How Much Business Income Insurance is Enough?
Editor's Note: The following opinion piece was provided by Lucas B. Hartford, president, and Audrey L. Machowski, underwriting manager, Evergreen USA RRG Inc. For more information, visit www.evergreenusa.com.
The Basics of Business Income
Business income is a very important coverage for many campground and RV parks to make sure they have as part of their policy. Sometimes referred to as "Business Interruption coverage," it is protection against loss of income or profits when a business suffers a property loss or damage from a covered peril such as a hurricane, fire or theft. The campground is covered from when the event occurs until restoration of the lost property occurs.
In addition Business Income can include Extra Expense coverage. The Extra Expense pays for expenses that may be incurred as a result of the property loss that would not otherwise have occurred.
If for example an RV park had its main building burn down which was where the office, store and bathroom were located, then it would be the property coverage that would pay for the restoration of the building. The net income which is lost from campers not coming to park would be paid for by the Business Income coverage. And if something such a portable restroom and portable office were rented to minimize the number of lost campers and lost income, then that would be paid by the Extra Expense coverage.
The Typical Way Business Income Coverage Amounts are Calculated
Evergreen is often asked “How much Business Income coverage do I need?” Amounts can vary from $25,000 to well in excess of $1 million. The average campground typically purchases $100,000 to $250,000 in Business Income & Extra Expense coverage.
The typical way that agents calculate business income is to use a Business Income Worksheet which, while effective is very time consuming, seldom completed accurately and very confusing. This worksheet is very often completed by the businesses accountant.
While the results of these worksheets are accurate in “Maximum Possible Loss,” they are very ineffective in calculating the “Maximum Probable Loss." The difference of the two being that the “Maximum Possible Loss” is just that – the absolute worst case scenario. This is often very different than the “Maximum Probable Loss,” which is the most likely maximum loss given other non-financial factors. When you think of the difference of these two types of losses, think:
- Possible = Any chance of it happening if everything went wrong.
- Probable = The most likely chance of the worst case scenario.
Campgrounds and RV parks are excellent examples of businesses that often have very different “Maximum Possible Losses” and “Maximum Probable Losses." We can demonstrate this with an example contrasting a "typical" campground with a ‘"ypical" restaurant (or any other type of business such as a store, office, etc.).
The Typical Restaurant
The typical restaurant that is family owned has one location and one building where all of the services and products are offered. If that one building were to burn down, there will be a complete and sudden halt of all operating income to the restaurant. Is it "probable" that a building can burn down? Absolutely. Therefore for the restaurant the maximum probable loss is all operating income to cease. And of course the worst case scenario from a business income point of view is to have all operating income cease, so in this case the "maximum possible loss" is the same as the "maximum probable loss."
The Typical Campground
The typical campground has a much better spread of risk. While it may be one piece of property the campground is on, the campground may have multiple entrances/exits that can be used if needed. There are typically multiple buildings to spread the risk. And operating revenue can come from multiple sources such as site rentals, cabin rentals, store sales and day use of the campground. The "maximum possible loss" is that an event occurs that prevents any sites from being reached, the cabins destroyed so they can’t be used and the store to be destroyed so no sales can be made.
What probably may occur is that one or more buildings are destroyed but not all. If the main office building is also the store and has bathrooms and this was destroyed, then there may be other options than shutting down the campground. The campground may have another bathhouse that campers can use so they can still stay on their sites. There may be recreation hall that can be used as a temporary registration office and/or store. And while things won’t be perfect and there will some loss of income, it won’t be a complete loss of income. Therefore the "maximum probable loss"is not the same as the "maximum possible loss."
Everyone has a different appetite for risk and the amount of insurance different people need to buy to feel comfortable varies significantly. Typically people buy the amount of insurance they feel they need for the most probable losses, because the amount they would need for all possible losses could prove very expensive.
A Better Way to Calculate How Much Business Income Coverage You Need
Rather than completing a very long worksheet which is apt to give you a business income coverage limit much higher than you need, there is a better way to calculate your coverage needs.
As a campground or park owner, sit back in your chair, close your eyes and think about what is likely to be your worst possible loss scenarios that you want to insure for. Maybe it is a total closure of your campground for two months due to a hurricane; or closure of store for nine months; or the loss of multiple bathhouses due to vandalism causing the code enforcement officer to shut down a portion of your sites till the bathhouses can be rebuilt.
When you have thoughts about your probable worst scenarios, then figure out what the net income loss will be for those scenarios. Your net income loss will be what you lose for gross receipts minus any saved expenses from the loss. So if your store has gross receipts of $100,000 for the summer but there is electricity of $1,000, cost of goods of $75,000, and labor of $10,000, then your net income loss will be $14,000. Closing 100 sites for two months due to code enforcement regulations for a lost bathhouse might be roughly calculated as:
Number of Sites 100
x Average Occupancy 70%
x Number of Days Closed 61
x Gross Receipts per Site Night $40
Total Gross Receipts $170,800
– Electricity Costs Saved $10,000
– Labor to Clean Sites $6,000
Total Net Income Loss $154,800
Figure out your Maximum Probable Loss for each worst case scenario and then purchase enough Business Income coverage to cover the largest amount you calculate. There are other factors which may increase or decrease this figure such as extra expenses, peak season or contract penalties (such as seasonal contracts).
While this method won’t be exact, it will give you a very reasonable result and should provide a level of comfort for you in the amount of insurance you need to purchase.
At Evergreen we often see people purchasing new parks that are bank financed where the banks require unreasonably large amounts of Business Income coverage. While we are willing to sell limits much higher than is reasonable, it is not fair to the park owner. Some banks will require a campground to buy Business Income coverage equal to one year of gross receipts. This is a ridiculous waste of money for the campground owner since it would require a total and complete closing of the campground for one year AND because Business Income is paid on net income it doesn’t even consider the saved expenses.
If you are in doubt about how much Business Income coverage, you need then take a little time and run through the likely scenarios in your head and then put them on paper. And, of course, take the time to talk with your insurance agent to help you figure out a proper amount of coverage for your campground or park.