Business Interruption Insurance

Whilst Property Insurance provides cover for physical loss or damage in the event of an insured peril, the aim of Business Interruption (BI) Insurance is to put a business back into the position it would have been in, had a loss not have occurred.

Different Type of Business Interruption Insurance Cover

There are three core types of Business Interruption cover:

• Gross Profit
• Increased Costs of Working (ICOW)
• Gross Revenue 

Considerations when determining which type of cover is most suitable include:

• How significantly would a material damage claim impact turnover?
• Is alternative local temporary accommodation available?
• Do you have specialist requirements?
• Would delays in sourcing, moving to and getting set up at an alternative temporary location have a negative impact on turnover?

For companies that don’t have stock and work in progress, but where a material damage claim would impact on turnover, then a Gross Revenue basis may be most suitable.

When considering cover on an Increased Costs of Working (ICOW) basis, it is important to understand that a policy is likely to only pay for additional costs such as:

• Additional rent for another premises
• Costs to provide services at a new premises e.g. internet access, telephones etc
• Costs to fit our the new premises
• Travelling expenses, if the new premises are further away

It is important to note that since most costs usually occur in the period immediately following a loss, Insurers tend to limit the amount that can be spent in the first 3 months.

Where cover is arranged on a Gross Profit basis, Insurers will pay additional costs incurred to save a reduction in turnover. However, an economic limit applies. You cannot spend more on Increased Costs of Working than the Gross Profit it is designed to save.

If cover is required for additional costs over the economic limit, this can be arranged by the inclusion of ‘Additional Increased Costs of Working’ cover.

What is the ‘Material Damage Proviso’?

Business Interruption policy wordings tend to include a ‘Material Damage Proviso’, requiring there to be a valid material damage claim for business interruption cover to be triggered.

Calculation of the Gross Profit Sum Insured (where cover is arranged on this basis)

The ‘Gross Profit’ sum insured for insurance purposes differs from an Accountant’s definition of Gross Profit.

Year End Accounts often show the Gross Profit as ‘Turnover LESS Cost of Sales’. However, many of the expenses that an accountant would deduct for tax purposes would still continue in the event of a claim. These therefore need to be insured. Examples of such fixed costs include: wages, rent or mortgage payments, council tax, insurance etc.

The Business Interruption Gross Profit Sum Insured for insurance purposes includes wages and other fixed costs and is calculated as follows:

Gross Profit = ‘Turnover (plus closing stock/work in progress) LESS Purchases (less opening stock/work in progress)’

Uninsured Working Expenses can also be deducted e.g. Freight and Packaging. These are charges that vary in direct proportion to turnover. If after a loss a business cannot produce anything, then it will not be using its raw materials (Purchases), nor will it be paying hauliers to send the finished goods to customers (Freight), nor will it be using its packaging materials (Packaging).

Uninsured Working Expenses are often shown as: Purchases; Bad Debts; Packaging carriage and freight; and Discounts allowed. However, the definition of Uninsured Working Expenses do vary between Insurers. It is therefore important to check the policy wording applicable and refer any additional variable charges, prior to deducting.

Once calculated, the Gross Profit figure needs to be adjusted to allow for (i) inflation, (ii) any anticipated changes and/or growth and (iii) the required indemnity period (e.g. 24 months = Gross Profit x 2, plus any allowance for growth).

If the Gross Profit sum insured isn’t adequate at the time of a loss, then an Insurer would usually apply average. This would reduce the claim in line with the degree of under-insurance. If the sum insured is significantly lower than what it should be, then an Insurer may claim that a material misrepresentation has taken place and avoid the policy.

Where business growth is anticipated, it is important to calculate the Gross Profit based on the projected turnover. Assume that a claim will occur on the last day in the indemnity period. Factor in the estimated future turnover for the entire indemnity period that the claim may span.

The Business Interruption Indemnity Period

What needs to be considered when determining the indemnity period, is the maximum time that it could take your business to get fully back up and running following a total loss claim. This needs to take into consideration the possible worst case scenario and the time it would take to:

• deal with the aftermath
• find alternative temporary premises and/or outsource
• demolish existing buildings; site clearance; design and plan new premises; apply for permissions; wait for approvals; tender and contractor appointment process; rebuild; fit out; move back in and reopen
• replace stock
• replace and commission general plant/machinery
• replace and commission specialist machinery
• restore both the supplier and customer base

The indemnity period should be of sufficient length to cover your business until it reaches the operational level that it would have been at had the loss not occurred.

Traditionally, indemnity periods are a minimum of 12 months rising to 36 months in 6 month stages (shorter or longer periods are available). It is important to note that if the indemnity period runs out, the Insurer stops paying. It is therefore prudent to opt for a period that factors in delays which may be outside of your control. For example, relying on contractors to provide quotes to enable the tendering process to progress, extended lead times for specialist plant and machinery etc.

Whilst a 24 month indemnity period may sound like it would be double the cost of a 12 month period, the premium for 24 months is actually usually less than 150% of the premium for a 12 month period.

A fire would usually present the worst case scenario and the indemnity period should be decided on the basis of a total loss situation.

Business Interruption Cover Extensions

Standard Business Interruption policies cover claims arising following a loss at the insured premises. However, there may be circumstances where Business Interruption losses are sustained following an incident elsewhere.

Not all insurers automatically include Business Interruption cover extensions. In addition, the type and scope of extensions do vary between Insurers and policy types.

The following are examples of some cover extensions:

• Suppliers Extension
  To provide indemnity where a loss at a suppliers premises impacts on your gross profit. Insurers tend to provide Unspecified Suppliers inner limits. However, if you are reliant on any individual suppliers, and dual sourcing would be a challenge, it would be prudent to consider higher limits for Specified Suppliers.
• Customers Extension
  As with the Suppliers Extension, Insurers tend to provide Unspecified Customers inner limits. However, if you are reliant on any specific customers for a significant proportion of your sales, and a loss at their premises could impact on your gross prof, it would be prudent to consider higher limits for Specified Customers .
• Prevention / Denial of Access
  To provide indemnity where a loss at a neighbour’s property results in you not being able to access your own premises. The scope of cover varies depending, however most Insurers require there to be a material loss to trigger cover.
• Diseases, Food Poisoning, Vermin, Pests, Defective Sanitation, Murder or Suicide
  Not all insurers include non-damage Business Interruption cover triggers.
• Lottery Winners
  This is a modern extension providing cover in the event that staff leave following a sizeable lottery syndicate win.

Where cover extensions are operational, details will be included in the policy wording. It is important to note that inner limits and cover restrictions will apply.

Other Extensions may also be available, including:

• Motor Vehicle Manufacturers
• Property Stored
• Property in Transit
• Motor Vehicles
• Contract Sites
• Exhibition Sites
• Electricity / Gas / Water / Telecommunication Suppliers Premises
• Loss of Attraction
• Death or Adverse Publicity of a Patron
• Action by Police, Government or other Competent Authority
• Failure of Electricity / Gas / Water Supply
• Failure of Telecommunications
• Essential Personnel