Business Interruption Insurance: What Every Owner Needs to Know

Understanding Business Interruption Insurance  

Business interruption insurance, also known as business income insurance, is coverage that helps replace lost income when an insured event disrupts your business operations. Unlike property insurance that covers physical damage to your building or equipment, business interruption insurance covers the income you lose during the recovery period following a covered event. 

This coverage becomes active when a covered peril—such as a fire, natural disaster, or other insured event—forces you to temporarily suspend operations or significantly reduce your business activities. The insurance helps cover ongoing expenses and lost profits while you work to restore normal operations. 

Weighing Costs Against Protection 

Business owners today face increasing premiums for business interruption coverage. Several factors contribute to these rising costs. Climate change has led to more frequent and severe weather events. Supply chain disruptions have become more common. Cyber threats pose new risks to business continuity. And inflation affects both the cost of coverage and the amount of coverage needed 

To determine if the cost is justified, consider the potential financial impact of an interruption to your specific business. To do this, estimate your daily revenue loss by calculating your average daily income and multiplying by the estimated recovery time. Then add in fixed expenses like rent, loan payments, insurance premiums, and employee salaries that continue during closure. Next, factor in costs for temporary locations, overtime pay, or expedited delivery of materials. Finally, consider the long-term impact of losing customers during closure. 

The total potential loss of all these factors combined often far exceeds the annual premium cost, making business interruption insurance a valuable investment for most businesses. If you need help tabulating the total cost to your business, you should consider working with an experienced financial advisor for small businesses. 

Determining Appropriate Coverage Types and Amounts 

Key Coverage Considerations 

Coverage Period: Most policies offer coverage periods ranging from 12 to 24 months. Choose a period that reflects realistic recovery times for your industry. 

Business Income Limits: Coverage should reflect your actual income and operating expenses. Many businesses underestimate these amounts, leaving them vulnerable during a claim. 

Extra Expense Coverage: This covers additional costs incurred to minimize the interruption period, such as renting temporary space or paying overtime to employees. 

Contingent Business Interruption: This covers losses when disruptions affect your suppliers or key customers, even if your property isn't directly damaged. 

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Industry-Specific Considerations 

Remember that it's important to get insurance that matches your specific needs, because different businesses can have varying needs. Manufacturers may need extended coverage periods for complex equipment replacement, for example, while retail business might need to focus more on seasonal considerations and customer retention. Service businesses often require coverage for data recovery and client communication, while restaurants need to consider perishable inventory and health department requirements. 

Key Person Insurance: Protecting Your Human Assets 

Key person insurance is a specialized form of business protection that deserves special attention. This coverage protects your business against the financial impact of losing a critical employee, owner, or partner. This type of insurance is critical because it helps to compensate for lost income due to the absence of a key individual. It also covers expenses for finding and training a replacement for that person, which can often be an expensive and time-consuming endeavor, and it also provides a financial cushion during that transition period. Finally, many lenders require key person coverage to protect their investment, so not having this insurance in place could mean losing out on a business loan. 

A common rule of thumb is to secure coverage equal to 5-10 times the key person's annual salary, though actual needs vary by business. Consider these factors when calculating key person insurance needs: 

• Annual compensation: Start with the person's yearly salary and benefits 
• Revenue generation: Estimate the person's contribution to business income 
• Replacement costs: Factor in recruitment, training, and learning curve expenses 
• Loan obligations: Include any personal guarantees the key person has made 

Best Practices for Business Interruption Insurance 

1. Conduct Regular Business Impact Assessments: Regularly evaluate your business's vulnerabilities and update your coverage accordingly. Consider new risks like cyber threats or changes in your business model to ensure you're not carrying too little coverage for your actual risk exposure. 
2. Maintain Detailed Financial Records: Insurance companies require documentation of your income and expenses to process claims. Keep comprehensive financial records and update them regularly. 
3. Review Coverage Annually: Review your policy annually with your insurance agent. Business growth, new locations, or changes in operations may require coverage adjustments. Remember to also adjust coverage amounts for inflation.  
4. Understand Policy Exclusions: Pay close attention to what your policy doesn't cover. Common exclusions include: pandemics (though some insurers now offer separate pandemic coverage); cyber attacks (may require separate cyber insurance); and government-mandated closures not related to property damage. You should also remember that most policies have a waiting period before benefits begin. 
5. Create a Business Continuity Plan: While insurance helps financially, having a plan to resume operations quickly minimizes the interruption period and reduces overall losses. 

Making the Right Decision for Your Business 

Business interruption insurance isn't just another business expense—it's a crucial component of your risk management strategy. Consider it as part of your overall financial strategy. Just as you plan for growth and investment, planning for potential disruptions protects your business's financial stability. 

Work with qualified professionals who understand your industry's specific risks and needs. A comprehensive approach to business protection includes not just insurance, but also emergency funds, business continuity planning, and regular financial planning. 

At WHZ we have a long history of experience partnering with business owners and entrepreneurs to create and maintain a comprehensive and strategic financial plan designed for both business and personal financial success. See how we can help you to both protect and grow your business by scheduling a complimentary discovery session on our website at whzwealth.com, or by calling us at (860) 928-2341.   

Authored by Principal/Managing Partner & Chief Strategist James Zahansky, AWMA®. AI may have been utilized for some research and initial drafting of this piece. Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. 697 Pomfret Street, Pomfret Center, CT 06259 and 392-A Merrow Road, Tolland, CT 06084, 860.928.2341. http://www.whzwealth.com.