Protection for E-85 producers: without adequate business income insurance, ethanol producers are at risk of significant losses that could put their operations in jeopardy

Risk & Insurance, Feb, 2008 by Darren Small

Summary

* In the ethanol industry annual income can vary greatly from one year to the next, making it difficult to determine how much business-income insurance limits to purchase.

* If a plant is damaged and out of operation, ethanol producers may be unable to meet payroll, unless they choose a business income policy with payroll protection lasting anywhere from 30 days to a year depending on their need to retain skilled workers.

* Ethanol producers should check to see how their policies define indemnity periods, how they value the finished stock, and how much insurance they provide in case of utility interruptions.

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As with any emerging industry, there is both promise and peril in the business of ethanol production.

Demand for alternative fuels has been growing in recent years in response to government mandates and increasing public concern about climate change. The ethanol industry got a big boost when Congress mandated in 2005 that oil refiners blend 7.5 billion gallons of renewable fuel, such as ethanol, in the nation's gasoline supply by 2012.

This growing demand for alternative fuels has opened up a promising opportunity for ethanol producers. With the government supporting demand for the product, there has been a rush of new entrants into the business. There are now some 125 plants in operation with 70 new ethanol plants under construction.

These endeavors are not without risk, however.

Ethanol plants are vulnerable to a number of perils that can damage or destroy critical business property and shut down operations for weeks, or even months, at a time. With operations at a standstill, ethanol producers face a loss of income as well as additional expenses as they try to get their plants up and running.

On top of that, it is a very volatile business, which puts producers at even more risk.

This volatility can be seen in the prices that producers pay for the feedstock and for their energy supply as well as the price they can charge for the finished ethanol product. U.S. corn prices, for instance, have increased sharply over the last year, making it more expensive for ethanol producers to buy the feedstock, while ethanol prices have fallen.

These pricing issues give ethanol producers little room for error and make them particularly vulnerable to losses that disrupt their normal operations.

Without adequate insurance, ethanol producers may suffer serious setbacks to their operations and may be unable to recover following a loss.

To guard against such potentially devastating outcomes, ethanol producers need property insurance that includes a business income policy tailored to meet their specific needs.

Most basic business income policies apply only to loss of income. They do not take into consideration continuing expenses, such as ordinary payroll, and extra expenses incurred to continue operations while recovering from a property loss. In addition, the policy may include a very limited period of indemnity, 30 or 60 days, giving the producer a very short period of time to rebuild property and restore operations. With this type of limited business income insurance, ethanol producers could find themselves stuck with significant uninsured business income exposures.

Ethanol producers need business income insurance that helps protect them against loss of income, but that also helps them meet payroll and absorb the extra expenses necessary for them to preserve critical operations while they rebuild property and production capabilities.

This coverage needs to include limits of insurance reflective of the values at risk and a period of indemnity long enough to restore lost or damaged property and operations. In other words, ethanol producers need business income insurance designed to help get them back in business following a property loss.

One of the most important factors to consider when purchasing a business income policy is how much insurance limits should be purchased. Business income limits are typically based on an estimate of annual income. In the ethanol industry, however, annual income can vary greatly from one year to the next.

In a good year, ethanol producers could potentially earn more than they expect and find themselves with insufficient business income limits. In another year, producers may earn less than expected and find they have more insurance than they really need.

Some business income policies include an "annual income on reporting" feature that provides buyers with a refund if they overestimate their annual income. This allows producers to buy adequate limits without overpaying for the insurance.

A business income policy is designed to provide insurance under a wide range of scenarios.

If an ethanol plant is damaged due to a catastrophe or some other peril, for instance, the plant may be out of operation for months while it is being repaired.

Ethanol producers may experience a shortfall in income for other reasons as well. Small ethanol producers, for instance, qualify for a tax credit that is based on volume production. If a plant is damaged, the producer may be unable to meet that volume production target and lose the tax credit. A business income policy should contemplate loss of that tax credit in the business income calculation.