What is Business Interruption Insurance?
Business interruption (BI) insurance is a policy designed to protect businesses against a financial setback that may result from a range of insurable events such as fires or natural disasters. Traditionally, business interruption insurance is purchased as part of an insurance policy that covers fixed assets like buildings, plant, machinery, contents and stock, such as business package or industrial special risks (ISR) insurance. It is also available as a standalone policy provided by specialist insurers.
The purpose of business interruption is to ensure a business remains financially stable during a period when it is unable to generate revenue. This may include the loss of profit that would have otherwise been enjoyed if not for the interruption, as well as various other additional costs that may be incurred whilst the business is recovering such as assistance in paying bills or rent and covering payroll.
Who should consider Business Interruption Insurance?
Businesses which:
- Rely on the sale of physical products – namely manufacturers, wholesalers and retailers.
- Operate from specialised property – including unique premises that would be difficult to relocate from, where there is a reliance on key stock, or operations are dependent on plant or equipment that cannot be immediately repaired or replaced.
- Have a heavy reliance on utilities – whereby an interruption to public utilities or key customers or suppliers would cause substantial impact to operations.
- Incur regular substantial fixed costs – ongoing costs such as lease payments, commercial finance on vehicles & equipment that would remain payable even if the business was not trading.
- Have contractual obligations – including fines, penalties or loss of rent under contract.
- Are a seasonal business – who rely on peak seasons to generate revenue.
What does Business Interruption Insurance cover?
Business interruption insurance is triggered by an insured event, such as:
- Damage to business property – such as fire, storm, vehicle impact or flood.
- Disruption or prevention of access to the premises arising from damage to:
- public utilities delivering gas, electricity or water
- suppliers or customers’ premises
- premises in the vicinity.
- Closure or evacuation – due to legionnaires’ disease, vermin, pests or defective sanitary arrangements, murder or suicide.
Following an insurable event and depending on the structure of the policy, business interruption insurance may cover a combination of the following:
- Loss of income – replacing the income the business would have earned if it hadn’t experienced the interruption.
- Loss of gross profit – replacing the gross profit the business would have earned due to a reduction in turnover and the increase of its working costs.
- Claims preparation costs – to engage a third party claims preparer to assist with quantifying the loss, managing the claim and support to obtain the maximum benefit payable under the policy.
- Increased cost of working – additional expenditure incurred for the sole purpose of avoiding or diminishing a reduction in turnover which could include for example the costs of trading from alternative premises or the use of accumulated stock of finished goods to reduce loss of turnover.
- Additional increased cost of working – additional expenditure incurred to maintain the insured business or service, but does not have to be solely for the purpose of reducing or avoiding a loss of turnover.
- Accounts receivable – cover for payments that are unable to be collected from customers due to loss or damage to records.
- Loss of rent – the amount which the business would have earned on rent if the insured loss had not occurred.
- Contractual damages – damages incurred for breach of contract resulting from non-performance under a contract, fines or cancellation charges for purchase of goods or services that can’t be utilised due to the loss
- Prevention of access by government authorities – loss incurred as a direct result of an intervention by a government authority which prevents access to or hinders the use of business premises.
What doesn’t Business Interruption Insurance cover?
Common exclusions include:
- Communicable diseases, including pandemics
- Failure to keep proper financial records
- Terrorism
- War, invasion or act of foreign enemy
- Losses arising from wear and tear, gradual deterioration or lack of maintenance.
Business Interruption Insurance Important considerations:
- Indemnity period – this is the maximum time that an insurance policy will cover the policyholder for an interruption to their business. The chosen period should be sufficient to allow for lodgement and acceptance of the claim, management of the claim, re-instatement of damaged property and the businesses recovery to its pre-interruption position. Many factors can contribute to an extended period of interruption to the business, including council requirements & environmental issues, supply chain issues, delays during catastrophes and time taken to generate the same level of revenue enjoyed prior to the loss.
- Accounting gross profit vs insurable gross profit – the use of accounting terminology in insurance policies can cause confusion. It’s important to note that the “Gross Profit” from an accounting perspective is not the same as “Insurable Gross Profit”. Accounting Gross Profit is simply revenue minus the costs of goods sold. The standard definition of Gross Profit in the Industrial Special Risks policy is as follows:
(a) the sum of Turnover and the amount of the Closing Stock and Work in Progress shall exceed.
(b) the sum of the amount of the Opening Stock and Work in Progress and the amount of the Uninsured Working Expenses as set out in the Schedule.
Note: The amounts of the Opening and Closing Stocks and Work in Progress shall be arrived at in accordance with the Insured’s normal accountancy methods, due provision being made for depreciation. To be adequately insured, only expenses that are variable in proportion to sales should be listed as an Uninsured Working Expense (e.g. purchases).
- Under insurance – as with property insurance, most business interruption insurance contains “Under-Insurance”, “Average” or “Co-Insurance” clauses. These clauses require that you select a sum insured that is appropriate for the actual exposure. In the event the sum insured is insufficient, the policyholder may be penalised in the event of a claim, with the insurers payout being reduced proportionally to the rate of under-insurance.
Bellrock strongly encourages policyholders to engage with a forensic accountant or claims preparer to review financial figures and assist with setting an appropriate sum insured. In doing so, insurers often agree to remove co-insurance clauses from the policy. For further commentary on underinsurance, see our article here.
Business Interruption claims example
A manufacturing business suffers damage to their workshop as a result of an electrical fire. The fire damages a key piece of machinery, causing the businesses output to substantially reduce. The business contacts their usual machinery supplier, who advises that the lead-in time for a new machine will be 3 months. This interruption causes a loss of business as they are unable to service their existing customer base.
The policyholder identifies that they are able to source a new machine from overseas within 4 weeks, however at a much higher cost than the local supplier. The additional cost for the machine is worthwhile, as it will save the policyholder from losing customers and return to trading much quicker. The business receives their new machine and is able to return to their previous level of productivity and profit within 4 months.
Luckily, the business has taken out business interruption insurance with a 12 month indemnity period, including adequate gross profit coverage, claims preparation costs and additional increased cost of working benefits. As a result of the damage, the insurer pays to the policyholder:
- Their loss of profit from the date of the damage up until the time the gross profit returns to the pre-loss level (4 months).
- Claim preparation fees to a third party consultant that assisted with quantifying the loss and managed the claim on behalf of the policyholder.
- The additional cost of expediting the replacement machine from overseas that the business incurred to avoid a further reduction in turnover.
Information required to obtain quotations
- Property information including asset schedule, construction, occupation, protection and exposure details
- Financial statements
- Company structure charts
- Leases
- Supplier and customer information
- Business continuity plans.
