Coverage Analysis: Sandy and Contingent Business Income Losses

Insureds joined in a mutually beneficial (or even exclusively beneficial) relationship with another business entity rely on the continued operational viability of that “non-related” entity. Their dependence on the goods, services, or mere presence of these external businesses leaves the insured vulnerable to financial loss should the relied-upon business or entity cease to operate following a property loss, even for a short time. Such relationships are often incorrectly referred to as contingent business income exposures; the correct term is dependent property exposure.

Unendorsed business income coverage pays the insured’s loss of income only when a covered cause of loss damages the insured location and results in a suspension of business operations. No protection is extended from the unaltered BI policy to indemnify the insured for its loss of income resulting from damage to and at an unrelated entity’s property. The policy must be endorsed to cover this external business income exposure – this dependent property exposure.

Insurance Services Office (ISO) has promulgated five business income and extra expense endorsements to protect the insured from this indirect (contingent) business income loss exposure:

• Business Income from Dependent Properties – Limited International Coverage (CP 15 01);

• Extra Expense from Dependent Properties – Limited International Coverage (CP 15 02);

• Business Income from Dependent Properties – Broad Form (CP 15 08);

• Business Income from Dependent Propertied – Limited Form (CP 15 09); and

• Extra Expense from Dependent Properties (CP 15 34).

Understanding these five endorsements first requires an understanding of the four property types upon which the insured depends and which are eligible for coverage in these endorsements.

Four entity types qualify as “eligible dependent properties”: 1) suppliers; 2) buyers; 3) providers; and 4) drivers. No, this is not ISO terminology, but such nomenclature (and rhyming) may allow for easier recall. The definition of each entity type along with their “official” names follows.

Suppliers: ISO refers to these as “Contributing Locations.” Contributing locations supply the insured with the parts, materials, or services necessary to manufacture its product or provide its service.

A supplier may be the insured’s sole source or main source of a critical part or service. If the contributing location cannot supply the part or service because of a property-loss-induced operational suspension, the insured cannot complete its work and is essentially out of business until the supplier resumes operations or an alternate source for the product or service can be found.

Policy language specifies that utility service companies such as water, power, or communication services do not qualify as “supplier locations.” A separate policy form outside the scope of this book covers these types of locations.

Buyers: ISO’s terminology for a buyer is a “Recipient Location.” A recipient location buys/accepts the products, goods or services of the insured. This may be the insured’s sole buyer or one that buys a majority of the insured’s output.

An example is an entity for whom the insured contractually agrees to manufacture, assemble, or provide a certain number or amount of goods or services. If the buyer’s (recipient’s) operations are suspended due to a covered cause of loss, it has no need to buy the insured’s goods. As a result, the insured’s income flow is disrupted until the recipient location returns to operational capability.

(See “Business Income Insurance Could Aid Dairy Farms Caught In Cheese Squeeze” below for a more detailed example. In the example article, one cheese producer was the sole or major buyer of milk from 88 dairy farmers in the area surrounding the cheese factory.)

Providers: A provider location is a “Manufacturing Location” by ISO terminology. A manufacturing location, as used in this endorsement, is not a location owned by the insured and part of the insured’s proprietary supply chain. Remember, dependent property coverage extends to protect the insured from business income losses emanating from the suspension of operations of “non-related” entities.

The dependent property endorsement describes a manufacturing location as one that manufactures “products for delivery to your customers under contract of sale.” An example is an engineering firm that designs a piece of equipment used in the construction industry but which does not have the facilities to manufacture the piece. Manufacturing is contracted to a specialty manufacturer. As orders for the equipment are received, the contracted manufacturing operation manufactures and assembles the finished product designed by the engineering firm.

If the manufacturing facility is damaged or destroyed by a covered cause of loss (i.e., a fire), the engineering firm loses the income from the sale of the equipment until the manufacturer returns to operational capability or another manufacturer can be found. The engineering firms’ loss of income is covered by the dependent property form (if correctly completed).

Likewise, an independent manufacturing representative may suffer a significant income loss if a manufacturer it represents shuts down due to a covered cause of loss and is unable to produce the product. If the insured loses income because a manufacturer can’t produce the product the insured sells, there is a dependent property exposure.

Drivers: Known to ISO as a “Leader Location;” drivers can include anchor stores (Wal-Mart, Sears, Belk, Hecht, Macy’s, etc.), sports and entertainment venues, and other such operations or entities that draw customers to the area.

Anchor stores draw shoppers to a particular mall or shopping center. Smaller retailers depend on those stores and the shoppers they bring to the location to hopefully pull customers into their shop while on the premises. Loss of a “leader location” in the form of an anchor store can reduce the income previously enjoyed by the smaller retailer.

A less-often considered driver is a sporting or concert venue. Hotels and restaurants in the city where the Super Bowl, World Series, or other events and attractions occur generally see significant increases in the occupancy rate and customer base leading to increased income. Should the stadium be severely damaged and the event moved, those businesses could lose a significant amount of revenue.

Consider, also, casinos or other attractions that may be attached to hotels. If the casino is damaged or destroyed, the hotel is likely to lose a large amount of revenue.

What “drives” customers to the insured’s location? That is the property on which the insured depends and against whose property loss the insured’s income needs to be protected.

Two of the five dependent property endorsements protect the insured from international exposures (if any); two focus exclusively on extra expense protection; one extends the full limit of business income (and extra expense if applicable) coverage to the dependent property; and three require the insured to specifically select a business income (and extra expense, if applicable) limit. Yes, that adds up to eight, but some crossover is present in the five forms.

