Business Interruption losses can be complicated, confusing, and for some business the damages are the end of the story. Having the right coverage for your business, your buildings, and the business property can make all the difference for your livelihood if a loss occurs. One additional coverage that is also common to purchase is Extra Expense Coverage. Many of our posts have given insight and case evaluations about Extra Expense claims:
- Incurred Expenses May Be Recovered Outside of the Period of Restoration – Understanding Business Interruption Claims, Part 94
- Commercial Property Insurance May Cover "Extra Expenses"
- Total Cessation is Not Required to Trigger Extra Expense Coverage — Understanding Business Interruption Claims, Part 81
Extra Expense Coverage is most often an additional coverage added to your BI insurance as an enhancement and if you elect to buy this coverage. Many brokers may consider it an essential extra. When you have a loss with an extra expense that is reasonable, necessary, and spent to continue operations you would have never incurred but for the loss you can make this claim.
But it is important to remember that under standard BI coverage, a claim can be made for Expenses to Reduce your loss that could appear to be an extra expense but are just an reduction costs. Expenses to Reduce your loss are an inherent part of your business income coverage. Expenses to Reduce are costs incurred after the loss that reduce or lessen your potential business income loss.
Kevin Grudzien’s article in PropertyCasualty360 last month set forth a good hypothetical that explains how policyholders can recover for expenses to reduce under the BI coverage. For a policyholder, knowing the proper coverage to make the claim under really matters when your policy either limits extra expenses or does not provide for the coverage.
Here is Grudzien’s explanation:
As an example, a small law firm has a fire that completely destroys its office. It does not own the building, but the landlord intends on rebuilding. The estimate to rebuild and to have the new space ready and available is 12 months. Fortunately, the firm has an online backup for all of its systems and does not lose any data. Naturally, the firm replaces all of its laptops immediately and finds temporary office space for the next year. Within two weeks, the entire firm is fully functional. It was also able to maintain and service all of its clients through the disruption.
The temporary short-term space is quite expensive and costs $15,000 per month. Based on its lease agreement, the firm is no longer responsible for paying its normal $5,000 per month rent; so the net incremental monthly rent amount is $10,000. This $10,000 monthly amount is an “expense to reduce” the Business Interruption loss.
I’m sure you are asking, why is the monthly $10,000 amount considered an “expense to reduce” versus an Extra Expense?
The key difference between Extra Expense and “expense to reduce” is that “expense to reduce” must equate to an amount lower than BI losses that would have been incurred absent the mitigation efforts.
In the example above, the law firm generates about $5 million in revenue on an annual basis. If it would not have found temporary office space and done nothing to mitigate its loss, it likely would have lost all of its clients and would have had a BI loss far more than the $120,000 “expense to reduce” amount. Therefore, the “expense to reduce” value is lower than the potential BI exposure. It would be common for people to mistake the $120,000 as an Extra Expense.
This is an important distinction and concept for public adjusters and policyholders to understand. Extra Expense coverage can be used when your loss exceeds your business income coverage but many mitigation effort expenses are really expenses to reduce.
Adjusters International has also published about these two types of expenses. Be sure to check out:
No matter how you look at these losses, all policyholders and insurance professional agree that it is critical for businesses to mitigate losses.
