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By CHRISTOPHER M. BROPHY, a director with the Property Insurance Claims practice at LECG, a global expert services and consulting firm, and RICHARD P. LEWIS, a partner in the Insurance Recovery Practice at Reed Smith LLP

Ordinary payroll coverage is a common endorsement in many property insurance and business interruption insurance policies. It provides coverage if a policyholder wants to retain key hourly employees, who are wholly idled after an incident and unnecessary to continuing operations.

Often, labor costs for hourly employees are necessarily incurred during a loss. With ordinary payroll coverage, however, the policyholder needn't show it was "necessary" to continue to pay employees. The coverage is typically available for 30, 60, or 90 days and is generally defined as: "The entire payroll expense for all employees of the insured, except professionals, officers, executives, department managers and employees under contract."

Some insurers contend that all hourly payroll incurred after the time period specified in the ordinary payroll endorsement is not claimable. For example, if the insured purchased 60 days of ordinary payroll coverage, they contend that any hourly payroll incurred after the 60 days is not claimable, regardless of whether the employees were necessary to continue normal operations. This inappropriately seeks to use a coverage extension to exclude coverage.

The initial question is whether it is necessary to continue payroll; only if this is answered in the negative would the policyholder need ordinary payroll coverage. As a practical matter, when a loss occurs, especially a partial loss, many hourly employees are necessary to continue normal operations.

To illustrate the true impact of ordinary payroll coverage, consider these examples:

Adam Co. owns a plant in Des Moines, Iowa. The plant employs 50 salaried employees and 100 hourly employees. The plant has two production lines. Because the hourly employees are highly skilled and critical to the plant operations, Adam's insurance group added 60 days of ordinary payroll coverage to the company's property and business interruption policy.

Example 1: A fire shuts the entire plant down for three months. The plant suffers a total sales loss for three months. Adam Co.'s management chooses to retain all of its salaried and hourly employees until repairs are complete.

A. Should insurance cover Adam Co.'s 50 salaried employees for the entire three months, until repairs are complete? Yes. Under most business interruption policies, amounts paid to salaried employees are treated as a continuing expense and paid.

B. Should insurance cover Adam Co.'s 100 hourly employees for the entire three months, until repairs are complete? Probably not. Because the insured only purchased 60-days of ordinary payroll coverage, only 60 days of hourly payroll is recoverable under the ordinary payroll provision. On the other hand, if the workers are employed to reduce the loss of income, the policyholder could claim the cost of employing them as Extra Expense, and if the labor costs were incurred to assist with the property damage, these costs would be claimable under the property damage portion of the claim. Further, the policyholder may be entitled to coverage for these employees if they reduce the eventual Extended Business Income loss when operations resume.

Example 2: A fire shuts down one production line for three months. Adam Co.'s plant suffers a fire that shuts down one of the two production lines for a period of three months. One of the plant's hourly employees is a crane operator. Although he typically operates both production lines, his services are required to operate the one remaining line during the partial production outage.

As many as 20 hourly employees worked on the production line that is now damaged. Plant management wants to retain them, although they will be wholly idled until repairs are complete.

The plant also has several hourly accounting employees. These employees are needed to continue work related to the remaining line, despite the lower production caused by the incident.

A. Should insurance reimburse Adam Co. for wages paid to the crane operator, although he only operated one production line rather than two?

Yes. Since the wages paid to the crane operator are necessary, they should be reimbursed without regard to ordinary payroll coverage. Some insurers would misconstrue the intent of ordinary payroll coverage and contend that only 50 percent of the crane operator's wages are covered after 60 days of ordinary payroll coverage because production declined 50 percent. This ignores the fundamental promise to pay "necessarily continu(ing)" costs.

B. Should the labor cost of the accounting employees be reimbursed by insurance?

Yes. The accounting employees' labor is necessary although production has declined as a result of the incident. Therefore, their costs should be reimbursed without regard to ordinary payroll coverage. Again, some insurers would misconstrue the nature of ordinary payroll coverage--an extension of an existing promise to pay necessary costs--and contend that only 50 percent of the accounting employee's wages are covered.

C. Should insurance reimburse Adam Co. for wages paid to the twenty hourly employees who were dedicated to the now-damaged production line who will be idled until repairs are complete?

Not necessarily. Wages paid to these employees should be reimbursed under the terms of the ordinary payroll coverage for a period of 60 days. After the 60 days, wages paid to idled employees would not be reimbursed under ordinary payroll coverage. (Some policies may provide 60 days of ordinary payroll coverage, but will allow for the full 60 days to be spread over a longer period, which can be helpful in the event of a partial loss.")

As in example No. 1, if these employees assist with the property damage, their wages should be reimbursed under the property damage portion of the claim. Also, if some of these employees work on the undamaged line, perhaps to run the line for additional hours to mitigate the loss, their wages should be reimbursed as Extra Expense. If Adam Co.'s policy provides for coverage during an extended period of indemnity, Adam Co. may also be reimbursed for these wages if it can demonstrate that the costs to recruit, rehire, and retrain the new employees will be greater than the cost of paying the employees while idle.

In general, payroll costs should be treated no differently than any other cost incurred by the insured after an incident. If the costs are necessary, they should be reimbursed by insurance, without regard to ordinary payroll coverage. If the costs are not necessary, and the employee is idled, they should be reimbursed for the time period that the insured carried ordinary payroll coverage. If the labor costs are incurred either to assist with property damage repairs or to mitigate the loss, they should also be reimbursed.

The intent of ordinary payroll coverage has been misconstrued on recent claims. Well-intentioned adjusters sometimes contend that unavoidable labor inefficiencies should not be covered after the number of days of ordinary payroll coverage. Should you have a B.I. claim, be sure coverage is property interpreted, and that you recover all that you are entitled to.

September 1, 2009

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