From an article appearing in Claims magazine,
"The Extended Business Income Form: Are Manufacturers Covered?"
Steven J. Meils, CPA, December, 1999
If 100 experts involved in the measurement of financial damages under the business income form were polled on this question, perhaps 99 of those 100 would state without hesitation that it was the intent of ISO to afford this coverage to manufacturers.
A differing view may emerge, however, when one closely examines the development of the form and prior ISO standard coverages, the exclusionary language found in the causes of loss forms related to business income, and the often-nonsensical results obtained when attempting such calculations.
ISO (Insurance Services Office) is a trade association of stock and mutual property and casualty insurance companies. The business income form discussed in this article is prepared on an advisory basis by ISO for its members.
Historical Development
The Business Income Coverage Form CP 00 30 was introduced by ISO in 1986 under its simplified commercial insurance program. The form replaced a series of other business interruption forms in use at that time. Prior to the introduction of this program, the gross earnings forms were the most common standard coverage forms in use. Two gross earnings forms were available, one for mercantile operations and the other for manufacturers. When the business income form was introduced, it made no such distinction and was generally understood to be available to all insureds.
A notable change in the business income form included the offering of an extended period of indemnity for not more than 30 days. Although an extended period of indemnity coverage could be obtained, under prior standard coverages, it was not part of the basic coverage offered and was only available to mercantile operations by policy endorsement. The extended period of indemnity coverage is intended to indemnify an insured for continuing losses after property is restored and operations are resumed, if pre-loss anticipated business volume is not immediately attained. Additional periods of coverage may also be elected under the policy.
There is nothing within the business income form that would differentiate coverages available for mercantile and manufacturing concerns. One could reasonably assume that the extended period of indemnity coverage should be available to both, if this judgment were made only by reference to the business income form. In fact, the only language found in the form that might serve to distinguish between manufacturing and mercantile insureds are the subtle, but perhaps important, references to finished stock (stock that you have manufactured) found within the policy definitions (G.1) and extended business income (A.3.d.). In those sections, the form distinguishes between the stock of a manufacturer and that of mercantile operation.
Exclusionary Language
It is the exclusionary language found in the causes of loss form that would seem to establish ISO’s intent. Under the Special Exclusions Relating Specifically to the Business Income Form, Section 4.a. (1), the policy states:
“We will not pay for:
(1) Any loss caused by or resulting from:
(a) Damage or destruction of finished stock, or
(b) The time required reproducing finished stock."
Not only does this language not allow a manufacturer to include in the period of restoration any time to replace its finished stock, it excludes any loss whatsoever that may result from the damage or destruction of its finished stock under the business income form.
Presumably, any business income loss that would result from a loss of sales during an extended period of indemnity that would have resulted from damage or destruction of finished stock would be excluded from coverage.
Additional language under 4.a. (3)(b) would provide:
“We will not pay for:
(3) Any increase of loss caused by or resulting from:
(b) Suspension, lapse, or cancellation of any license, lease, or contract. But if the suspension, lapse, or cancellation is directly caused by the suspension of operations, we will cover such loss that affects your business income during the period of restoration.”
This exclusion would also appear directed toward manufacturers because most mercantile operations do not maintain sales contracts with their customers. The provision would have the effect of excluding any business income loss that may result from sales losses as a result of cancellation of contracts during an “extended period of indemnity.”
If any possibility of recovery for a manufacturer under an extended period of indemnity coverage were not obliterated by the exclusions described above, they most certainly would be by a final exclusionary provision found in the cause of loss form. (4.a.5): "We will not pay for: (5) Any other consequential loss.”
We must then ask the question: What is a consequential loss?
In seeking to understand policy issues, I often refer to two authors whose careers span most decades of this century. While their books are somewhat obsolete because the coverage forms they discuss have changed since their books were written, many of the authors’ insights remain useful in garnering understanding of business interruption issues.
In his book, Business Interruption Insurance Coverage and Adjustment, published by Howell-North in 1957, K.W. Withers, an executive general adjuster, wrote:
Losses that are consequential to direct business interruption loss are excluded under all forms of coverages. Loss of trade would be an example of a consequential loss. If a business is suspended for a period of 5 or 6 months, it is bound to lose customers to competitors. Liability under business interruption coverage ceases when the property is completely replaced and the subsequent loss of trade is not compensable under this coverage.
