Mending the Gap: How to Insure Loss of Business Income
Loss of business income became an all too common occurrence at the outset of the COVID-19 pandemic.
Internationally, businesses were forced to shut down to check the transmission of the SARS-CoV-2. Even worse, the business income (BI) coverage they had purchased to mitigate the losses…covered nothing.
This unfortunate exposure occurred because there were (and still are) few insurance companies extending BI coverage for loss of revenue during a pandemic. “You’re on your own” was the implied message when policyholders demanded financial sheltering.
But commercial real estate owners and operators concerned about being caught in limbo in another pandemic have recourse besides insurance companies. This article delves into the three primary practices that can flexibly cover financial losses.
The most viable option to insure against the loss of business income is savings.
Setting aside a certain percentage of commercial real estate income has rescued many owners and operators who were hit with unexpected financial woes.
The greatest benefits of using your own savings to offset the loss of business income are flexibility and immunity from red tape. Substantial savings eliminate the dependence on an insurance company — especially their schedule or interpretation of what is covered or otherwise — or haggling with a third-party processor in order to receive crucial resources. That is, such funds can be pulled on demand.
The only drawback of using savings is the length of time required to accumulate funds sufficient to alleviate a medium- or long-term loss of revenue.
Increased Security Deposits
Increased security deposits have also emerged as a practical strategy to insure against loss of business income from non-paying tenants.
Prior to the COVID-19 outbreak, credit grade was inversely proportional to security deposit requested — so, on average, the higher the credit grade of a commercial tenant, the lower the security deposit threshold a landlord would set.
Yet when the pandemic unfolded and forced even AAA tenants to default on their rents, this implicit industry standard no longer seemed applicable. Now, commercial real estate owners and operators are implementing stricter security deposit standards that require large cash commitments.
The rationale behind this latest condition is, should a tenant or business default, there will be more money available for landlords to recoup. That said, states or local jurisdictions may restrict landlords’ autonomy in this regard and cap security deposits. Therefore, it’s best to check with a legal representative before you set the fee.
Rent Guarantee Insurance
Rent guarantee insurance had largely been popular among residential real estate landlords even before the first reported case of COVID-19 infection. Unfortunately, their CRE counterparts had limited access to this insurance product pre-COVID-19.
However, in the wake of the pandemic, several companies have introduced options for commercial real estate owners and operators to receive similar protection — to which the intended consumers have responded with enthusiasm.
CRE landlords have widely adopted rent guarantee insurance because of the absence of a ‘physical damage’ requirement in order to approve a claim. This stipulation was the basis for most insurance companies’ decision to limit business income coverage during the pandemic.
Fortunately, rent guarantee insurance can remedy this imbalance and cover the landlord if a tenant misses a payment — either successively or intermittently. Additionally, the landlord can add the cost of this insurance to rent so the tenants bear the expense instead.
The only potential downside to rent guarantee insurance is the narrow scope of coverage. As this is a newer product in the U.S., companies are offering to insure loss of rent for just six weeks to six months.
Nonetheless, this increasingly popular policy can provide a concrete buffer against loss of business income.
Shift the Burden, Ease the Woes
COVID-19 has shown business owners that there are certain events and contingencies that insurance won’t cover, such as the loss of business and rental income due to government-mandated shutdowns.
To prevent future gaps in coverage, commercial real estate owners and operators must be prepared to shift the burden of protection back to the other parties involved, specifically the tenant and the landlord.
Fortunately, there are a few mitigation tactics to de-escalate the impact of gaps in coverage and increase your chances of compensation. Saving aggressively, raising security deposit requirements, and purchasing rent guarantee insurance coverage are proven ways you can offset potential losses.
Still, only time will tell which approach will be the most effective: BI or DIY.