recognizes that, in practice, most losses don't reach the amount of the policy's theoretical annual coverage base. Thus, a policy with an 80% coinsurance clause will fully cover the business so long as the insured covers 80% of the theoretical coverage base.
Extra expense insurance can be a valuable add-on to a business interruption policy. It covers costs during restoration that wouldn't have occurred had there been no damage. Examples of extra expenses that companies commonly incur during rebuilding are:
Because the company is obligated under the policy to resume operations as soon as possible, extra expense insurance is often vital to a speedy recovery.
Many family business owners gamble their companies' very existences on the hope that a serious catastrophe will never strike their offices or facilities. But the truth is, it can happen to any company at any time. By managing the risk with insurance, you'll put your business in a much better position to survive — and your family on much safer financial footing.
If you already have a business interruption policy, review your coverage regularly to ensure it's still adequate. Specifically, revisit ordinary payroll and extra expense coverage as well as coinsurance. Your CPA can help you analyze all the pertinent cost-related data and generate lost profits claims.