When I was in college, there was an English professor named Frank Kinahan, who taught a class called “The Little Red Schoolhouse.”  A lot of my fellow students (not me, of course!) apparently thought that if they could just write their papers in enough of an arcane and convoluted manner, people (including their professors) would think they were really smart and advance them in life.  Professor Kinahan believed that it was his job to disabuse the students of that notion. He was pretty good at it.  His motto was straightforward and clear. Simple writing is persuasive writing.

Given the hornbook rules of insurance policy construction (all ambiguities are construed against insurance companies, for example), you might think that insurance companies would follow Professor Kinahan’s advice and go out of their way to make things simple. They don’t. I’m not sure whether they don’t because the nature of the risks they seek to cover is too complicated, or because they think that if they write in enough of an arcane and convoluted manner, they’ll have “wiggle room” when coverage disputes arise. Either way, it creates work for people like me, so I suppose I shouldn’t complain.

The concept of business interruption insurance is pretty simple. A covered event happens. Your business shuts down. You’re insured for your “but for” income during the period of restoration – that is to say, “but for” the unfortunate event, you would have made X dollars, and instead you made Y dollars (or lost money).  As you can guess, the concept of BI coverage, because it’s largely an effort to predict the future, leads to more than its share of disagreements.

An interesting wrinkle recently arose in a case in Massachusetts.  A company called Verrill Farms ran a farm store.  The store burned down.  Within two days of the fire, Verrill reopened its business at alternate locations at reduced capacity. Within a month, Verrill resumed full capacity at temporary facilities. After the fire and during the process of restarting the business, no employees were laid off. All employees who remained on the payroll were involved in operations that allowed Verrill to maintain its business and generate income.

Verrill submitted a claim under its businessowners policy, based on its loss of net income in the year after the fire. A disagreement arose as to what expenses could be included in the calculation of net profit or loss. The policy contained a 60 day limit for claims relating to payroll expense. The carrier (Farm Family) argued that it didn’t have to pay for the cost of ordinary payroll expense during the period of restoration, beyond that 60 day limit.

But Verrill never made a claim for a direct payment of the cost of its ordinary payroll; it sought only to include payroll expense in the calculation of net profit or loss for the appropriate time period. The question, then, was whether the cost of ordinary payroll could be included in the calculation of net profit or loss in order to determine the loss of business income.  

In ruling for the policyholder, the Court first described the purpose of the ordinary payroll coverage endorsement:  “The purpose of this coverage is to make a direct payment to the insured for the cost of ordinary payroll, for a specified period of time, in the event that the business cannot resume its operations immediately or not at all during the period of restoration. When the business is able to restart its operations, a direct payment of the expense of ordinary payroll is no longer necessary because the business is generating income which pays its payroll expenses. Here, Verrill was able to resume its business operations at alternate locations, within two days of the fire at its store… Since the salaries of ordinary payroll employees were being paid, at all times, from revenues generated by the resumption of operations, Verrill made no claim for direct payment pursuant to the limited ordinary payroll endorsement.”

Next, the Court described the way in which ordinary payroll expense figures into the calculation of net income or loss:  “By refusing to include the cost of ordinary payroll as a deduction from gross revenue in the calculation of net profit or loss, which is the basis to determine loss of business income, Farm Family is artificially inflating Verrill Farms’ net revenue for the year after the fire. The artificial increase to net revenue also incorrectly decreases Verrill Farms’ actual loss of business income…The only rational reading of the policy, considering the contract as a whole as well as its purpose of making Verrill Farms whole, is that it requires the loss of business income to be determined by the difference between the amount of net profit or loss earned during the partial resumption of operations and the amount of net profit or loss that Verrill Farms would have earned had no fire occurred. The gross income earned during the period of partial resumption of operations (the restoration period) has to be reduced by the amount of legitimate and necessary expenses for that period, including ordinary payroll, in order to determine net profit or loss.”

This case represents another example of the Number One tenet for policyholders:  Always read the policy (no assumptions allowed), and, if there‘s a reasonable construction supporting your position, don’t take “no” for an answer.

The Court’s decision contains an excellent explanation of business interruption coverage generally, and you can read it here.