Author: Chris Boggs
Question:
One of our insureds recently suffered a business-closing loss resulting in the loss of significant business income. Coverage was written using the CP 00 30 applying 90 percent coinsurance. The insured completed the business income report/worksheet (CP 15 15). Payroll was included in the worksheet and no payroll-limiting endorsement was attached. The claims adjuster refused to cover the cost of continuing payroll during the period of restoration citing this wording as the reason:
3. Loss Determination
a. The amount of Business Income loss will be determined based on:
(3) The operating expenses, including payroll expenses, necessary to resume "operations" with the same quality of service that existed just before the direct physical loss or damage;
The adjuster stated the only way to get coverage for payroll during the period of restoration is by attachment of the CP 15 04 – Discretionary Payroll Expense endorsement. Is the adjuster correct in the denial?
Answer:
The short answer is, no, the adjuster is incorrect in the application of the policy wording and in the statement that the only way to get payroll coverage is by attachment of the CP 15 04. This application of the form wording and the recommendation to attach the endorsement does not conform to the policy wording, the available payroll-limiting endorsement (CP 15 10) or even logically.
Both business income forms define business income to mean:
Business Income means the:
a. Net Income (Net Profit or Loss before income taxes) that would have been earned or incurred; and
b. Continuing normal operating expenses incurred, including payroll.
The definition does not limit payroll to the payroll necessary to resume normal operations. Payroll is a part of and included as an available class of continuing normal operating expenses. If this were not so, there would be no reason for the CP 15 10 – Payroll Limitation or Exclusion endorsement which allows certain payrolls to be excluded. If they were already excluded, this endorsement would not be necessary.
Also, the CP 15 15 – Business Income Report/Worksheet does NOT deduct any payroll expenses unless the CP 15 10 is attached; further evidence that payroll is included and classed as a continuing normal operating expense when applicable. (One caveat, payroll is classed as an ongoing operating expense only when the insured pays employees during the period of restoration.)
To continue within the business income policy, the coinsurance condition found in “D. Additional Condition" defines “business income" the same as the insuring agreement. Further, it states that the only expenses deducted when determining whether the coinsurance condition has been met are as follows:
In determining operating expenses for the purpose of applying the Coinsurance condition, the following expenses, if applicable, shall be deducted from the total of all operating expenses:
(1) Prepaid freight - outgoing;
(2) Returns and allowances;
(3) Discounts;
(4) Bad debts;
(5) Collection expenses;
(6) Cost of raw stock and factory supplies consumed (including transportation charges);
(7) Cost of merchandise sold (including transportation charges);
(8) Cost of other supplies consumed (including transportation charges);
(9) Cost of services purchased from outsiders (not employees) to resell, that do not continue under contract;
(10) Power, heat and refrigeration expenses that do not continue under contract (if Form CP 15 11 is attached);
(11) All payroll expenses or the amount of payroll expense excluded (if Form CP 15 10 is attached); and
(12) Special deductions for mining properties (royalties unless specifically included in coverage; actual depletion commonly known as unit or cost depletion - not percentage depletion; welfare and retirement fund charges based on tonnage; hired trucks).
These are the same deductions found in the CP 15 15. Note that payroll expenses are adjusted or deducted only when the CP 15 10 is attached – as highlighted above. Further evidence that payroll is covered as a continuing normal operating expense when incurred unless altered by endorsement.
This creates a reasonable expectation in the insured's mind that payroll is covered unless specifically excluded.
Loss Conditions (paragraph C) is the only policy section of any business income form that appears to intimate that payroll is excluded from ongoing operating expenses, but this is due to a misapplication or misunderstanding of the form:
C. Loss Conditions
The following conditions apply in addition to the Common Policy Conditions and the Commercial Property Conditions:
3. Loss Determination
a. The amount of Business Income loss will be determined based on:
(1) The Net Income of the business before the direct physical loss or damage occurred;
(2) The likely Net Income of the business if no physical loss or damage had occurred, but not including any Net Income that would likely have been earned as a result of an increase in the volume of business due to favorable business conditions caused by the impact of the Covered Cause of Loss on customers or on other businesses;
(3) The operating expenses, including payroll expenses, necessary to resume "operations" with the same quality of service that existed just before the direct physical loss or damage; and
(4) Other relevant sources of information, including:
(a) Your financial records and accounting procedures;
(b) Bills, invoices and other vouchers; and
(c) Deeds, liens or contracts.
