By LeRoy H. Utschig, CPCU, ARM

Several main boiler and machinery forms can be used to cover a client's exposure to loss of income and the extra cost of doing business as a result of damage to a covered object. In analyzing the exposures, I will use primarily ISO forms.

Daily indemnity

During the late 1960s, an old hotel in a Midwestern city suffered a loss. The business, which we'll call Old Hotel, Inc., had an ancient boiler. The hotel lost heat during one of the first cold days of the fall. Repairs to its boiler took about seven days. Old Hotel put in a claim to its boiler insurer for $21,000 in revenues lost during the seven days that the boiler was not operating.

The insurer responded that although there was coverage, there was none for the first three days of the loss. Coverage was provided at $1,500 per day, starting with the fourth day. As four days were covered at $1,500 per day, the insurer offered Old Hotel $6,000 for its $21,000 loss. The actual loss exposure was about $3,000 ($21,000/7 days = $3,000) per day. The insured understood the 72-hour deductible but did not understand why it was so far underinsured on the daily limit.

Dissatisfied over the boiler loss, the owners of Old Hotel changed insurance agents. The new agent looked at a number of Old Hotel's prior boiler insurance contracts and found that the limit of $1,500 per day for time element had not been changed in 15 years. There had been no change in the object limit even though Old Hotel had bought a new boiler and upgraded its system 10 years earlier. The new agent rewrote Old Hotel's boiler insurance with a higher limit on the covered object and daily indemnity coverage.

An insured does not need to prove the amount of its loss when insured with daily indemnity coverage. Were this limit higher than what the insured needed, some insureds would do everything possible to prolong a loss. Some insurers will not write daily indemnity coverage for the entire amount of an insured's loss exposure. The idea is that if an insured is paying part of the claim itself, the policyholder will have incentive to get back into operation as quickly as possible. A common underwriting rule when I was actively writing boiler insurance was to write the daily indemnity coverage for no more than 75% of the insured loss exposure. This was the underwriting philosophy of more than one boiler insurer. That percentage will vary from one insurer to another.

The lesson from this scenario is that it is necessary to review the limits on boiler contracts. Just as good agents review a client's building and personal property insurance limits every year, they also annually review a client's boiler limits on both the object and time element coverages.

Extra expense

To illustrate extra expense coverage, let's consider a fictitious milk processing plant (MPP), which handled about 25 truckloads of milk every day. The plant was located in the middle of dairy country in southeastern Wisconsin, and trucks brought in the raw milk from the dairy farmers who, among them, had several thousand head of dairy cows. Depending upon the farmer, these cows were milked either two or three times per day. There is a short time frame within which the fresh milk from the cows must be processed. The plant processed the milk with such processes as homogenization, pasteurization, and bottling of various kinds of milk such as skim, 1%, 2% and whole milk (Vitamin D). Part of the plant's equipment was a high-pressure (more than 15 pounds per square inch) boiler.

Damage to the plant occurred when straight-line winds of more than 100 miles per hour blew down major electrical transmission lines. When the power was cut off from one direction, electricity would come from another direction. In total, there were four directions from which the electricity could come. Every time the electricity was interrupted from one direction, it then came from another direction, and power surges occurred.

The power surges ruined the controls on the boiler, thereby preventing it from producing the steam and hot water necessary to operate its plant. It would take a minimum of 20 days to have the boiler fully operational again. MPP needed to find another milk processing plant.

About 20 miles from MPP another milk processing plant called Protein, Ltd., had the capacity to handle its own normal flow of milk plus the added volume of milk that MPP had been handling. However, in order to handle the increased amount of milk, Protein would need to operate its plant 24 hours per day. Both MPP and Protein's employees would be working side-by-side during this time.

The overtime pay to Protein and MPP's employees would be paid by MPP, and Protein would charge for the use of its plant. In addition, MPP would have to pay for the increased cost of transportation because all of its milk trucks would need to drive farther. MPP's extra expense coverage on its boiler policy would pay for:

* Overtime pay

* Leasing charges from Protein

* Increased transportation cost for MPP's milk hauling trucks

Milk Processing Plant had an extra expense limit of $240,000. Its extra expense claim was for $75,000. MPP was shocked when the adjuster stated that it could recover only $30,000.

Like its counterpart in the regular property forms, boiler and machinery extra expense coverage has a limit per month that applies. In this case, the time to repair the boiler was 20 days. Hence, the one-month limit of $30,000 applied. Had the loss been for between more than one month but less than three months, the recovery would have been $60,000.