Business Income from Dependent Properties – Limited International Coverage (CP 15 01): Only the dependent business income exposure created by suppliers (contributing locations) and providers (manufacturing locations) is contemplated in the CP 15 01. Additionally, the insured must select a specific amount of business income coverage to extend to those listed locations. This endorsement is designed to extend dependent property coverage for suppliers and providers located outside the traditional coverage territory (as defined in the property policy). The CP 15 01 can be used with either the CP 00 30 or the CP 00 32 and extra expense coverage can be added.

Extra Expense from Dependent Properties – Limited International Coverage (CP 15 02): This is exactly like the CP 15 01 except that the only covered exposure is the extra expense loss suffered as a result of a covered, loss-induced suspension of operations at the dependent international location. The CP 15 02 can be attached to only the pure extra expense coverage form (CP 00 50).

Business Income from Dependent Properties – Broad Form (CP 15 08): This endorsement extends business income and extra expense coverage (if the CP 00 30 is used) to dependent property losses emanating from any of the four types of dependent properties (suppliers, buyers, providers, and/or drivers). The entire business income and extra expense coverage limit is available to pay the loss resulting from the dependent property’s suspension of operation, provided it is caused by a covered cause of loss.

Business Income from Dependent Properties – Limited Form (CP 15 09): Almost exactly like the CP 15 08 with one major difference, this endorsement requires the insured to specify the amount of business income (and extra expense if the CP 00 30 is attached) coverage desired. This endorsement is used if: 1) the insured did not desire business income protection at its own premises; or 2) the insured desires separate or different coverage limits for the dependent property exposure.

Extra Expense from Dependent Properties (CP 15 34): This endorsement mirrors the CP 15 09 except that only extra expenses resulting from the closure of the dependent property are covered – the endorsement can be attached to only the pure extra expense coverage form (CP 00 50). Like the CP 15 09, the insured is required to choose the limits of extra expense desired. All four dependent property types are eligible for protection under this endorsement (like the CP 15 08 and CP 15 09).

Rates for dependent property coverage are largely based on the relationship between the insured and the dependent property – when the dependent property is a supplier, buyer, or provider. If the scheduled dependent property is the sole supplier (contributing location), buyer (recipient location), or provider (manufacturing location), the rate to add this protection is double or more than double compared to the situation where there are several suppliers, buyers, or providers. The greater the insured’s dependence on the other location, the higher the rate.

Similar terms and conditions apply to all five dependent property endorsements. Each applies these four conditions:

Both the broad and limited Business Income from Dependent Properties endorsements (the CP 15 08 and CP 15 09) stipulate that the business income loss will be reduced if the insured can resume dependent property operations by finding another buyer (recipient location) or supplier (contributing location). Further, neither the CP 15 08 or CP 15 09 can be used when the Business Income Premium Adjustment endorsement (CP 15 20) is attached.

Three dependent property endorsements extend coverage to eligible dependent properties not listed in the schedule of dependent locations. The CP 15 08, CP 15 09, and CP 15 34 provide coverage for these “miscellaneous locations.”

This additional coverage extends a minimal amount of dependent property coverage for locations the insured neglected to schedule, but from which the insured suffers a dependent property loss.

Payment under this extension is limited to .03% (.0003) of the sum of all limits shown on the schedule per day of suspension. If the total scheduled dependent property limits are $1 million, the most payable under this additional coverage is $300 per day ($1,000,000 x .0003 = $300).

Part of the business income risk management process is uncovering these dependent property exposures. The insured may be unaware of the potential income loss created by these relationships. Five endorsements have been created to cover most dependent property exposure faced by the insured.

Who would have thought that a cheese factory’s inability to make mozzarella cheese would cost so many dairy farmers their livelihood? Eighty-eight (88) dairy farmers in western Vermont and New York have taken an economic hit from a September 29 (2008) fire at the Saputo Cheese USA plant in Hinesburg, Vt. (about 12 miles southeast of Burlington).

News reports quoted Vermont’s Department of Agriculture Food and Markets as saying that the cheese plant purchased nearly 1 million pounds of milk per day, which totaled 10 percent to 12 percent of the state’s entire milk production. Each of the 88 dairy farmers, on average, supplied the plant with more than 11,300 pounds of milk every day. Unless alternate buyers could be found, the farmers would lose this major source of income for at least another two months, according to company officials.

The dairy farmer’s loss of income arising out of the fire damage to Saputo could have been covered under the dairy’s business income policy, if there was one. Attaching one of two “dependent properties” endorsements would have provided the necessary protection against this loss of income:

Business Income From Dependent Properties – Broad Form (CP 15 08); or

Business Income From Dependent Properties – Limited Form (CP 15 09).

These two forms offer the same breadth of coverage; the limit of business income coverage is the only difference. The Broad Form (CP 15 08) makes the entire business income limit available to cover a dependent property loss; whereas the Limited Form (CP 15 09) allows the insured to choose lower coverage limits applicable to dependent property loses, or provide dependent property coverage without purchasing business income for the insured location.

Four classes of dependent properties are extended coverage under these endorsements:

• Contributing locations – Those that supply the insured with materials and products;

• Recipient locations – Those the buy from the insured;

• Manufacturing locations – Those that are within the insured’s manufacturing chain (also an insured); and

• Leader locations – Those that draw customers to the location of the insured.

Saputo Cheese is a recipient location for each of the dairy farmers and likely accounted for a large percentage of the farmers’ annual income. Losing a large part of its income for three months could be devastating for any insured. However, there is an insurance solution to this exposure.

Few businesses fail following a major loss due to the lack of property coverage. Most business that don’t reopen or that close shortly after reopening do so because of the devastating loss of income. Insuring the possibility of business income loss arising out of direct damage and the loss of income resulting from damage to or destruction of a dependent property could save the insured from financial ruin.