It's your policy

by Joseph F. Mangan, CPCU

Extra Expense: It is Not For Everybody

Extra expense coverage protects a business against the additional cost of maintaining operations when a covered cause of loss damages the property the business relies on to generate income. Any business that can sustain a loss needs at least some extra expense coverage. Most of the businesses who are your current and potential clients, on the other hand, don’t have to go out and buy extra expense insurance. Business income coverage satisfies their needs.

It’s a question that comes up constantly. Somebody discovers extra expense insurance, and starts to believe that every business account has a desperate need for it. That’s understandable among

newcomers to insurance and the owners of businesses that aren’t large enough to employ a professional risk manager, but it’s a mistake agents and brokers can’t afford to make.

A limited amount of extra expense coverage has always been a standard feature of business interruption insurance. The extra coverage goes hand in hand with the obligation the policy imposes on the insured to limit the size of the business interruption loss by any reasonable means. It makes sense for insurance companies to pay the additional cost an insured incurs to maintain operations as far as possible because that reduces the amounts they will have to pay for income the business loses as a result of the loss. That’s where business income and extra expense forms part company.

Business interruption forms have always included extra expense coverage, but limit it to the amount by which the insured reduces the business interruption loss the insurer would have had to pay if the insured had not incurred the additional cost. That’s enough for most businesses. A manufacturer or retail- er, for example, can almost always reduce the loss of income following damage to its property without spending more than it saves the insurer. That’s enough for your typical client.

For some businesses, simply closing down after a loss is not an option. They have to remain open, and maintain some minimum level of service to their customers. Service businesses are the most obvious example, and that includes insurance agents and brokers. Just think about what would happen to your book of business if a fire closed your office for two or three weeks and your clients had to wait for you to complete repairs and reopen before they could purchase new policies, get renewals, process endorsements or submit their own claims. Now consider how you would feel if your bank told you they couldn’t let you get any of your money or write any checks because of a fire at their back office. You couldn’t let you get any of your money or write any checks because of a fire at their back office. You would find a new bank, just as your clients would look elsewhere for insurance. Some manufacturers and retailers face similar exposures, and perceive a need to continue their operations whether or not it costs more than the income they would have earned. Those are the businesses that need separate extra expense coverage.

Determining the appropriate limits for, extra expense requires a little imagination and a basic knowledge of the coverage. About ten years ago when the industry simplified the commercial lines forms, they came out with a single time element form that included both loss of income and extra expense. That approach has one advantage. A single amount of insurance is available for both kinds of time element losses, so that most insurance buyers can get by with less total coverage. The full amount of insurance is also available for any loss, no matter how quickly the insured gets back into business. The problem with this approach is that it exposes the insurer to the potential for accumulating large time element losses in a very short period of time. That makes it expensive.

Extra expense coverage has always included a type of monthly limit, expressed as a percentage of the limit of liability. Typically, the insurer will pay forty percent of the extra expense limit when the period of restoration does not exceed thirty days, seventy percent when it is longer than thirty days but not more than sixty, and the full limit when the insured incurs the extra expense over a longer period. By reducing the exposure to loss for a brief shutdown, this allows the insurer to lower the rates for extra expense.

Two factors influence the amount of extra expense coverage a business needs: the amount or time over which it will have to incur the additional cost and the total amount it will have to spend to continue normal operations after a loss. Getting an accurate estimate of either factor requires a fair amount of advance planning. Most businesses have a reasonably good feel for how long it would take them to restore full operations, either by making repairs at their present location or by relocating. They need to know that to plan their business income coverage in any event. The same kind of planning can put a price tag on alternative services they would need to continue their operations if a fire or other covered cause of loss shut them down.