Business Interruption insurance covers the loss of income that a business suffers after an unforeseen incident which has restricted normal trade for a period of time.
A property damage insurance policy will only cover the physical damage to a business, while the additional coverage of a Business Interruption policy covers the Gross Profit that would have been earned as it is designed to put a business in the same financial position it would have been in if no loss occurred. This would assist in maintaining good business relationships with clients, customers and suppliers which is imperative for their future trading.
In addition there are a number of extensions available under a Business Interruption policy that provide additional cover over and above the standard wording. Some policies may include some such covers within their standard wording but for most these are the extensions that need to be requested, they include:
There are many factors that need to be considered when deciding on the amounts that need to be insured for each risk and the length of the indemnity period that is covered. It is imperative that great consideration is given to this to ensure that your business is appropriately covered and you do not find yourselves underinsured.
Gross Profit as the subject matter of a Business Interruption policy differs from the Gross Profit as reported in a company’s financial statements. Gross Profit in accounting terms is often displayed after a deduction of fixed and variable costs such as wages, rent and taxes; whereas Gross Profit for Business Interruption purposes is the turnover less some (but not all) variable costs referred to as the specified working expenses as they are specified in the policy wording. These variable costs are deducted from the turnover because in the event of an interruption to the business, they will vary directly in proportion to the resulting drop in turnover, e.g. purchases of raw materials. As some variable costs are excluded from the cover, it is therefore essential for a business to understand Gross Profit when taking out this type of cover, as issues may arise due to uncertainty.
There are different types of Business Interruption cover. It is essential for a business to understand the difference between turnover and earnings and whether what they are really seeking is protection for lost earning capacity during the indemnity period (e.g. for the time lost during recovery); or cover for lost turnover, when determining the most appropriate type of cover.
Choosing an appropriate indemnity period requires careful consideration. The period should start at the date of the loss (giving rise to the interruption to the business) and represents the maximum period (i.e. the worst foreseeable scenario) which the business is affected as a result of the damage.
This period is often set short. Generally it is the over-optimistic analysis of the incident and the length of time required to restore the business (whilst maintaining a certain level of service or production) that is misjudged. The period selected should represent the full estimated time during which the business might be affected in consequence of the damage and which it would take to restore the business to its level of profit before the damage happened.
There are many factors to consider for, e.g. is the company currently occupying a listed or tenanted building; is the business reliant on specialist machinery or stock which may take significant time to source; time taken to demolish and clear the site; time taken to re-staff if necessary.
There are often crucial elements of the recovery process that are unforeseen and can have a serious impact to the business. External influences outside the control of the policyholder which they did not foresee can often extend the recovery period. It is therefore vital to understand what risks are involved and to ensure that the business is not limited by underinsuring the time period.
Failing to look far enough into the future when setting sums insured is another common mistake. It is essential to take into consideration not only the anticipated Gross Profit for the period of cover which should include allowance for any growth trend in the business but also the effects of a loss beyond the end of the insurance policy period i.e. the indemnity period.
Seasonal trends and bumper periods of trade should be taken into account when setting the appropriate maximum indemnity period. Policies can be arranged with a specific seasonal uplift included (for example, a 25% increase in the sum insured for a set period of peak trading).
This additional cover is especially important for businesses where disruption, however substantial, is likely to have a negligible effect on turnover e.g. where a trade association whose income is derived from a levy on its member. A fire destroying its offices would have little or no impact on its turnover, however, they may be left with significant costs for temporary premises.
This additional cover can provide substantial benefits to a business during the recovery process. Essentially it allows the freedom to take necessary actions without having to justify those decisions immediately in terms of cost effectiveness.
It is vital when purchasing this insurance type that losses are recoverable across the whole business and not just the specific premises suffering the damage. For example, consideration should be given to the potential impact of a loss at a head office or a warehouse which supplies to several retail outlets, or the co-dependence of manufacturing and distribution divisions at separate locations. It is important that all the interdependencies of sites and functions are taken into account and recognised within the insurance cover.
In the Manufacturing and Retail sector, the assembly of a finished product may rely on the delivery of components from numerous sources. If just one of these component suppliers were to suffer a loss, this would be felt considerably further down the chain than just the immediate customer. Therefore, the relevance of all associated parties in the chain should be considered in determining appropriate cover. This can be especially important where goods may be sourced from distant locations, such as China, with associated order, transport and delivery implications.
Typical coverage:
The relevance of all these and others should be seriously considered when determining the appropriate cover.
The policy will provide cover for the activities of the business as is named in the Policy Schedule. It is important to ensure that all of the activities of the business are correctly identified and named in the schedule.
Lorega is the UK’s most respected claims expert, working independently for you. Their Loss Recovery insurance policy can provide you with unlimited advice from one of their expert Chartered Loss Adjusters to help you prepare, negotiate and settle your Business Interruption claims. The service is also available for material damage losses. Lorega acts independently of your insurance company to help you achieve the fairest and fastest settlement possible.
