Business Interruption Factsheet
Business Interruption (BI) should be an essential part of your business insurance protection to provide cover against both loss of income and additional expenses you incur in the event your business suffers a temporary interruption due to an insured incident.
However, it can be complicated. There are many different options and types of cover available and the key is to select the right cover suited to your business. If not, things can go wrong when a claim occurs.
The Common Problems
- Underinsurance
- The sum insured is insufficient – there is often a misunderstanding of how to calculate the correct figure, but also failure to project far enough forward. The fact that the accountancy definition of Gross Profit differs from the insurer’s definition for many businesses doesn’t help! (See later for more on this issue and how to calculate the correct figure)
- The Indemnity Period (the period insurers will pay your losses following the event that gave rise to the claim) is not long enough – It is easy to underestimate the time it will take to get your business fully back up and running in the event of a serious incident. 12 months may not be (and is frequently not) long enough and you should consider indemnity periods of 18 or 24 months or longer. Whilst you will need to increase the sum insured in proportion, the good news is that generally doubling the sum insured does not double the premium. For more guidance see ‘How to assess a suitable Indemnity Period’ below.
- The wrong type (or lack) of cover
This can be anything from not having the right form of BI cover (see later for the main types of cover) or inadequate cover for losses arising from supplier’s or customer’s premises (particularly if outside the UK), a reliance on utilities or access to your premises. Also, have a look at our ‘Think outside the box’ section. Do you need a bespoke cover for your business?
Do not fall foul of policy small print such as the Material Damage Proviso (for cover to apply under the BI Policy, the damage causing the loss must also be covered by a Material Damage Policy) and a few policies even stipulate the material damage cover must be under the same policy as the BI.
- Failure to Review
You need to keep your sum insured and coverage under review (at least annually) to ensure it remains in line with trends and changes within your business, especially if you are expanding rapidly or diversifying. We often come across businesses that have not properly reviewed the sum insured for years.
The Main Types of Cover
‘Full BI’ – covers loss of ‘Gross Profit’ following a reduction in turnover. The insurance provides funds for you to pay ongoing expenses and overheads (other than the uninsured working expenses), as well as net profit.
In addition, ‘additional expenses’ incurred for the sole purpose of avoiding or diminishing a reduction in your turnover will be covered, although for the expenses to be covered, they must pass an economic test, ie they save or bring in at least as much as it reduces your claim.
Increased Cost of Working (ICOW) – can also be known as Additional Cost of Working and is a limited form of cover that may be suitable for businesses deriving most of their income away from their premises such as contractors or a business that can very easily relocate, such as a small office. These policies just cover extra expenses you incur to maintain income, but do not pay for any of the ongoing costs relating to staffing or the premises that have been damaged. These expenses may be for overtime, additional rental or ‘business as normal’ advertising and will be covered if they are reasonable (and ideally cleared with the insurer in advance), but are not subject to the same strict economic test as applies to ‘additional expenses’ cover.
Additional Increased Cost of Working – this is the term usually used for ICOW when it is covered in addition to ‘Full BI’ and is recommended to supplement the ‘additional expenses’ cover. If you suffer a major loss there will inevitably be extra expenses that will not necessarily pass the economic test for additional expenses, but are still reasonable and possibly essential in terms of the medium and longer term interest of the business. Examples include temporary repair costs or contracting work out to continue to supply customers and as there is no economic test to consider, another advantage of this extra cover is that quicker approval of these expenses can usually be obtained from the insurer or loss adjustor.
Other covers may be relevant to some businesses and include:
Book Debts (outstanding debit balances) - covers outstanding debts that cannot be traced or established as a result of accounting records being destroyed by an insured event such as a fire, although some policies restrict cover to the cost of reproducing records and chasing money owed. Book Debts insurance is no longer considered an essential cover as most businesses now have computerised accounting records that are usually stored off-site in the ‘cloud’. However, it can still be very useful if back-up systems (which are often a requirement of cover) are not set up properly or fail.
Rental Income – is generally either an optional cover or provided automatically by Property Owners and Landlord policies but may also be required within a ‘Full BI’ policy if there is an element of rental income for a business or a connected insured party.
