Business Interruption Insurance
Business interruption insurance (or consequential loss and loss of (gross) profits insurance) provides cover for the financial losses due to an interruption to a business caused by material damage to property.
For example, a factory is destroyed by a fire. Besides the physical damage, they will also suffer a loss of business income while part of the operating expenses will still continue. They will also incur extra expenses to keep the business going as good as they can while still losing the profit they were making before the fire. All these losses are covered by business interruption insurance.
Business interruption insurance is usually purchased in combination with property insurance but can be issued as a separate stand-alone policy.
Loss of Gross Profit
Business interruption insurance covers the loss of Gross Profit resulting from an interruption in the business, following a physical damage to the physical assets by a risk or peril covered under the property damage insurance.
Gross profits under business interruption insurance (not to be confused with your accounting definition) is the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services.
Gross profit includes costs that continue after an incident such as rent, advertising, insurance, salaries of permanent employees. It does not include costs that vary in proportion with the level of output (also known as uninsured working expenses), such as purchase of raw materials, packaging, transport, sales commissions, office supplies, utilities, etc. must be paid regardless of the level of output.
Gross profit is calculated by deducting variable expenses (which are also known as uninsured working expenses) from the turnover. The figures are adjusted for differences between opening and closing stock.
Business interruption insurance is forward-looking: it aims to keep you in the same financial position as if the loss or damage had not occurred. This means that insured Gross Profit should be based on your budget for the next financial year (or corresponding period if the indemnity period is longer than 12 months). As the financial result of the business is difficult to predict exactly, business interruption policies usually work with an estimated sum insured with adjustment after the end of the policy period based on the actual, audited financial report.
As the condition of average (under-insurance) applies to business interruption insurance, it is important to ensure the sum insured is accurate.
Increased cost of working
In order to reduce the loss of Gross Profits, a business can decide to take certain measures to such as hiring alternative premises and equipment, additional staff or engage in a marketing campaign to assure customers of their continued supply.
A business interruption insurance provides coverage for such additional expenses provided that they are made with approval of insurers and have a mitigating effect on the claim that otherwise would have to be paid.
(Maximum) Indemnity period
Business can be affected for a long period of time by an interruption. Even after the property damage has been repaired and production resumed, sales can still be lower important customers have moved to another supplier. Gross profit insurance will continue to pay for this shortfall in sales, however, limited to maximum indemnity period that you have selected.
Maximum indemnity period is defined as:
“the period beginning with the occurrence and ending not later than the maximum indemnity period thereafter, during which time the business is affected by the interruption occasioned by the damage”.
It is therefore important that in deciding the maximum indemnity period the insured will need to take into account the type of business, the time taken to replace specialist machinery, the types of customer and other factors that may have an impact upon the speed of company’s recovery to its anticipated trading position. If the insured selects an indemnity period that is too short, then the consequences are similar to under-insuring a building.
Payment of indemnity by insurers is not limited by the expiry date of the policy: if the loss or damage has occurred within the policy insurers will continue to pay as long as the business is affected, subject of course to the maximum indemnity period.
A standard business interruption policy only covers loss of gross profit which are a result of insured damage to the insured’s own premises. However, the insured’s business may also be affected by damage at third party premises for which a number of extensions to cover are available.
The most common extensions include:
- losses resulting from damage to the premises of suppliers
- losses resulting from damage to the premises of named customers. Limits apply based on the estimate of maximum turnover which is dependent on each named customer
- losses resulting from access to an insured’s premises being prevented due to damage to nearby premises.
- losses resulting from damage to the premises of a public utility (gas, electricity, water or telecommunications)
- losses due to the occurrence of a notifiable disease, vermin, defective sanitary arrangements, murder and suicide
An inner policy limit applies to the cover provided by each of these extensions.
Cover includes the cost of accountants’ or auditors’ fees incurred in preparing a claim. There is no separate sum insured for this item. This is the only class of business that allows for the preparation of the insured’s claim to form part of the claim itself.
Other bases of cover
Although the majority of business interruption insurance is written on a gross profit basis, there are other types of cover which are tailored to particular circumstances or to the needs of certain types of business. These include:
- Increased cost of working only. This more restricted form of cover may be chosen by some businesses, whose income would not be reduced in the event of physical damage to the insured’s property. Typically these are office type risks that only need a temporary office from which to conduct their business.
- Additional increased cost of working. This type of cover is offered as an extension to a standard business interruption policy and removes the economic limit which would otherwise apply to the increased cost of working cover. It may be needed by businesses which operate in an extremely competitive environment, whose customers are extremely difficult to regain once lost.
- Gross revenue/fees/rentals cover. This type of cover is suitable for businesses that have few or no expenses which vary with turnover, such as solicitors and other professionals and property owners.
- Advanced profits. This type of policy provides protection for the future earnings of a new business or an extension to an existing business. It differs from a standard business interruption policy in that the indemnity period only starts to run from the date on which income would have started to be earned from the new enterprise, rather than the date of the physical damage.