SIMPLIFYING BI&EE IN < 1,500 WORDS

SPARK | Can one explain all the key features of Business Income & Extra Expense (BI&EE) in < 1,500 words?

WORD COUNT | 1,358

LEADERSHIP NOTES | Executive – Most underwriters have a sub-optimal understanding of BI/EE. This is partially because so much of the industry starts their journey underwriting BOPs which include BI/EE by default using ALS (Actual Loss Sustained). Addressing this common knowledge gap is a simple way for your underwriters to provide an uncommon advisory service to your distribution network. Not everyone on the team needs deep knowledge, have 1-2 experts in this space and a system that facilitates the cross-pollination of said knowledge amongst the team.

Producers – Underinsurance for BI&EE is one of the most common coverage gaps. Therefore, familiarity with how it works, and common mistakes made, can be a useful wedge for closing new clients. Finding such gaps increases the probability that you don’t have to close based on price alone.

FUNDAMENTALS | Failure Rates – Almost a quarter of all businesses never reopen after a disaster [1]. This rate almost doubles if we focus on small businesses [2]. As most businesses have building and contents coverage, a primary driver for this failure rate is missing or inadequate business income and extra expense coverage.?

BI – Business Income covers the sum of the insured’s net income (that would have arisen had the covered loss not occurred) plus their continuing expenses. These are post-loss expenses that need to be paid even though a loss occurred, such as paying key staff or certain taxes. Conversely, with non-continuing expenses, such as variable production costs, as the insured no longer pays these, there is no need for reimbursement.

EE - Extra Expense Coverage exists to benefit both insured and the carrier. Extra Expenses are those that expedite the insured’s return to full operating capacity (e.g. a rental space for manufacturing operations to continue while the insured’s primary site is being repaired) reducing the amount the carrier pays for business income.

Old School – Simple napkin calculations often provide adequate validation for BI&EE. The complexity of these calculations should increase commensurately with increased exposure. A simple example is validating a BI limit for an apartment complex by calculating the monthly per unit rent said limit equates to.

Net income vs profit – Although used interchangeably, net income and profit have different meanings. Revenue minus total expenses yields net income. Net income can be positive or negative. Profit (by definition) is always positive. This is a minor difference with a significant distinction. Net income’s capacity to be positive or negative has material implications in the unfortunate and unlikely event of a severe loss as we’ll see in the practicing the craft section.

Commodity vs Value – If you’re a producer selling on price, there is a temptation to reduce BI&EE limits. However, if you pursue this tactic, you’ll be racing other producers to the bottom. Although one can build a book using this approach, it’s a tough model to sustain & scale. Conversely, if you sell the right BI&EE limits, you may close fewer accounts (at least earlier in your career), but you’ll be doing so properly and in the long run that’ll show up in your profit sharing checks and retention numbers.

PRACTICING THE CRAFT | Deductible – Business Income coverage is also called Time Element coverage. This is because it provides indemnification for a loss that occurs over time instead of coverage to replace an item (e.g. a building) that was lost or damaged at a single point in time. As such, the deductible for BI coverage is often a waiting period, and the standard is 72 hours. I once underwrote a sneaker store that was in Copley Square (i.e. right at the end of the Boston Marathon). After the 2013 bombing, they lost their biggest three days of sales for the year. If you’re a small business, you can usually reduce this default waiting period to 24 hours for a small additional premium. If you’re a larger business, consider consulting with your producer about switching to a monetary deductible and/or switching from a time based to monetary limit (which often results in savings as it reduces uncertainty from a carrier perspective).

Period of restoration – Many insureds attempt to restore their operational capacity after a loss as quickly as possible and assume their coverage will protect them until they do. However, coverage for BI&EE is only afforded for a reasonable amount of time. What’s reasonable is determined independently of the insured’s efforts. A frequently quoted case on this topic is Lava Trading, Inc. v. Hartford Fire Ins. Co.. The September 11, 2001 terrorist attack destroyed Lava Trading’s office on the 83rd floor of One WTC. They had a back-up office in place in October of 2001. Lava’s operations put in a claim for the full 12-month limit of their policy (alleging that their income was well below expectations during this period). However, the court sided with Hartford who only paid the insured through October of 2001. [3] If Lava Trading’s policy had contained an extended period of indemnity, they would have reduced the likelihood of needing to litigate this claim (although other issues also arose in this case).

Insurance vs. Resiliency – While insurance is a great tool for managing risk, it’s crucial to keep in mind that it’s just one of many. Consider the following scenario:

• The insured closes because of a covered cause of loss to their manufacturing plant...
• The insured cannot honor a key ship date with their sole purchaser...
• The sole purchaser considers this a breach of contract and finds another supplier within a week...
• The insured is operational 3 weeks later but, they now have no buyers

Standard business income coverage policies will not be helpful here. As carrier payment is limited to the reasonable amount of time it takes to resume operations and not the actual time. The insured’s business will fail if they can’t quickly find a replacement buyer. One way to solve this problem is to seek key contract coverage, which is available in the E&S market. A more optimal way to address this situation is to augment the resiliency of the organization by working to diversify their revenue streams.

Iron Triangle – If you’re unfamiliar with the Iron Triangle, check out my recent post [4]. This model can be helpful to consider when reviewing BI&EE exposures. If you’re writing a simple low exposure class, like habitational, you can’t afford to spend much time on BI analysis (remember, your time as an underwriter equates to the company’s money). As such, you want to be cheap and fast (i.e. spend minimal time on analysis and turn the quote around quickly). Conversely, if you’re writing a food manufacturer, you want to be good & fast (i.e. spend the time to do a thorough BI analysis and turn the quote around as quick as feasible).

Requirement for positive net income – Using a standard ISO form, if net income is not positive (e.g. Lemonade Inc as discussed in EDITION 5 [5]), the insured will not be eligible for indemnity payments under business income (which includes continuing expenses). A lot of companies, particularly tech-startups, pay a sizeable amount for business income coverage given their substantial revenues but, per Continental Ins. Co. V. DNE Corp. such companies are paying for something that they likely won’t benefit from [6]. In defense of carriers, payment here could (depending upon specifics) violate the indemnity principle which seeks to return the insured to their pre-loss state and not be of net benefit to the insured. One way to improve this situation is through better education of our sales force.

SNEAK PEAK | I’ll do a deeper dive into key BI&EE coverages in a future article but, endorsements to be aware of in this space include peak season, monthly limit of indemnity, dependent time element, utility services, key contract coverage, and extended period of indemnity.

Thank you for reading!

CITATIONS | [1] https://www.fema.gov/press-release/20230502/stay-business-after-disaster-planning-ahead [2] https://emilms.fema.gov/is_0111a/groups/23.html [3] Kraus, G., Malecki, D., & Massmann, S.. Commercial Property Coverage Guide. The National Underwriter Company. 2015. [4] https://www.dhirubhai.net/posts/bryan-hurwitz_the-iron-triangle-commercial-insurance-activity-7231993447899938817-z4Ji?utm_source=share&utm_medium=member_desktop [5] https://www.dhirubhai.net/posts/bryan-hurwitz_financialanalysis-deeplearning-underwriting-activity-7229094385001324544-l7Dl?utm_source=share&utm_medium=member_desktop [6] https://law.justia.com/cases/tennessee/supreme-court/1992/834-s-w-2d-930-2.html