The core principles of business interruption explained

14 August 2017

If the unexpected strikes and your business is interrupted, having the correct sum insured and maximum indemnity period (MIP) on your business interruption (BI) policy is vital if you are to recover the full value of your loss. BI indemnifies the policyholder for lost turnover or gross profit that would be earned ‘but for’ the insured event. The cover is forward looking and the sum insured must reflect future growth in the business. Budgets or medium-term forecasts may be used to establish the BI sum insured, and the adequacy of the insured sum is also linked to the MIP selected.

If the unexpected strikes and your business is interrupted, having the correct sum insured and Maximum Indemnity Period (MIP) on your Business Interruption (BI) policy is vital if you are to recover the full value of your loss. BI indemnifies the policyholder for lost turnover or gross profit that would be earned ‘but for’ the insured event. The cover is forward looking and the sum insured must reflect future growth in the business. Budgets or medium-term forecasts may be used to establish the BI sum insured, and the adequacy of the insured sum is also linked to the MIP selected.

Insured sums
Underinsuring your BI policy can be costly. Some policies include an ‘average’ condition whereby the settlement value may be proportionately reduced based on the ratio of sum insured over value to at risk.‘Declaration-linked’ policies contain no ‘average’ condition, but do penalize the insured if the value declared is materially different from the value at risk.

Maximum indemnity period considerations
The policyholder is required to select the period of time for which they want to buy BI cover - the MIP. This period must be sufficient to allow for the physical reinstatement of damaged assets and for the business to recover to anticipated levels of turnover. MIPs can be as short as 12 months, but this is not usually sufficient time for most businesses to fully recover from an insured event. The following factors need to be considered:

Buildings

If a building is damaged, insureds must consider the cost and time impact of both rebuilding and partial repair. Most claims involve partial damage rather than total loss and require repair rather than a complete rebuild.

On a pro-rata basis relative to the extent of damage, partial reinstatement nearly always takes longer than a complete rebuild. Insureds who own their own buildings must consider the potential time impact of planning, health & safety, and regulatory processes. Leasehold property can take longer to reinstate than owned property as a landlord’s decision-making process may not be aligned with the tenant’s drive to expedite the recovery of the damaged building.

Plant and equipment

You will also need to factor in the impact of any long lead-times when replacing production-critical plant or equipment. Insureds are unlikely to be able to influence manufacturer’s supply timelines, so it is recommended to assess potential lead times and the subsequent economic impact conservatively when considering repair or replacement options.

Customers

The nature of your customer relationships and frequency of transactions will help determine the business recovery time that needs to be built into the MIP. If an annually negotiated supply contract for the regular supply of goods is interrupted, it could result in losing the customer at the next renewal, for example.

The duration of the MIP must therefore be sufficient to allow time to recover lost customers or replace them with new business to restore business activity to the level anticipated before the loss.

BI can be complicated but there is no excuse for getting the basics wrong. Working with your broker to map the risks your business faces and ensure you have the right insured sum and MIP are vital first steps.

For further information on Business Interruption insurance, please contact Jason Trimble, Managing Director – National Broking Leader, at ClientFirst@jltcanada.com