Other consequential losses discussed by Withers include:
· Loss of customers due to moving to a new location because of the destruction of original property
· Increased operating costs because of a new location
· Increased operating costs due to replacing destroyed equipment with equipment requiring more maintenance, operating labor, depreciation charges, etc.
· Increase in capital investment because of destruction of original property
· Deterioration of stock, such as raw stock or field crops due to inability to use
In Business Interruption Insurance, What is Covered, published by National Underwriters in 1980, Frank S. Glendening, a CPA and consultant to the insurance industry for many decades, recites a list of consequential losses similar to those provided by Withers. “The contention that an insured’s market had disappeared for the ensuing season after the premises could have been restored, is of no concern to the insurance companies.," he wrote. "Loss is limited to the length of time it takes to replace the property specifically described in the policy. Any later loss is consequential….”
Even the court in Midland Broadcasters v. Insurance Company of North America, 636 F. Supp. 165 (Kansas, 1986) determined that losses incurred after a period of restoration ended were consequential losses not covered by the policy. Business income losses resulting from sales losses sustained as a consequence of direct physical damage after a period of restoration, i.e., a loss of customers, therefore, would not be covered if the term “consequential” is given its ordinary meaning. Unfortunately, this exclusionary language could also apply to mercantile operations, whose losses resulting from a diminishment of sales volume after the period of restoration would be no less consequential than those of a manufacturer.
Why then, would ISO offer an extended period of indemnity coverage on one form and then provide exclusionary language in another that would effectively preclude any possibility of recovery? If it is ISO’s intent to provide extended indemnity coverage only to mercantile operations and not manufacturers, it must modify its exclusionary language concerning consequential losses to except the sales losses of mercantile operations during an extended period of indemnity. If ISO intends that this coverage should be afforded to all insureds, then it should remove or modify the exclusionary language discussed herein from its causes of loss forms, because the provisions are without meaning or purpose.
Calculations
When calculating the business income loss of a manufacturer, the traditional approach is to measure the sales amount of production that would have occurred under normal operations during a period of suspension. The loss evaluator must then determine the sales amount of lost production that would also result in lost sales, either during the period of suspension or thereafter (the monetary loss). The business income loss is then determined based on calculated values.
Even if one were to abandon the traditional approach, how should the sales loss be calculated? Should we ignore the sales amount of production during a period of restoration and simply compare anticipated sales with actual sales? How then, do we respond to the losses of a manufacturer who produces stock and builds inventories in anticipation of later seasonal demand? Should projected normal sales be compared to actual sales during the 30-day extended period of indemnity? Must normal sales for this purpose be reduced to reflect sales that would have resulted from sales of finished stock damaged or destroyed in the loss?
If the insured recovered the business income amount under the policy for the sales amount of lost production during the period of restoration, should the sales that would have occurred from that production during the extended period of indemnity be eliminated from normal sales in the calculation to avoid double recovery? Should we add to normal sales for our extended period of indemnity loss calculations the sales amount of anticipated normal production that would result in lost sales during the 30-day extended period of indemnity, if those lost sales result from contract cancellation (those losses excluded from coverage in the causes of loss form)? Can we ignore entirely the policy language that would suggest that no loss could be computed for a manufacturer under extended period of indemnity coverage because it would be a consequential loss?
For those who advocate that the extended period of indemnity coverage is available to manufacturers, there will be no easy answers to these questions.
For Consideration
It is not this author’s intent to question how individual underwriters choose to interpret their contracts or respond to losses under their coverage forms. Because measurements required under the business income form for manufacturers are often complex, adjusters must rely on experts to provide advice and calculations concerning these matters. If, after a consideration of the issues raised here, you determine that the common views concerning this issue are inconsistent with a reasonable reading of the contract, you may wish to ask your consultants to reconsider their positions when evaluating and calculating financial losses for you under the extended period of indemnity provisions of the policy.
