A business may obtain insurance to provide coverage for direct losses sustained to the business property. In addition, it may also purchase coverage for indirect losses sustained as a result of suspending operations due to an insured event. The most common type of this coverage is called "business interruption" or, more recently, "business income" coverage. The purpose of this insurance is to place the insured in the same position as it would have been in had no interruption to its business occurred.
For example, an insured may obtain a policy of fire insurance to cover its business property and contents in case of a fire. However, such insurance probably does not cover indirect losses sustained by the insured, such as loss of income while the insured rebuilds the business. A loss of income may then cause the insured further problems, such as the inability to pay bills and salaries. Business interruption insurance would cover such indirect losses.
Prior to 1986, two "gross earnings forms" were used for business interruption insurance, and the forms were attached to the direct damage policy form. One form was for use with mercantile and non-manufacturing risks, and the other was for manufacturing or mining risks. These forms were mostly replaced with a simplified commercial property program involving new forms, and "business interruption" insurance was replaced by "business income" insurance.
The new business income forms cover an insured's loss of business income sustained because of the suspension of operations while it restores its business after a peril. "Business income" means the net income, net profit, or net loss before income taxes that would have been earned or incurred plus continuing normal operating expenses.
The amount of business income loss is based on the net income of the insured before the damage, the likely net income of the insured if no damage occurred, the operating expenses necessary to resume operations, and the insured's financial records.
Loss of Earnings
An insured must show that gross earnings or business income would have been earned during the period of interruption if there had been no damage to the business and that there are prospective earnings. A business that is not running but is under construction to begin running may obtain business income coverage from the date that operations should have begun. In addition, a business operating at a loss may also recover under a business income policy because it may still have a substantial loss of income in the form of continuing expenses, to the extent that those expenses were being incurred prior to the damage.
Loss of Profits
Business income is dependent on the net profit that would have been earned or the net loss that would have been incurred by the insured. "Profit" is the amount over and above the costs of either the goods sold or the materials in the manufactured product, labor costs, overhead, and administrative costs, less taxes. If the goods or materials, labor, overhead, administrative costs, and taxes exceed gross earnings during the period of interruption, there is no loss of profit.
When determining an insurer's liability for actual loss sustained by an insured, courts generally look to the language in the business income policy for the procedure for such determination and to the past and probable future experience of the business. Past experience supplies the basis from which a projection into the period of interruption can be made. A new business that has no past experience may still recover under the policy for anticipated profits if they are based on real circumstances. The probable future experience is based on the general business environment and is measured from the date of the damage.
Period of Indemnity
When looking at the future probable experience of a business in order to determine a business income loss, there is a necessity for a "cut-off period." The loss of profits must occur during the period of recovery or suspension of operations.
Causal Relationship Between the Loss and the Insured Event
Causation is sometimes an issue when determining if an insured is entitled to coverage for a suspension in operations. If the business is damaged by an obvious peril, such as fire, the existence of a covered peril, causation, and the date of damage are all apparent. Sometimes, however, the insured event and its causal effect are neither so readily apparent nor so easily established. Some courts require that the insured must actually suffer physical damage from a covered peril. Other courts find that the actual insurable event need not occur as long as it is imminent and that the insured need not prove physical damage to the property.