Is Your Business Properly Protected?

Business Interruption, commonly referred to as BI insurance, is designed to help protect a business against the financial consequences of an insured event that disrupts normal trading. Depending upon the policy wording and circumstances of the claim, cover may include loss of income or profit together with additional expenses reasonably incurred to keep the business operating or help it recover.

 

Damage to your premises, equipment or stock can be difficult enough for any business to deal with. However, the physical damage caused by a fire, flood, escape of water or another insured incident may only be part of the financial impact.

If your business is unable to trade normally following an insured loss, you could experience a significant reduction in turnover while continuing to face wages, rent, finance payments and other ongoing expenses.

This is where Business Interruption Insurance can become particularly important.

Understanding how your Business Interruption cover has been arranged is important because inadequate sums insured or an insufficient indemnity period could leave a significant financial shortfall following a major claim.

What Does Business Interruption Insurance Cover?

Business Interruption Insurance is generally intended to place the business, as closely as the policy allows, in the financial position it would have been in had the insured incident not occurred.

A claim may therefore take account of factors including:

• Loss or reduction in turnover
• Loss of insured gross profit or gross revenue
• Continuing business expenses
• Increased costs incurred to maintain trading
• Temporary premises or alternative operating arrangements
• The time required for the business to recover following the incident

The exact protection provided will depend upon the wording of your individual insurance policy, so it is important to understand both the basis of cover and the period for which protection applies.

Two commonly used approaches are Loss of Gross Profit and Loss of Gross Revenue.

Loss of Gross Profit Business Interruption Cover

Loss of Gross Profit is a widely used form of Business Interruption insurance and is frequently associated with businesses where a proportion of operating costs will reduce if trading stops.

Retailers, wholesalers and manufacturers are examples of businesses that may have significant variable costs associated directly with producing or selling their goods.

Under a Gross Profit basis, certain costs that are expected to reduce or disappear following an interruption may be identified as Uninsured Working Expenses (UWEs).

These might include specific purchases, carriage, packaging or other costs directly linked to turnover, depending upon the business and, importantly, the definition contained within the insurance policy.

By excluding appropriate variable expenses, the business does not necessarily have to insure costs it would no longer incur following a loss.

However, this also introduces an important risk.

Insurance Gross Profit Is Not Necessarily Accounting Gross Profit

One of the common areas of confusion surrounding Business Interruption Insurance is the term gross profit.

The definition used by an insurer can differ significantly from the gross profit figure shown in a company’s annual accounts.

For this reason, simply taking the gross profit figure from your accounts and using it as your Business Interruption sum insured could result in inadequate cover.

Businesses should carefully review the definition contained within their policy and ideally discuss the calculation with their insurance broker or professional adviser.

What Is Underinsurance?

Underinsurance occurs when the amount of insurance purchased is insufficient to meet the true financial exposure of the business.

In Business Interruption claims, this can happen for a number of reasons. For example:

• Turnover has increased since the policy was arranged
• The Business Interruption sum insured has not been reviewed
• Variable costs have been incorrectly identified
• The wrong definition of gross profit has been used
• Inflation or business growth has not been adequately allowed for
• The selected indemnity period is too short
• The business has underestimated how long a major disruption could affect trading

The consequences can be serious.

Depending upon the policy wording, an insurer may apply an Average condition or another underinsurance provision where the declared or insured amount is inadequate. This can potentially reduce the amount paid following a claim.

For example, if a business is materially underinsured, it should not automatically assume that the insurer will simply pay the policy limit. The settlement could potentially be reduced further depending upon the terms and conditions of the policy.

This is why Business Interruption cover should be reviewed regularly rather than simply renewed using the same figures each year.

Loss of Gross Revenue Business Interruption Cover

For some businesses, a Gross Revenue basis may provide a simpler method of arranging Business Interruption Insurance.

Rather than calculating insured gross profit after deducting specified uninsured working expenses, this approach is generally based more directly upon the reduction in revenue or turnover following an insured loss, subject to the precise terms of the policy.

Gross Revenue cover can be particularly appropriate for businesses with relatively few costs that vary directly in line with turnover.

One advantage is simplicity.

Establishing expected revenue over the chosen indemnity period can sometimes be more straightforward than determining which expenses should or should not be deducted under a Gross Profit calculation.

Reducing the complexity of the calculation may also help reduce the risk of incorrectly establishing the required level of Business Interruption cover.

However, there is no single basis of cover that is right for every organisation. The appropriate method will depend upon the structure, operating costs and circumstances of the individual business.

What Happens If Your Business Can Still Trade?

Not every Business Interruption claim involves a complete shutdown.

A business may be able to continue operating at a reduced level following an incident. This is known as a partial interruption.

