A recent IRMI article titled “Limiting the Interruption in Business Interruption” discussed the importance of considering payroll during the risk assessment phase of obtaining business insurance coverage. The forms regarding business income and ordinary payroll are hyperlinked for ease of use and understanding.

A major expense for any organization is employee payroll and benefits (if directly related to payroll and paid by the organization: FICA payments, union dues, and workers compensation premiums) and one that must be reviewed and understood prior to loss as to the extent, if any, that should be continued during the period of restoration. An organization can decide to treat all payroll and benefits as a continuing expense and not remove it from the worksheet and thereby include all within the limit insured. Some organizations may decide that it can lay off certain employees that are not critical for the organization’s recovery during the period of restoration. Each organization is different in terms of employee skills, local job markets (low or high unemployment), and cost to retain new employees when prior ones are not available for rehire.

The typical approach for most organizations is to decide what class(es) of employees should be paid during the period of restoration and which ones should not. Most insurers use the term "ordinary payroll" to define that which may be excluded totally or paid for a specific period of time (90 days, 180 days, etc.) by the named insured. Ordinary payroll is a term defined by ISO in form CP 15 10 06 07 as "payroll expenses for all your employees except: officers; executives; department managers; employees under contract; and additional Exemptions, shown in the Schedule as: Job Classifications; or employees." It is possible that certain employees by name or class may fall within the definition of "ordinary payroll" but the organization deems their contribution to be needed during the period of restoration. An exemption to the broad definition of "ordinary payroll" can be used in order to continue payroll and benefits for these key employees. ISO Form CP 15 04 06 07 Discretionary Payroll Expense is used for this purpose.

I find that an example from the National Underwriter FC&S Bulletins is always helpful in understanding the practical application of certain policy endorsements:

Business Income and Ordinary Payroll

Q

A client I handle purchased business income coverage through ISO form CP 00 30. Endorsement CP 15 10 was attached to limit coverage for ordinary payroll to six months. This insured suffered a covered loss and was partially shut down for nine months. I believe he should be allowed to recover ordinary payroll expenses during the entire nine months because the company was only partially shut down.

The insurance company has disallowed ordinary payroll expenses past the six-month time frame. Is that correct?

Ohio Subscriber

A

The standard business income form CP 00 30 provides coverage for the actual loss of business income during the "period of restoration" which, in this case, would be nine months. The form defines business income as net income that would have been earned or incurred had the loss not happened and continuing normal operating expenses incurred, including payroll. Endorsement CP 15 10 limits coverage for ordinary payroll to the period stated on the endorsement.

Since this insured limited ordinary payroll coverage with the endorsement to six months, only the amount accrued during the six-month period of the shutdown can be included in the loss settlement.

Also illustrative is the trial court’s ruling in Consolidated Companies, Inc. v. Lexington Ins. Co., 2009 WL 211751 (E.D. La. 2009). Although this opinion was vacated and remanded by an appellate court on other grounds, the trial court was affirmed on the accounting principles involving the calculation of net profits to the exclusion of ordinary payroll in a case where the business partially resumed operations to minimize its business losses:

Lexington contends that the jury award of $7,071,120 in lost profits as part of the business-interruption claim improperly compensates Conco for its ordinary payroll, which is not covered under the policy. Lexington argues that Conco’s computation of its claim for lost profits, by subtracting its actual profit in the aftermath of Hurricane Katrina of $279,006 from the profit it would have otherwise earned is an “end-run” around the exclusion for ordinary payroll. Specifically, Lexington argues that, by deducting $12,900,000 of ordinary payroll in calculating actual net profit, which Conco then subtracted from “but for” profit to compute damages, Conco increased its lost-profit recovery by $12,900,000. Lexington argues that the amount of Conco’s net profit after resuming operations must be calculated independently of the amount Conco spent on ordinary payroll. When net profit is calculated this way, argues Lexington, Conco suffered no covered “actual loss” under the policy.

There is no provision in the policy under the “Resumption of Operations” provision that, in calculating the actual profit or loss sustained by the insured during the period of restoration, the net profit prevented from being earned be reduced by ordinary payroll paid during the resumption period. Conco generated over $205,000,000 in revenue when it resumed operations and spent $12,900,000 of that revenue on ordinary payroll. In determining the net profit earned of $279,006, ordinary payroll was properly deducted from the revenue generated during the resumption of operations.

  • Bruce McDonald

    During a recent CE course on Business Income, the instructor stated that insurers have won court cases in which they denied paying “ordinary income” as part of operating expenses during the period of restoration citing that ordinary payroll expenses were not “necessary” to resume operations. The insurer refused to include ordinary payroll expenses even though the insured had included ordinary payroll in the calculation of the business income limit on the worksheet and had more than adequate limits. The instructor recommended that policies be either endorsed to limit ordinary payroll to 30 days, and only to include that amount in the worksheet calculation, or to add the Discretionary Payroll Expense form CP1504 for the desired amount and include that amount in the worksheet calculation. Do you know of any court cases where the underwriter has prevailed using such an argument?