It is important for an agent and client to discuss the proper limit for extra expense coverage. Typically, the greatest amount of extra expense will be incurred during the first month after the loss. As time progresses, the extra expenses will tend to diminish somewhat.

Business interruption

In another fictitious scenario, Southern Lumbermill, Inc. (SLI), used natural gas to run its gas fired turbine. The turbine was used to run the dynamo to produce electricity for all of the electric motors in the mill. The plant was running at full capacity. All of the electric motors were running and the turbine was operating near its total capacity. A need for any more electricity would push the turbine beyond its maximum output.

Although Southern Lumbermill usually processed only softwoods, it had a chance to process an order for hardwoods. (Hardwoods are more difficult to cut than softwoods.)

There are many saws in a typical lumber mill. A log comes in one end and is cut into different sized boards as it continues straight ahead through the plant. The final "cut" occurs when the boards are planed so that they are smooth on all four sides.

SLI's processing of the batch of hardwoods brought about an increased demand for electricity. This put more of a demand on the dynamo generating the electricity. The demand became greater and greater, pushing the dynamo beyond its limit. Although there was a safety relay that would shut the dynamo off if there was too much demand for electricity, the relay malfunctioned. There was a large explosion in the dynamo and the electrical panel that controlled the flow of electricity to the entire plant. Without the damaged dynamo and electric control panel, there was no electricity to run any part of Southern Lumbermill.

After the repairs had been completed and SLI was back into operation, SLI presented a business interruption claim to its boiler and machinery damage insurer. The claim consisted of typical business income (property term for this coverage) or business interruption (boiler term for this loss exposure) expenses. The claim included such items as utilities, insurance, depreciation, lease payment, loan payments, and wages for salaried and hourly paid workers.

The insurer would pay for all of the listed expenses except the wages for the hourly paid workers. Per the definitions and exclusion clauses in the contract, the insurer considered the wages for the hourly paid workers as ordinary payroll. Ordinary payroll is not automatically covered on a boiler and machinery business income form. This is in direct contrast to property time element where coverage is automatically provided for ordinary payroll.

Ordinary payroll

Ordinary payroll can be covered on a boiler and machinery business interruption contract by adding an ordinary payroll endorsement to the policy. When including coverage for ordinary payroll, be sure to include these expenses when establishing the total amount of business interruption protection. For insurance purposes, a working definition of ordinary payroll includes:

* Payroll expenses

* Workers compensation insurance premiums

* Social security taxes

* Group medical and disability coverage

* Group life insurance premiums, if any

Extra expense

Some extra expense coverage is included in the boiler and machinery business interruption coverage. It is similar to one of the two property business income forms. Southern Lumbermill's business interruption loss would have been $3 million. However, SLI spent $700,000 in extra expenses. By incurring the extra expense, Southern Lumbermill reduced the business income part of the loss by $500,000. The insurer paid only $500,000 of the $700,000 extra expense claim.

No coinsurance?

Boiler and machinery business income is commonly written on an "agreed amount form." At the inception of coverage and annually thereafter, the insured must complete a business interruption report of values. If the insured completes the annual reports on time, there is no coinsurance penalty. A coinsurance penalty does apply if an insured does not submit its report of values on time.

Combined business interruption and extra expense

The next claim situation demonstrates another of the boiler and machinery business interruption coverage forms. Coverage is provided with a limit per month. It also covers extra expense without a limiting feature. For example, let's say a machine shop that does nothing to reduce a loss sustains a $750,000 business interruption loss. However, the machine shop does incur extra expenses to shorten the length of time that it would be out of business. It spends $100,000 in extra expense, thereby reducing the business income part of the loss by $75,000. Even though the extra expense does not actually reduce the overall claim, the combined business income and extra expense coverage will pay for all of the business interruption and extra expense claims.

Summary

These are some of the key points discussed concerning boiler and machine business income:

* The limit on daily indemnity needs to reviewed periodically.

* Extra expense coverage is provided on a limited basis.

* The regular business income form does not cover ordinary payroll.

* Ordinary income can be covered on business interruption by endorsement.

* The boiler and machinery business interruption form that is most like the commercial property's business income form is a reporting form policy. To avoid any type of "coinsurance" penalty, the insured must submit a business interruption report to the insurer within the allotted time.

* Extra expense as a separate coverage is available. Only a fraction of the policy limit is available each month. *