Issues with Business Interruption Coverage in Case of Loss

Many insurers issue a business owner’s policy in case of accidental loss. The policy generally provides a number of different types of coverage, including business interruption coverage.  Business interruption coverage provides that, that in case of a loss that affects business income, the insurer will pay for the actual loss sustained due to the necessary suspension of operations during the period of restoration. Unfortunately, the calculation used to determine coverage often allows insurers to avoid paying the full amount of actual lost business income.

If you are a business owner that has suffered a loss, such as a fire, we invite you to Contact Us to speak with an attorney about your situation and ensure that you receive all of the reimbursement you are entitled to under your policy.

The Formula Used by the Insurance Industry

The standard used by the insurance industry to calculate business income loss is designed to calculate the loss in net income/lost profits.  The insurer collects the gross receipts over a given historical period, such as the prior twelve (12) months of operations.  It then subtracts the revenues actually earned during the period in question.  This is known as lost revenue.  The insurer then subtracts the cost of goods sold from the lost revenue.  What is left is the net income/profit that the business would have earned if the loss had not occurred.

The Formula Used by the Legal Profession

While insurers use their own formula to determine their reimbursement amount, that formula typically does not align exactly with the language used to define “business income” within the policy itself.  The text of one standard provision reads, “Business Income means the: (a) Net Income (Net Profit or Loss before income tax) that would have been earned or incurred if no direct physical loss or physical damage had occurred; and (b) Continuing normal operating expenses incurred, including payroll.”  A plain reading of this language suggests that in time of suspended operations, a business is entitled to payment from an insurer for both the net income lost, plus normal operating expenses actually incurred.

The interpretation of this policy language was at issue in Polymer Plastics Corp. v. Hartford Cas. Ins. Co.[1] In Polymer Plastics, the plaintiff, a business that sustained a loss to its facility because of storm damage, argued that it was entitled to “continuing normal operating expenses” in addition to “net income” as per the express language within the policy.[2] The court found this interpretation of the policy was not supported because the policy states that the insurer will only pay for the loss of business income sustained due to the suspension of operations caused by the loss.[3]  The court essentially conflated the common definition of the phrase “loss of business income” with the policy definition of the term “business income” to come to the desired result, despite the obvious fact that “business income” was expressly defined within the policy and there was no rational support for the contention that the parties intended for two definitions of the same term to co-exist simultaneously.

The Court then articulated a formula for calculating business interruption loss that is slightly different that the one used by the insurance industry.  Specifically, the court stated that the “formula for ‘actual loss of business income’. . . is: Net Income (that would have been earned/incurred) plus Continuing Normal Operating Expenses (actually incurred) minus Gross Income (actually earned).”[4] Of note, the Ninth Circuit Court of Appeals upheld the Nevada District Court’s decision in an unpublished opinion.[5]

By way of example, let’s assume that Business A suffered a fire in one of its facilities and, while it had a historic monthly income of $100,000 per month, during the suspension of operations it has only been able to generate $50,000 per month.  Let’s also assume that Business A has a cost of goods sold that equals seventy percent (70%) of gross income.

Using the district court’s formulation of the policy provisions to calculate business interruption loss, Business A’s net income would have been $30,000 ($100,000 – $70,000 = $30,000), which added to the normal operating expenses actually incurred of $35,000 ($50,000 x .7 = $35,000), minus the gross income actually earned of $50,000, totals a lost business income of $15,000 ($65,000 – $50,000 = $15,000).  Of note, while the Federal district court framed the business interruption loss formula differently than it is commonly framed by the insurance industry, both formulas achieve the same result.

Tactics Used by the Insurance Industry to Reduce Your Business Interruption Payments

Application of the business interruption loss formula is simple in theory, but in practice, insurers are in the business of making money, and one of the ways they do this is by adjusting the value of the claim downward.  The insurance adjuster may calculate historic monthly income by considering the average monthly income over an extended period of time in order to reduce the historic average monthly gross revenues, even though it is plain from the balance sheet that there has been significant recent growth.

For example, six months prior to the loss, Business A may have grown from $100,000 in gross monthly revenue to $150,000 in gross monthly revenue through acquisition of an additional store.  However, if the insurance adjuster calculates the average gross monthly revenue using the prior twelve (12) months, the average gross monthly income will total $125,000, not $150,000.  This will reduce the amount of lost profit a business owner would otherwise be entitled to under the policy.

Alternatively, the insurer may reduce the amount owed to a business owner under the terms of the policy by inflating the cost of goods sold so that the monthly net income that would have been generated is diminished.  This is done through artificial inflation of payroll, utilities, taxes, and other costs associated with the provision of goods or services by the business, or by failing to properly account for extra expenses occasioned by the loss.  Unfortunately, in practice most insurers will not show the math they used to calculate business interruption loss and expect the business owner to blindly accept that the insurer paid what was owed.

Tactics Used by the Insurance Industry to Increase Their Own Profits

Further complicating business interruption loss is the fact that a business can suffer a cash-crunch as revenues plummet because of contracted operations caused by the loss.  Insurers oftentimes sit on payments they know are due and owing until the end of the restoration period, knowing immediate payment is required for continued liquidity and viability of the business.  They also delay restoration of normal operations by failing to timely authorize payments to contractors for repairs, or to timely authorize payment to replace equipment.  Again, insurance companies are in the business of making money, and one of the ways they do that is by delaying payment as long as possible on as many claims as possible so that they can reap the time-benefit of invested premiums.  This can result in significant permanent damage to a business and can even render it insolvent, yet insurers will not acknowledge the decreased value of the business caused by the delay in payment, and will maintain that they are only required to cover the net income lost during the period of restoration.

If you have suffered a covered loss for which you are entitled to business interruption payments, it is very difficult to know whether an insurer is correctly calculating your business income loss.  Chances are, they are not, and most of the time they will not show you their calculations.  Often, on your own, you may be limited in your ability to prevent your insurer, who has agreed to protect your interests, from instead harming you by putting their own interests first.

If you are a business owner that has suffered a loss, such as a fire, we invite you to Contact Us and speak with an experienced attorney about your situation.  Doing so can make the difference between the ultimate viability or insolvency of your business.

[1] 2006 U.S. Dist. LEXIS 103077 (D. Nev. Sept. 26, 2006).
[2] Polymer Plastics, 2006 U.S. Dist. LEXIS 103077 at *17.
[3] Id.
[4] Id. at 22.
[5] Polymer Plastics Corp. v. Hartford Cas. Ins. Co., No. 08-17497 (9th Cir. 2010).


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