Advance Loss of Profits (also called Delayed Start Up) – a specialist cover for delays in construction projects. Whilst this tends to be for larger projects the cover should not be overlooked in circumstances where a business is relocating or there are significant building works at a business premises such as an extension.
How to assess a suitable Indemnity Period
The indemnity period should be long enough to put your business back to the same level as you would have been if you hadn’t suffered the loss (including growth you expected to have occurred during the indemnity period).
It is easy to underestimate the time everything can take and whilst 12 months may seem a long time, it may not be long enough, so you should consider the following:
- How long will it take to repair or rebuild your premises? For serious losses architects and surveyors will be involved, there will be a tendering process, local authority requirements are likely to have changed and may involve new planning permission, building regulations, asbestos removal and disability access alterations. Expect delays if your building is old or listed and if you are not the owner, will your landlord make swift decisions?
- How quickly can new machinery be delivered and commissioned? Are there long lead times, especially if it is specialised, custom built or comes from overseas. Is second hand machinery available?
- Are alternative premises available and viable given the nature of your business or do you have the need for a specific location?
- Can you subcontract work to others to fulfil customers’ orders and keep them happy? If not and you lose them be realistic as to how long it will take to win them back or replace them. A longer indemnity period can give you breathing space to regain your market position, particularly if you are dependent on just a few customers.
- Is your business seasonal? If a loss occurs at the ‘wrong’ time, could you miss more than one critical season?
- Don’t underestimate the inconvenience and management time involved with the claims process and getting back on your feet, any other growth plans you had may slip while you deal with the claim.
How to calculate sums insured
Gross Profit is usually defined by most insurers along the following lines:
Insurance ‘Gross Profit’: turnover less uninsured working expenses and bad debts, adjusted for the difference between stock and work in progress between the start and end of the financial year. See later for a working example.
Uninsured Working Expenses (also known as uninsured variable costs) are those that vary in direct proportion to turnover and are not incurred if you do not make sales, ie the purchase of raw materials and the cost of packing and freight. Some costs such as power and heating may reduce following a loss but will not vary in direct proportion to a reduction in turnover, so should still be insured. However, some costs such as payments to subcontractors and sales commissions may need discussion before deciding whether they should be insured and in cases where variable costs are significant and savings likely following a claim, consideration can be given to insuring a percentage of the cost.
Accountancy v Insurance – as mentioned earlier, Accountants and Insurers often use a different definition of Gross Profit. Accountants traditionally define Gross Profit as net profit + fixed costs (standing charges), but the problem is this does not include production or manual wages. These wage payments are usually included within the ‘cost of sales’, which accountants treat as variable costs and are not included in their Gross Profit figure.
However, the manual wage roll is extremely unlikely to vary in direct proportion to a reduction in turnover and whilst savings are likely by reducing hours and laying off staff (particularly if there is a prolonged interruption), there will be redundancy costs, notice periods and would you really want to lay off key staff? Most BI policies are therefore set up to cover wages in full (ie they are not treated as uninsured working expenses).
A Gross Profit Policy is suitable for many businesses including manufacturers, retailers and wholesalers, but alternatives on a Gross Revenue or Income basis are available where the whole of the revenue or income is covered without deduction. This basis tends to be used in the professional services sectors where variable costs are limited.
Project Forward – you should work on the basis that a loss could occur on the last day of the period of insurance and include inflation and anticipated growth during the indemnity period. Assuming you are reviewing your sum insured at renewal date, this means you need to project forward at least 2 years (longer if your indemnity period is more than 12 months).
Insurers do appreciate the difficulties in forecasting and setting sums insured and generally offer Declaration Linked Policies with a 33.3% uplift in the estimated sum insured as a means of overcoming the problem, although it is still important to get the estimate as accurate as possible.
Increased Cost of Working - Assessing the sum insured is not an exact science and you should try to gauge the additional costs you may incur if you had to relocate on a temporary basis. Some insurers impose monthly payment limits and if these apply to your policy, you need to assess what you are likely to need in the first few months (when most additional costs are likely to be incurred) and calculate the sum insured from there.
