Business Interruption Insurance: What It Will -- and Won't -- Cover

If you think you don’t need business interruption insurance, you might want to talk to Allison Dorst.

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The Chatham, N.J., resident, who operates three ecommerce websites selling sportswear, was reimbursed for $10,000 in storage and relocation costs after an early winter snowstorm in 2011 caused a week-long power failure and melting snow endangered $50,000 of inventory stored in her basement.

This fall, Superstorm Sandy brought a prolonged power failure that shut down Dorst’s customer-service lines, causing sales to evaporate. She’ll also see lower sales because of a month-long delay in the delivery of next season’s styles. Fortunately, her interruption policy will reimburse the profit Dorst lost because of those missed sales.

"That was real money last time, but nothing compared to what I’m going through now," she says.

Related: How One Franchise Owner Got His Businesses Running After Hurricane Sandy

Unlike Dorst, most business owners don’t have interruption insurance, says Richard McGrath, independent broker at McGrath Insurance in Sturbridge, Mass. Cost may be a factor in why entrepreneurs pass on such coverage: Policy prices range from $750 to $10,000 or more, depending on business size.

But businesses may want to reconsider interruption insurance given the rising number of natural disasters. The annual total has increased from 400 major incidents in a typical year to more than 600, according to a recent survey from global insurer Allianz. 

Before getting interruption insurance, here are some issues to consider:

Common limitations
Most standard business insurance policies cover only loss or damage to tangible items -- your equipment and inventory and your warehouse, office or store -- and not lost profits if your business cannot operate.

To get business interruption coverage added to your business policy, you’ll need to document your current net income. If your net profits are substantial, beware of low per-incident limits -- $30,000 per incident is common – because they might cap your coverage far below the amount you’d need, McGrath says.

Related: Picking up the Pieces: Sandy's Impact on Small Businesses (Photos)

If your company is growing quickly, document many months of profits to demonstrate that income is accelerating. If you suffer an interruption, this will allow you to project that income would have continued to grow. Otherwise, the insurer may limit your coverage to the amount of the past year’s profits, says Bob Freitag, a public claims adjuster at AmeriClaims  in Indian Trail, N.C.

Next, carefully note the types of interruptions you want to cover. Your interruption coverage will mirror what you covered in your main business policy, Freitag says. If you didn’t include flood coverage in your general policy, for instance, you won’t have interruption coverage for flooding, either.

Note that loss of utilities is often excluded from standard interruption policies, especially downed electric transmission lines -- the very issue that has bedeviled East Coast business owners post-Sandy. If you want that covered, Freitag says, you will need to add a rider to your policy.

Calculating coverage
To figure out your ideal coverage amount, you should envision how your business would be affected by a catastrophe, McGrath says. To start, examine all the costs that would continue even if your business couldn’t operate, such as loan or lease payments and taxes. Also, note charges that might cease, such as utility service to a destroyed building.

If you would want to keep workers on the payroll while you rebuild your factory or store to avoid losing skilled labor, your insurance should reimburse you for their salaries.

Additional coverage
Even standard business interruption coverage doesn’t take care of every possible disaster cost. If you leave a destroyed warehouse and rent one that costs more, interruption insurance will cover only the old rate, McGrath says. Likewise, building replacement may be more expensive than expected due to new codes and modern materials costs. To cover these, you need an "extra expense" rider, Freitag says. It’s that type of provision that reimbursed etailer Dorst for the cost of moving her inventory in last year’s storm.

Your business is also at risk when related businesses are affected by disaster. For instance, an explosion at your website host’s server farm could take your site down or a key supplier may be unable to deliver if it’s wiped out in a hurricane. These events hurt your financial results even though your facility may be undamaged. "Contingent business" insurance covers your lost profits in these disaster scenarios, McGrath says.

Getting reimbursed
Insurers will generally exclude the first few days after a disaster from their calculations, so put aside what you’d need in cash to cover those costs, Freitag says. Then, furnish your insurer with extensive documentation of your lost profits. Consider saving your records electronically off-premises or storing printed copies elsewhere, so you’ll still be able to prove your losses even if your main facility is destroyed.

Related: 5 Steps for Managing Disaster Recovery for Your Business