Business Income Agreed Value
Business income agreed value suspends the coinsurance condition for 12 months. Qualifying for agreed value protection still requires the insured to complete the Business Income Report/Worksheet (CP 15 15) at the beginning of the policy period and every year thereafter. If an updated worksheet is not completed annually, the policy reverts back to a coinsurance form with all its applicable penalties. So this is not the best option if the insured and/or the agent are trying to avoid the worksheet.
"Agreed value" signifies that the insured and the underwriter agree up front on the amount of "insurable" business income subject to loss. The insured agrees to carry that pre-determined amount of coverage; in return the underwriter agrees to pay the entire business income loss up to that limit without the application or consideration of coinsurance or the actual business income (if the insured underestimated).
To clarify, the insured is not required to carry or limited to the 12-month business income amount calculated using the worksheet. The amount is and should be based on the estimated "period of restoration" and the percentage of a year that period represents. Calculating the "period of restoration" and ultimately the coinsurance is still necessary and was detailed in several earlier posts. All ISO-published coinsurance percentages are available for use with the agreed value option (50, 60, 70, 80, 90, 100 and 125%).
For an easy example, assume the insured estimated that a full year is required to return to "operational capability" and selects 100 percent coinsurance (estimated "period of restoration" / 12 = maximum coinsurance percentage) to account for the estimated time. Should the insured choose the business income agreed value option with 100 percent coinsurance, they are now committed to purchasing the full 12 month business income estimated amount ("J.1."). If the insured purchases any amount less than the required amount calculated, they are subject to a loss payment penalty.
The agreed value penalty is calculated exactly like the coinsurance penalty except that it has nothing to do a miscalculation of the actual business income during the coverage period. This penalty is assessed because the insured failed to purchase the amount of coverage they and the underwriter agreed would and should be in place. In essence, the insured is penalized for not meeting contractual requirements, whereas the traditional coinsurance penalty is assessed to assure the insured carries proper coverage and that the insured collects ample premium for the exposure.
An example of the difference between business income agreed value and traditional coinsurance is attached. For sake of the example, assume this insured is a manufacturing operation that underestimated the actual business income earned during the coverage period ("period of restoration") when completing the CP 15 15. All the necessary information for the calculation and comparison is found in the attachment.
Without the agreed value option the insured could have been out-of-pocket more than $61,000. How much greater would the uninsured amount have been had this been a much larger manufacturing entity? Hundreds of thousands of dollars could be left for the insured to pay.
Business income agreed value is a useful coinsurance-suspending option. Since the insured and the underwriter agree to the exposure and coverage amounts in advance, there is no question whether there is enough coverage at the time of the loss. Only a total shutdown exceeding the estimated maximum period of restoration will show the effects of any underestimation of the business income amount.
Activating this option increases the business income premium by about 10 percent compared to the traditional coinsurance coverage. However, business income agreed value has the lowest rate per $100 of protection when compared to the two remaining non-coinsurance options.
Monthly Limit of indemnity
This option to traditional coinsurance allows the insured to completely avoid coinsurance and sidestep the requirement of completing a business income report/worksheet (although that should no longer be an issue). There is no real up-front calculation associated with this option; the only calculation done is at the time of the loss, to decipher the maximum limit available during any one 30-day period.
Two decisions are required with this option: 1) the limit of coverage; and 2) the "monthly limit of indemnity" coverage fraction. No "formal" income calculations are done, so the limit is little more than a guess made by the insured. The second decision requires the insured to choose from among the three available "monthly limit" fractions: one-third (1/3), one-fourth (1/4) and one-sixth (1/6).
The monthly-limit fraction serves to cap the amount of coverage available in any 30-day period. The chosen amount of coverage is multiplied by the fraction to arrive at the maximum pay out during any 30-day period. For instance, if the insured purchases $300,000 of coverage, the maximum amount available in any 30-day period is:• 1/3 monthly limit = $100,000 maximum available for each 30 day period;• 1/4 monthly limit = $75,000 maximum available for each 30-day period; and• 1/6 monthly limit = $50,000 maximum available for each 30 day period.
One myth surrounding this option is the function of the denominator in claims settlement and payout. Some believe and teach that the denominator (the bottom number) limits the number of months the insured will get paid. That is, if the insured chooses 1/3 monthly limit of indemnity they will only be paid for three months of lost business income. That is fully and completely false, unless the limits are completely used in the first three months.
The denominator serves NO OTHER purpose than to limit the amount the insured can receive in any one 30 day period. Continuing with the above example, the insured choosing 1/3 monthly limit has up to $100,000 available for any 30-day period during the period of restoration." Business income loss payments will continue until the insured uses up the full $300,000 or returns to full "operational capability," whichever comes first. If it takes six months to use up the entire $300,000, that's how long the policy will pay.
Monthly limit of indemnity, contrary to its name, is actually a "non-indemnity" option; meaning that the amount of coverage has no real or known relationship to the insured's business income exposure or estimated "period of restoration." As such, the insured is entitled to receive the entire amount regardless of how long it takes. Again, the only two limitations are: 1) the monthly limit (as decided by the fraction); and 2) a return to "operational capability" before the limits are completely used.
If coverage is provided using the CP 00 30 (Business Income (and Extra Expense) Coverage Form), it is important to remember that the fraction does not apply to the extra expense coverage. However, the amount needed to cover any extra expense must be added to the business income limit purchased.
For example, if the insured wants $300,000 business income (BI) coverage and $120,000 extra expense (EE) coverage, he should purchase $420,000 in total protection. The maximum payout is limited to $420,000, but the amount available for extra expense in any one month is not limited by the fractional amount. If the 30-day BI amount exceeds the fractional limit, the entire extra expense loss is still paid. This continues until the total of both BI and EE losses reaches the limit purchased.
Click here for an example of monthly limit of indemnity loss settlement with extra expense coverage (using the CP 00 30). The example assumes $420,000 and 1/6 monthly limit of indemnity. Notice that the payout goes until the limit is used.
Maximum Period of Indemnity
The last and simplest of the non-coinsurance options, the maximum period of indemnity limits business income and extra expense payments to 120 days or until the limit is spent whichever occurs first. Like the monthly limit of indemnity, the amount of business income is little more than a guess.
This is a good option only if there is absolutely no question that the insured can return to operational capability within 120 days. Insureds that qualify might include those that:• Do not require any specialized facilities to operate and can run the business from practically any location. These insureds do not own the building and has quick access to leasable space; or• Can operate using other locations to absorb the production lost at the damaged facility (this is probably rare).
Maximum period of indemnity is a non-indemnity option. Like the monthly limit of indemnity option, the limit of coverage is not based on the actual exposure. Unlike the monthly limit option, coverage is limited to a specific number of days. If the insured does not use the entire limit during the 120 day period, the insured is simply out of luck (to some extent as they still had their business income exposure paid during the 120 days).
Of the three non-coinsurance options, this one carries the highest rate. Of course, the higher rate is somewhat offset by the lower limits likely purchased. This may not be the best option for the insured.
Finishing Up!
With the detailed discussion of the CP 15 15 in earlier posts, looking for a non-coinsurance option out of lack of understanding may not be necessary. However, if an insured is unsure of the amount of expected business income or is unwilling to provide the required accounting data, a non-coinsurance option may be the only way to cover the business income exposure.
Insureds need to understand the options, the costs involved and the limitations on coverage. The paragraphs above have provided a quick overview of the three options available. The next post details extra expense protection and its various coverage options.