Standard Business Interruption Policy Extensions
Business Interruption policy wordings are generally triggered by loss or damage caused by an insured peril occurring at a company’s business premises, however, many policies now have a range of standard extensions for losses arising from the following.
Public Utilities – interruption of supply of electricity, gas, water and telephone lines. Cover generally operates following damage from an insured peril at the utilities premises/sub-stations etc although some insurers provide cover up to the terminal ends of the supply to a customer’s premises and may not require damage to occur. Deliberate acts of the supply authority will be excluded.
Suppliers premises – most policies provide cover for interruption arising from damage at a suppliers premises in the UK up to a limit of say £100,000. Higher limits are generally available but you will need to specify the supplier and the insurer is likely to require details of the supplier’s premises. Some insurers will also cover suppliers premises outside of the UK but will normally restrict the type of damage they will cover and requests to include earthquake or flood are likely to require individual consideration. Some insurers will also provide cover for the suppliers of suppliers.
Customers premises – covers interruption arising from damage at a customer’s premises. Similar limits, restrictions and underwriting considerations apply as with the suppliers extension above.
Calculating the limit required for extensions, particularly for customers and suppliers premises is not an exact science but requires more than a cursory assessment of the turnover generated from a particular source. For suppliers, factors to consider include whether there are alternative suppliers and what % of your products will be affected if the supplier cannot supply.
A specific component that is vital to your business and obtained from a single source requires careful consideration, whereas for other less essential components that have general availability from a number of sources, the loss of a supplier is more likely to be an inconvenience and the unspecified suppliers premises limit maybe fine. As regards the supplier themselves, at the good end of the scale is the large global multi-site corporate with sophisticated business continuity plans, whereas the much greater risk is with a smaller supplier at a single site without the backup of a large corporate organisation.
There are then a range of other extensions available in respect of the following events at or in the immediate vicinity of your premises. Many are common to most policies, but not all, and the exact cover provided will vary from insurer to insurer.
Murder or Suicide
Closure of your premises by a Statutory Authority – reasons could include food poisoning, vermin, defective sanitation or a notifiable disease (following Covid, virtually all insurers now specify the diseases that are covered by their extension).
Denial of Access – if access to your premises is prevented or restricted following damage in the vicinity of your premises.
Loss of Attraction – damage to an attraction within a certain geographical area causing a downturn of visitors to the area. Since Covid the geographical restriction may be no more than a mile from your premises.
Non-Damage – most of these extensions require damage to have occurred from an insured peril to trigger cover. Prior to Covid, many insurers also offered non-damage extensions, particularly relating to denial of access and loss of attraction covers but these were the wordings that became subject to the Covid Business Interruption court rulings and any insurer now providing non-damage cover will be very specific and limited as to the scope of cover provided.
Many insurers also provide extensions in respect of damage at the following.
Contract Sites
Exhibitions
Property in Transit
Patterns, moulds, tools at third party premises
Essential Personnel – death or permanent disablement of key staff. Some insurers restrict cover to directors, but others include senior key staff.
Employee Lottery Win
Specialist Cyber and Engineering covers –Business Interruption policies generally provide cover arising from damage caused by perils covered by a standard Material Damage or Property policy which normally exclude cyber and engineering covers such as hacking/viruses and mechanical breakdown. Business Interruption arising from these events is available under specialist cyber and engineering policies.
Insurers generally impose individual limits to their various extensions which are often relatively modest, from £25,000 to £100,000 but can usually be increased on request. Some covers will be subject to an excess, which is often a time period rather than a monetary amount and in some cases a franchise applies (short interruptions are excluded but full cover from the start of the interruption is provided if the limit is exceeded).
‘Think outside the box’ – What could happen to your business?
Back in 2011 UK business came under threat from a very unlikely source. The ash cloud from the Icelandic volcanic eruption closed the UK’s airspace and disrupted air transport links. Fortunately it did not last long, however what it did do was open our eyes as to the potential for totally unexpected events to interrupt business, although not wide enough for Covid!
