To analyze the business income policy’s response to the crossover of an excluded event and a covered event, we begin with the Business Income Insuring Agreement found in Insurance Services Offices (ISO’s) business income policy. The form reads: We will pay for the actual loss of Business Income you sustain due to the necessary “suspension” of your “operations” during the “period of restoration”. The “suspension” must be caused by direct physical loss of or damage to property at premises which are described in the Declarations and for which a Business Income Limit Of Insurance is shown in the Declarations. The loss or damage must be caused by or result from a Covered Cause of Loss.
Several key terms and phrases within the insuring agreement are important to all business income losses:
- Actual loss of business income;
- Suspension of operation;
- Direct physical loss of or damage to property; and
- Covered cause of loss
In the article “Coronavirus: Does Business Income Respond,” Big I addressed the lack of business income coverage for the government-mandated shutdown due to COVID (so far courts seem to agree). Because the linked article focused on the lack of coverage for COVID-related governmental shutdown, one important topic was not detailed – how to calculate the business income loss.
Both ISO-promulgated business income forms (the CP 00 30 and CP 00 32) provide the same guidance on how the business income loss is calculated:
3. Loss Determination
a. The amount of Business Income loss will be determined based on:
(1) The Net Income of the business before the direct physical loss or damage occurred;
(2) The likely Net Income of the business if no physical loss or damage had occurred, but not including any Net Income that would likely have been earned as a result of an increase in the volume of business due to favorable business conditions caused by the impact of the Covered Cause of Loss on customers or on other businesses;
(3) The operating expenses, including payroll expenses, necessary to resume “operations” with the same quality of service that existed just before the direct physical loss or damage; and
(4) Other relevant sources of information, including:
(a) Your financial records and accounting procedures;
(b) Bills, invoices and other vouchers; and
(c) Deeds, liens or contracts.
During this pandemic panic and the resulting governmentally decreed business shutdowns, a key concept regarding the calculation of a business income loss is the loss determination provision found in 3.a.(2). Notice the phrasing, “The likely net income…if no physical loss or damage had occurred….”
Over the last several months, businesses were forced to close by governmental decree. Obviously, the business is losing income during the government-mandated shutdown, and as was detailed in the linked article, there is no coverage for this loss of income.
But “what if” there is a loss during the period the business was forced closed by the government, one that would be covered in “normal” conditions? Is there coverage for this loss? How is it calculated?
Assume this scenario, the business was closed by order of the state, 30 days before the business could have reopened it is damaged by a fire. Three months are required to repair the damage and reopen the business. How will the required shutdown affect loss settlement?
As per policy wording, the loss is adjusted based on “The likely net income….” The “likely net income” during the government decreed shut down is zero.
Because the “likely net income” is zero during the government-forced shutdown, the insured is not due any indemnification for that period. The unrealized revenue results from an excluded cause of loss. The efficient proximate cause of the lost revenue during the first 30 days of this period of restoration is the government shutdown – not the fire.
Efficient proximate cause is the basis of business income claim payments. What is the direct or efficient proximate cause of the loss of revenue during the period of business shutdown?
If the efficient proximate cause of lost revenue is a covered cause of loss, the lost revenue is covered. If the efficient proximate cause is an excluded cause of loss, there is no coverage for the lost revenue. If an excluded cause and a covered loss cross over, the income lost during the time attributable to the excluded cause is not reimbursed.
Business income calculations are based on efficient proximate cause. Was the business closure and resulting loss of income the result of a covered cause of loss or an excluded cause of loss? If a covered cause of loss occurs during a period created by an excluded cause of loss, the carrier only owes what would or could have been earned once the government shutdown ends.
In the absence of the fire, which is the covered cause of loss, the insured would not have earned any net income during the governmental shutdown, thus the business income policy does not owe for income that would not have been earned anyway. Income lost due directly to the covered cause of loss (the fire) after the government decree is lifted is compensable under business income – because the continued shutdown is directly related to a covered cause of loss.
Business income payments are a function of efficient proximate cause of loss. Why was the business not operational? Adjusting the claim differently would put the insured in a better position than they would have been in had there been no covered loss – which violates the principle of indemnification around which property insurance is based.
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