Business Interruption Insurance Guide

Business Interruption insurance is there to protect against loss of income or profits which arise as a result of damage to property from an insured peril e.g. fire, flood or theft.

We believe it’s important to consider how you would keep your business running in the event of a loss, including how you would continue to continue your normal business activities, pay bills and maintain relationships with your clients and suppliers.

Consider for example, a factory is destroyed or damaged by fire. Aside from the physical damage to the factory, machinery and contents which will need to be repaired or replaced, it is likely the insured will suffer a loss of income during the period they are recovering from the loss. They may also incur additional costs e.g. the cost of renting alternative premises to try and maintain the turnover of the business. These are the type of costs that would be covered by a business interruption policy.

Typical cover provided:

There are two key things to consider when purchasing business interruption cover:

• How long it will take to put the business back in the position it was before the loss – known as the Indemnity Period
• The income (either Gross Profit or Gross Revenue) that would apply to the business if they were trading as normal during the Indemnity Period – known as the Limit of Indemnity

Indemnity period

The Indemnity Period should take into consideration the length of time it will take to complete the rebuilding and repairs required plus how long it will take to return the business to the position it was before the loss. This period will vary between 6 and 36 months (in 6 month increments) and must be selected very carefully, once the indemnity period is exceeded insurers payments for loss of Gross Revenue/Profit will cease. We always recommend that consideration be given to a worst case scenario when determining your indemnity period.

As an example, an indicative time scale for an Industrial business may be as follows:

Which Cover Do You Need and How Much?

There are a number of ways insurers can cover Business Interruption depending on your activities and requirements.

Loss of Gross Profit

This is the most common choice of business interruption cover in the UK, it covers net profit (as a result of reduction in turnover following the loss), fixed costs and any increased cost of working.

Insuring on a Gross Profit basis means an insured can opt to remove any costs that they will not be liable for during the indemnity period e.g. materials, payroll for staff who will not be employed, freight and rent. Because of this, the sum insured is reduced and therefore the premium payable is likely to also be reduced, however it is important to note that incorrectly identifying the variable costs is a common source of underinsurance.

It is also important to note that an accountant’s calculation of Gross Profit differs to an insurer’s calculation of Gross Profit. This is because accountants consider manual staff wageroll part of “cost of sales” and therefore a variable cost. Insurers consider manual staff wageroll a fixed cost as they are of the understanding that you wouldn’t want to cull your skilled labour force in the short term following a loss as this would mean having to re-hire and re-train new personnel and consequently it would take even longer for the business to return to its position before the loss.

Loss of Gross Profit cover is aimed at customers with many directly variable costs such as those in the manufacturing and retail sectors. However it is also applies in many other industries.

Loss of Gross Revenue

If a business identifies that there are limited variable costs and in the event of a loss where they are unable to trade, their outgoings would remain mostly unchanged then a Loss of Gross Revenue basis may be a better choice.

The benefit of this cover is that there is no complicated calculation to select the Limit of Indemnity, it is simply the business turnover for the Indemnity Period plus consideration for any expected growth or decline in such. Due to the simpler nature of determining the Limit of Indemnity for Gross Revenue the instances of underinsurance are reduced dramatically.

Traditionally Gross Revenue has been considered most suitable for the service industry where they are unable to easily trade from another location e.g. hotels, solicitors and estate agents.

 Increased Cost of Working

This covers any additional expenditure necessarily and reasonably incurred for the sole purpose of avoiding or diminishing a loss in turnover following an insured loss e.g. hiring alternative premises, temporary staff, additional freight or storage etc. There are two ways to include this cover

• The definition of Gross Profit and Gross Revenue will automatically include Increased Costs of Working
• It can be purchased on a stand alone basis for businesses who don’t foresee a loss of revenue/profit in the event of a loss at their premises

Increased Costs of Working is subject to an “Economic Limit” – this means that you can only spend £1 to save £1 of turnover and therefore all additional costs must be necessary, reasonable and able to be justified by the business that has suffered the loss. Consider the following:

• Increased Cost of Working incurred of £50,000, loss of turnover avoided £200,000 – Policy would pay the full £50,000
• Increased Cost of Working incurred of £50,000, loss of turnover avoided £30,000 – Policy would pay £30,000

As many insureds are unaware of this important settlement feature of Increased Cost of Working we always advise that any Increased Costs are agreed by the loss adjuster before they are incurred.

Additional Increased Cost of Working

This is the term usually used for Increased Cost of Working when it is covered in addition to Gross Profit/Revenue and not within the existing sum insured. Additional Increased Cost of Working is not subject to the “Economic Limit” which means that although the costs still have to be necessary and reasonable they can be agreed more readily as long as they are incurred within the pre-agreed limit.

If it is determined that the costs incurred do fall within the Economic Limit then these can be covered by the main Gross Profit/Revenue sum insured, thereby freeing up more expenditure, if necessary, under the Additional Increased Cost of Working section.

There are a few insurers who may write Additional Increased Cost of Working in isolation however it is usually included in addition to Gross Profit/Revenue.

Business Interruption Extensions

To further complicate this already perplexing cover there are a number of extensions that should be considered when purchasing Business Interruption, a few of these are listed below:

• Suppliers – interruption to your business as a result of damage at a supplier’s premises
• Customers – in the event of damage at a customer’s premises they may not be able to take delivery of a product/require your service for either the short, medium or long term which will cause a loss of revenue/profit for you. This extension is especially important for businesses that have a small customer base.
• Loss of Attraction – this extension is vital for retailers/businesses who rely on “passing trade”. In the event this passing trade was reduced as a result of damage at a third party premises then any loss of your own gross revenue/profit would be paid under your policy.
• Utilities – if you were unable to trade as a result of damage at the premises of a public utility (gas, water, electricity, telephone/internet etc.)
• Notifiable disease, vermin, defective sanitary arrangements, murder and suicide – especially important for those in the hotel or food industries
• Denial of Access – covers loss of revenue/turnover in the event damage in the vicinity prevents you from accessing your premises for example a fire at neighbouring property causes drifting smoke or is declared unsafe causing the Local Authority to prohibit access to neighbouring properties
• Non Damage Denial of Access – there may be instances where access to your premises is prevented but there has been no damage to property e.g. bomb hoax, criminal activities meaning the police restrict access or indeed adverse weather. This is a non-standard addition to a business interruption policy as it extends the cover beyond the material damage warranty (as detailed below).

 Material Damage Warranty

This states that there must be a property damage policy in place which covers the physical damage to the premises and its contents, for the business interruption policy to be effective. Therefore, the perils under the business interruption policy must always mirror the material damage cover for a claim to be payable.

There are several types of business interruption policies, the most common being:

• all risks
• fire and specified perils
• engineering

Claims process

Due to the complexities and forensic nature of business interruption claims, a loss adjuster will usually be assigned by the insurer in the event of a claim.

The Loss adjuster will calculate your business’ loss of profits, and ensure the claim is inclusive of both tangible and intangible losses. Crucially, the evaluated loss should be based on business forecasts (what would have been achieved had the event not happened) and not simply the previous years’ earnings. This should take into account all influencing factors such as seasonal variations and planned expansion.

The settlement figure is calculated using the turnover in the months following an incident to the corresponding period in the 12 months preceding the incident. Within the wording there is an extension for the cost of accountants’ or auditors’ fees incurred in preparing the claim despite there being no separate sum insured for this. This is the only class of business that allows for the preparation of the insured’s claim to form part of the claim itself.

If you would like any help or advice arranging your business insurance speak to one of our colleagues for a no obligation review.