For example, a manufacturer may lose access to one production area while another part of its operation continues. A retailer might continue trading online while its physical premises are closed. A hospitality business could potentially operate with reduced capacity while repair work takes place.

These situations can make Business Interruption claims more complicated.

Some costs may reduce in proportion to the reduction in activity, while others may continue in full. The business might also incur additional expenditure to maintain turnover.

This could include:

• Renting temporary premises
• Hiring replacement machinery or equipment
• Outsourcing production
• Paying additional transport or distribution costs
• Using temporary storage
• Increasing staffing or overtime
• Implementing temporary IT or communications systems

These additional expenses are often referred to as an Increased Cost of Working.

Whether a particular expense is recoverable will depend upon the policy wording, its financial benefit to the business and the circumstances of the claim.

What Is the Business Interruption Indemnity Period?

Another crucial element of Business Interruption Insurance is the indemnity period.

The indemnity period is the maximum period during which the policy can respond to an insured loss of profit or revenue following an insured incident, subject to the terms of the policy.

This is particularly important because the indemnity period should not simply represent the estimated time required to repair the building.

The financial impact of a major incident can continue long after the physical repairs have been completed.

Imagine a business suffers a serious fire and requires nine months to rebuild and reopen. Even once the doors reopen, turnover may not immediately return to its previous level.

During the closure:

• Customers may have moved to competitors
• Key employees may have left
• Contracts could have been lost
• Suppliers may have changed arrangements
• Production schedules may have been disrupted
• Stock may need to be replenished
• Customers may need to be informed that the business has reopened
• Sales and marketing activity may be required to rebuild demand

The appropriate indemnity period therefore needs to consider the full recovery period of the business, not simply the reconstruction period.

Is a 12-Month Indemnity Period Enough?

Many businesses historically selected a 12-month indemnity period, but this may not be sufficient following a serious loss.

A major property claim can involve several stages before normal trading resumes, including:

1. Investigation of the damage
2. Removal of damaged materials
3. Surveys and professional reports
4. Planning or regulatory approvals
5. Design and specification work
6. Tendering and appointing contractors
7. Obtaining materials and specialist equipment
8. Rebuilding and reinstatement
9. Replacing machinery, fixtures and stock
10. Recommissioning the premises
11. Rebuilding turnover to its expected level

Supply-chain pressures, specialist machinery lead times and planning requirements can extend the recovery process considerably.

For some businesses, an indemnity period of 24 or even 36 months may therefore be more appropriate. The correct period will depend upon the individual risk and should be considered carefully with your insurance adviser.

Could Your Business Survive a Major Interruption?

One useful way to review your Business Interruption Insurance is to consider a realistic worst-case scenario.

Ask yourself:

If we suffered a major fire tomorrow, how long would it genuinely take before the business was trading at the same level it would have achieved had the fire never occurred?

Then consider:

• How quickly could alternative premises be found?
• Is specialist machinery required?
• How long would replacement equipment take to obtain?
• Could employees work from another location?
• How dependent are you on one supplier?
• Could customers easily move to competitors?
• Would regulatory approval be required before reopening?
• How quickly could lost turnover realistically be recovered?

The answers may be very different from the period required simply to repair your premises.

Review Your Business Interruption Cover Regularly

Business Interruption Insurance should evolve as your business changes.

If your turnover grows, you acquire new premises, install additional machinery, change suppliers or alter your operating model, the financial consequences of an interruption can change as well.

When reviewing your business insurance, consider whether:

• Your turnover figures remain accurate
• Your Business Interruption sum insured reflects expected future trading
• Your Gross Profit or Gross Revenue basis remains appropriate
• Uninsured Working Expenses have been correctly identified
• Business growth and inflation have been considered
• Your indemnity period remains realistic
• Major suppliers or customers create additional dependencies
• Your disaster recovery plans remain achievable

Business Interruption Insurance can be one of the most valuable elements of a commercial insurance programme, but only when the basis of cover, sums insured and indemnity period properly reflect the needs of the business.

Need Help Understanding a Business Interruption Claim?

Following a serious property insurance claim, understanding the interaction between physical damage, Business Interruption losses and the requirements of your insurance policy can be challenging.

Safe and Insured helps policyholders understand and manage property insurance claims, helping businesses navigate the claims process and work towards getting their property and operations back on track.

If your business has suffered insured property damage and you are unsure what happens next, speaking to an experienced claims professional at an early stage can help you understand the claim process and the information your insurer may require.

Insurance policies, definitions and cover vary. This article provides general information only and should not be regarded as insurance, financial or legal advice. Policyholders should refer to their individual policy wording and speak to their insurer, insurance broker or professional adviser regarding their particular circumstances.