21 July 2020

The pitfalls of getting Business Interruption insurance wrong

Business Interruption insurance is a complex matter, with a lot at stake and a high margin for error. Calculating and configuring the level of cover you require is never simple, but it’s one of the most important covers to get right, as underinsurance could significantly affect your ability to recover in the event of a major incident.

For example, if your business is out of action, are you best insured on a Gross Profit, Gross Revenue or Increased Cost of Working basis? For what period of time should your Indemnity period apply? And have you considered such factors as planning permission, replacing specialist machinery or finding a suitable location? Here, we look at some of the areas you need to consider when calculating the indemnity period and level of cover you need to have in place.

Indemnity period

A common error when calculating your Indemnity Period is to consider only the Physical Recovery Phase. The general rule when considering a return to your previous level of trading is to allow at least double the physical resumption period. For example, if your business loses 40% of revenue over a 12-month period following an event, it’s realistic to assume it will take a further 12 months to gain back that level of revenue. Obviously, this varies from business to business. If you’re dealing with the general public, you may make a quicker return than if your work is generated business to business.

Physical Recovery Phase

The Physical Recovery Phase itself is subject to a variety of factors. For example, is the building owned or rented, and do you have special requirements, such as building height, load-bearing capacity, craneage, pits, environmental licences and customer approval or accreditation? The general period for restoring a building following significant loss due to such events as fire or flood is usually around 18 months. This takes into consideration such factors as planning and availability of contractors. You may also need to consider lead times for replacement plant & machinery, especially if they need to be built on a bespoke basis, and replacement stock or components. Also, how easily can you reinstate utilities such as power, water and IT connections?

Other factors

A range of other factors may also impact revenue. For example, are all income streams affected or are some protected, such as online sales? What about seasonality? Has the event happened at the worst possible time and how will this impact future years’ income? What about customers? How easily can they move to an alternative supplier? If you lose IT data, how will it impact the business? Is it possible to outsource key functions, such as production? These are all questions you need to ask when calculating the length of your indemnity period, which may well extend beyond 24 months, possibly up to 36 months.

Calculating Gross Profit

This is a complex process and many insurers offer online calculation tools. As a rule of thumb, Gross Profit refers to Gross Revenue less Purchases, which includes such items as stock or raw materials. Gross Profit should be future-based and projected for the forthcoming year. For example, over a 36-month period, if the business is growing at a rate of 20% each year, Year One figure needs to be + 20%, Year Two needs to be inflated by a further 20% and that figure further inflated by 20% for Year Three.

Business Continuity Plan

Studies show that two out of five businesses don’t recover following a major incident, which is why it’s so important to have a robust Business Continuity Plan in place. This should include factors such as critical function analysis, risk assessment, assigning responsibility and contingency plans. As the business evolves, all these factors will be tried, tested and reviewed over a period of time to help minimise loss and protect the business in the event of a major incident.

As you can see, there is a lot to think about. It’s always better to have more BI cover in place than less and we would certainly recommend caution and taking professional advice. If you would like to discuss BI insurance, we will be happy to help you in reviewing your existing limits and putting forward some solutions to optimally protect your business.

To discuss your business interruption and for guidance on obtaining suitable cover, please contact [email protected] or 0116 265 4300.