Few would have predicted that much of the world economy could be closed down or disrupted from a single event and BI insurance cover arising from Covid was a highly controversial subject at the time. However, with the exception of specific pandemic cover for some large corporates, the most high-profile example being the Wimbledon Tennis Championship who reportedly bought pandemic cover, the insurers that were forced to pay claims following the FCA Test Case ruling, or subsequent judgements, did so because of poorly drafted policy wordings which were never intended to provide cover for national or even regional lockdowns.
The intention of the infectious disease and non-damage extensions of cover were to compensate a business following an event at or in the locality of their premises. The intention was to provide cover for the likes of a TB (tuberculosis) outbreak, which although serious could be contained and would only affect a small area.
Insurers provided this cover because their exposure to losses was limited, could be quantified and reinsured if necessary. Policies for smaller businesses were not priced to cover risks with such widespread exposure as a pandemic involving a previously unknown disease. These risks are simply too big for mainstream insurance and the cover available has been the preserve of the large corporate world where risks are individually assessed and underwritten.
Insurers have now tightened their policy wordings as a result of Covid and certainly for smaller business, are unlikely to provide any BI cover should a future pandemic occur again. There has been talk of a pooling scheme along the lines of PoolRe for terrorism and FloodRe for flood where insurers share the risk but with Government backing in case claims occur before sufficient reserves are built up but as yet nothing has materialised.
Despite business interruption cover for national or worldwide events likely to be outside your control, nevertheless it is still wise to assess the unexpected that could disrupt your business. Certainly, we have dealt with claims from some unlikely sources over the years. An example being a Sussex company whose ‘dumb’ terminals were controlled by their Head Office in Florida. The electricity supply to the Head Office was cut for a number of days following a hurricane. Our client was unable to work until the Florida electricity supply was reconnected, but fortunately a suitable extension was in place on our client’s BI policy. Consider what type of risks could leave you exposed. Do you have a reliance or dependency with any aspect of your business or risks that are different from the norm? It could be:
- Cyber risks (hacking, viruses etc) to your systems, communications or on line revenue?
- Research and Development Departments.
- Specialist vehicles or transit risks.
- A liability for fines or penalties if you cannot honour contractual commitments.
- Is there vulnerability in your supply chain? Could it be that you are at risk with one of your supplier’s reliance on one of their suppliers? Could your supply chain be affected by the likes of strikes, political risks or insolvency?
- Are there any risks specific to your trade sector?
These should be identified as part of your risk assessment and business continuity planning and you should talk to us about any issues or concerns that you have as most risks can be insured.
As mentioned Business Interruption can be complicated and we have tried to deal with the main issues here, but please feel free to fully discuss your individual requirements with your usual contact.
Gross Profit Sum Insured Calculation – an example
From Financial Year End 31.12.23
Gross Profit =
Turnover: £1,000,000
Closing Stock and Work in progress: £10,000
Total: £1,010,000
Less
Uninsured Working Expenses (generally)
- Purchases: £350,000
- Packing and Freight: £50,000
- Bad Debts: £5,000
Opening Stock and Work in Progress: £5,000
Total: £410,000
Gross Profit: £600,000
Projecting Forward*
Financial Year end to Policy Start 31.12.23 – 30.6.24: £15,000
Insurance Year 1.7.24 – 30.6.25: £30,750
12 months Indemnity period 1.7.25 – 30.6.26: £32,288
24 months Indemnity period 1.7.26 – 30.6.27: £33,902
Sum Insured for Insurance year 1.7.24/25
12 months Indemnity Period: £678,038
24 months Indemnity Period: £1,423,878
*If you are working from figures from your last year end accounts you need to make an adjustment to bring the figures up to date, including an allowance for the insurance year ahead and then allow for growth/trends in the indemnity period. For convenience, the example assumes 5% annual growth, so there is £15,000 (2.5%) catch up to the start of the insurance year, £30,750 (5%) for the insurance year and a further £32,288 (5%) for a 12 month indemnity period assuming a loss occurs on the last day of the insurance year. For a 24 months indemnity period you would need to add another £33,902 (5%) for the second year of the indemnity period and then double the sum insured.