C.3.a.(3) states that part of the loss determination includes adding: The operating expenses, including payroll expenses, necessary to resume "operations" with the same quality of service that existed just before the direct physical loss or damage. Some suggest this means that the only payroll expenses covered by the form are those necessary to resume operations. If that's the case, the same logic must be applied to any covered operating expenses meaning that the policy covers only operating expenses absolutely necessary to resume operations – not those that occur throughout the period of restoration. That's not how this provision works.
Read and applied correctly, this wording fully supports the fact that payroll is covered as an ongoing operating expense unless specifically excluded by the insured. Consider this:
- When analyzing its business income exposure, the insured concludes that it cannot risk losing any employees during the period of shutdown (the period of restoration); if the insured stops paying the workers, they will find other jobs.
- If the insured loses some, most or all the employees during the period the business is closed, it will have to find and hire new employees when there is income available from the operation. This will delay the insured's ability to reopen as quickly as it could if all the employees where ready to go. This delay is not covered as part of the period of restoration because of the business income's form wording regarding when the period of restoration ends.
- The insured concludes that all employees are necessary to resume operations as soon as the building is ready and it needs a way to finance that expense (the BI form).
- Because all employees being readily available when the building is rebuilt is necessary to resume operations, the insured does NOT deduct payroll from the business income worksheet (CP 15 15) and does not attach the CP 15 10 removing coverage for payroll.
- The insured pays a premium based on a business income limit that includes payroll (as found in the definition of business income).
Further, the loss determination section explains what documents are looked at to determine the amount of business income loss, it is not a coverage-limiting section. The “Other relevant sources of information" listed in 3.a.(4) will include payroll records as this is not limited to just the three types of records listed (proved by use of the term, “including").
Ultimately, the insured has a reasonable expectation that payroll is covered. If this was not so, and the CP 15 04 was required to garner coverage for payroll, the insured would potentially have to pay twice for the same coverage. First when payroll is included in the business income limit (because the insured did not exclude payroll using the CP 15 10) and again when the CP 15 04 is attached. Paying twice for the same protection is unreasonable and somewhat illogical.
The business income form, within the definition of business income as found in the insuring agreement, includes continuing normal operating expenses and payroll. If the insured does not want to include payroll, or only some payroll, it has the option of endorsing out payroll with the CP 15 10. Payroll expenses are covered by the BI form unless endorsed out; if this was not the case, there would be no need to have an endorsement removing payroll (CP 15 10).
Further evidence is found in the CP 15 10 which reads:
A. In the Business Income (And Extra Expense) Coverage Form and the Business Income (Without Extra Expense) Coverage Form, Business Income includes continuing normal operating expenses, including payroll, subject to all applicable policy provisions.
If the Payroll Expense Limitation is indicated in the Schedule, then Business Income includes payroll expense only up to the number of days shown, with respect to the job classifications and/or employees subject to the provisions of this endorsement. The number of days need not be consecutive but must fall within the "period of restoration" or extension of the "period of restoration" if an extension is provided under this policy.
If the Payroll Expense Exclusion is indicated in the Schedule, then payroll expense is excluded from Business Income with respect to the job classifications and/or employees indicated in the Schedule.
Even the exclusionary endorsement wording states that coverage is included for payroll.
Whether or not the CP 15 04 - Discretionary Payroll Expense endorsement is a necessary endorsement is not the primary debate; given the evidence, the endorsement is not needed to extend payroll coverage. In fact, this seems to be a relatively unnecessary endorsement.
Last Updated: July 20, 2018