Business Interruption Insurance: an overview of this critical cover

Depending upon the type of business you run, Business interruption (BI) Insurance could be as critical to you as liability insurance but its often not given the level of consideration it warrants.  Here’s our brief guide to BI insurance and what to think about when taking it out.

What is it?

Business Interruption (BI) provides protection against a reduction in Gross Profit as a consequence of a material loss arising from an insured event. For example, if as a result of a fire your stock is destroyed and your premises are temporarily uninhabitable, your business will suffer from a reduced turnover in the subsequent months or years. A BI policy will protect you against this reduction in turnover or pay additional working expenses to mitigate or prevent the reduction in turnover.  

Why is it important?

If correctly arranged, BI cover could prevent your business from suffering further following a catastrophe; consider how long your business could survive with no income and what the impacts would be. Would you lose clients and key employees? Would you be contractually obligated to continue to make mortgage or rental payments for the affected premises, how could you afford these?

Claim Example

A Firth & Scott client suffered a fire at their village shop. They received a total of £154,656.80 from their insurers as a result of the loss, of which a sum of £109,098.04 related to the BI section.

Issues to Consider

  • Correct sums insured – we find that a large proportion of new clients have incorrect sums insured. This means that in the event of a claim they would be likely to only receive a proportion of the claim settlement, depending on the level of underinsurance, or there is even the potential that the claim could be refused
  • Indemnity Periods – this represents the maximum period of time for which you can claim, starting from the date of loss and finishing when you gross profit returns to normal
  • Extensions to cover – protection under a Business Interruption policy can be extended to provide additional protection common extensions include :
  • losses resulting from damage at the premises of suppliers or customers
  • losses resulting from damage at the premises of a public utility
  • losses due to the occurrence of a notifiable disease, vermin, defective sanitary arrangements, murder and suicide
  • losses resulting from damage at the premises of your telecommunications provider
  • losses resulting from access to your premises being prevented due to damage to nearby 

How much should I insure for?

The Business Interruption sum insured should represent your annual turnover and closing stock, less opening stock, carriage costs and annual purchases. The amount insured should represent the anticipated figure for the forthcoming period of insurance. If your insurance is based on a longer Indemnity Period this has to be taken into account. For example, if it is based on a 24 month indemnity period it should represent the figure for the forthcoming two year period. Also consider that if for example a claim came in on the last day of your policy year, you would need to be insured for the anticipated figure for the following 12/24/36 months from the date of the loss.

You must make a ‘fair representation’ to your insurers because in the event of a claim you would need to demonstrate the above workings and be careful not to underinsure as Insurers will proportionately reduce any potential claims settlement you receive if they deem that your income would have knowingly been much higher.

What is an indemnity period and how long should I choose?

The indemnity period represents the maximum period of time for which you can claim, starting from the day of the damage, for loss of gross revenue due to a loss of turnover as a result of an insured event. A 12 month Indemnity Period may be adequate for the majority of minor claims which you may suffer. However, if you had a major catastrophe such as a severe fire or flood, from our experience this Indemnity Period will be inadequate.

It is quite probable that you would not be back trading from your premises within a year. Even when you are back trading it is likely that your turnover could be adversely affected for a significant period of time afterwards.

Factors to take into account when considering the period of indemnity are:

  • Your Building – is it old, graded/listed, what are the terms of lease?
  • Are you dependent upon a small number of customers? If so, would the loss of one customer affect you?
  • How long would it take to clear up, rebuild, refit, restock and recover lost customers?
  • How vital is your location to you?
  • Do you have any machinery that would be difficult to replace?

From our experience it always takes a lot longer for trading to get back to its previous level than clients anticipated. We would therefore strongly recommend that you opt for at least a 24 month indemnity period.

Increased Costs of Working Only Basis of Cover

The increased cost of working basis of cover is an alternative option for office based risks which for the majority of small claims, particularly for clerical risks, will prove adequate. It provides cover for the costs and expenses necessarily and reasonably incurred by you for the sole purpose of minimising the reduction in income to your business during the Indemnity Period, but not exceeding the reduction in income saved.

If however a catastrophic event occurred such as a major fire or flood, whilst additional costs such as rental of temporary premises, staff overtime and computer costs would be claimable, it is almost inevitable that the attentions of your key personnel and directors would be diverted from maximising revenue into business continuity planning and insurance claim preparation and inevitably your income would fall as a consequence.

Business Interruption is a complex matter as there will be specific aspects of your business which will require careful consideration when arranging your cover correctly, The Chartered Institute of Loss Adjusters report that 40% of businesses lack adequate BI cover. At Firth & Scott we have vast experience of arranging Business Interruption insurance for our clients and can provide you with expert advice in this key area, if you would like to discuss this further, please contact Steve Allwright or Stevie Jeffrey on 0115 8400300.