Business Interruption Insurance: Expelling Myths and Misunderstandings
“Double, double toil and trouble, fire burn and cauldron bubble” proclaim the three witches before prophesising the future of Macbeth in Shakespeare’s famous Scottish play. Unfortunately, in real life should “fire burn” we simply cannot look into the seeds of time and say with absolute certainty what will happen afterwards.
Suitable insurance protection can help though. Business interruption insurance whilst undoubtedly a complex area is by no means a dark art. It’s an essential component of disaster recovery and in this article, we aim to provide you with a clearer understanding of its main ingredients.
If your trading is affected following an insured event like a fire or a flood, the earning capacity of the business will be affected. Business Interruption insurance – properly arranged – will provide a source of income to help pay the bills until normal trading is resumed.
Many businesses insure their ‘gross profit’ but what is this? The answer to that question depends on who you ask. The word gross has five separate entries in the Oxford English Dictionary, so it should come as no surprise that the term ‘gross profit’ can mean different things to different people. Its meaning in the insurance industry is different from how it’s understood in other walks of life. It’s a common mistake to just take the figure next to the words ’gross profit’ in your accounts and base your cover on this. If you do so, there is a very real chance you will be dangerously underinsured. The insurance definition of gross profit will be in your policy – but beware, not all policies are worded the same.
How then, do you calculate the insurable gross profit? Well, it’s a sum of subtraction rather than addition. You take your estimated income and subtract the costs that you won’t incur whilst trading is interrupted. Be careful though. You should only deduct costs that will definitely decline in proportion with turnover. A knowledgeable broker will guide you on what should and should not be deducted. In simple terms, it’s likely to just be the cost of purchases that should be taken away from your estimated income. If you set the cover correctly, then there should be sufficient funds coming from the insurer to allow the business to meet its responsibilities.
If you are not paying your staff, then your competitors might. An error that regularly presents itself is where a business has deduced staff costs in the mistaken belief that they do not form part of the insurable gross profit. If you do this, there will not be enough money coming from the insurers to pay the wages. In some cases, non-skilled staff can be laid off and re-engaged relatively easily but that is not always the case and great care should be taken here. It’s recommended that you never deduct any staff costs without first discussing it with your broker.
When setting the cover it’s usual to go to your last set of accounts. Whilst this is an excellent starting point, Business interruption cover is about insuring what might happen in the future not the past. You need to look ahead and adjust your cover accordingly. Bear in mind that a disaster could happen on the last day of the insurance policy and it’s the period thereafter that’s insured.
Claims payments made by the insurers are limited by time. Usually either 12, 18, 24 or 36 months. This is known as the Indemnity Period and it starts when your property sustains damage and lasts for the duration selected. So how long should you set your indemnity period for? That can be a very difficult question to answer but you should always err on the side of caution and imagine worst case scenario. Don’t assume all will go well as the risk of assumption is a dangerous one and delays can come in many forms.
Ian Christie of Christie & Co (Assessors) Ltd who has 40 years’ experience in adjusting claims advises, “Businesses should have at least 24 months as a minimum Indemnity Period. This however requires a decision by the insured when the policy is being arranged. A period is selected which the insured concludes is the maximum length of time that the business would be affected by destruction of, or serious damage to the premises or machinery or stock. It is prudent to choose a longer rather than a shorter period as many factors outside the control of the insured can influence the way in which the business can or cannot get back to normal."
If your Indemnity Period is not long enough your business may not have the ongoing funds to continue trading.
When the hurlyburly’s done will the battle to save your business be lost or won? It would be a tragedy if it collapsed due to inadequate insurance arrangements.
By Robert Campbell, Account Executive at Bruce Stevenson Insurance Brokers