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Business Interruption Insurance

Business Interruption Risk Advisory

Insurance for your business assets is absolutely essential to ensure you are able to survive an insured catastrophe. Insurance protection of your Turnover or Revenue, is equally essentially to ensure business survival, as it is designed to cover your ongoing expenses (like salaries, rent etc.), as well as making good your expected Net Profit your would have earned, but for the insured catastrophe.

This cover essentially only triggers, if an event covered by the Fire section of the policy occurs, which causes an insured reduction in Turnover/Revenue.

Understanding Business Interruption

What Business Interruption Insurance Does

Business Interruption insurance protects the financial position of a business when an insured event stops or reduces trading.

Property insurance repairs or replaces damaged assets. Business Interruption insurance deals with the financial consequences that follow.

If a fire destroys part of a factory, the property section may pay to repair the building and replace damaged machinery. That does not solve the wider problem. The business may be unable to manufacture for months, turnover may fall, customers may move elsewhere and many operating expenses may continue.

Business Interruption insurance is designed to replace the insured income lost while the business recovers and to fund certain additional costs incurred to keep trading or reduce the loss.

Put simply, property insurance repairs the damage. Business Interruption insurance helps the business survive the recovery.

Where Cover Starts

The Physical Damage Trigger

Standard Business Interruption cover starts with insured physical damage.

A fire usually produces two separate losses. The first is the physical damage to the building, machinery or other insured property. The second is the financial loss caused by the interruption that follows.

If the physical damage is not insured, the related Business Interruption loss will usually not be insured either.

Certain extensions can provide wider protection where the interruption originates away from the insured premises. Damage at an important supplier, customer or utility provider may, for example, interrupt the business even though its own property remains undamaged.

The trigger is just as important as the amount insured.

Getting The Figure Right

Calculating Your Cover

Gross Profit

One of the biggest misunderstandings in Business Interruption insurance is the meaning of gross profit.

Insurance gross profit is not necessarily the same figure as the gross profit shown in the annual financial statements or the accounting gross pfofit.

Under a typical Business Interruption policy, the calculation starts with turnover and allows only certain expenses to be deducted. These are generally the costs that reduce when trading stops and are named as uninsured working expenses under the policy. These costs vary in direct proportion to the turnover like Purchases.

Expenses that do not vary in direct proportion to the turnover, such as salaries, rent, rates and many other operating costs usually remain part of the amount being protected as they may continue even when income has stopped.

A business that simply copies its accounting gross profit into the insurance schedule is often materially underinsured.

The correct figure must be calculated using the definition in the policy wording and schedule.

Revenue

Revenue basis is generally used for businesses that have little or no cost of purchases or other uninsured working expenses.

Instead of calculating an insurance gross profit by deducting specified variable costs (uninsured working expesnses) from turnover, the business insures 100% of its gross revenue.

This basis is therefore commonly suited to service businesses where most expenses continue even when trading is interrupted.

The sum insured should represent the full projected revenue for the selected indemnity period, allowing for expected growth, inflation and other relevant trends.

The key distinction is simple, where a business has significant purchases or variable costs that cease when trading stops, a gross profit basis is appropriate. Where there are effectively no such deductions, a gross revenue basis should be used.

How Much Should You Insure?

If the business expects insurance gross profit of R10 million over the next 12 months and chooses a 24 month indemnity period, the starting point is R20 million.

But the policy itself normally runs for 12 months. A major loss could happen on the last day of that policy year, and the 24 month interruption could then continue for another two years. The sum insured therefore needs to allow for what the business is expected to earn during those future years.

The calculation should also allow for known growth, inflation, seasonality, new contracts, expansion and other changes that could increase future earnings.

The sum insured must include VAT.

To sum up, the sum insured must reflect the future income at risk over the full indemnity period, not just today’s annual figure multiplied by the number of years. If the sum insured is incorrect proportionate underinsurance is applied to claim.

Not The Same As Repair Time

How Long Should You Insure For?

The indemnity period is the maximum period for which the Business Interruption policy can respond after insured damage.

It should not be confused with the time needed to repair the building.

A business may rebuild its premises in eight months and still take another year to return to the trading position it would have reached had the loss never happened. Customers may have moved to competitors. Specialist machinery may take months to manufacture, ship, install and commission. Planning approvals may delay rebuilding. Skilled employees may leave. Stock may need to be replaced. Supply contracts may need to be rebuilt. Market share may take time to recover.

The correct question is therefore not: “How long will it take to repair the damage?” It is: “How long could it realistically take before the business is trading at the level it would have reached if the loss had never happened?”

For many businesses, twelve months is too short.

The correct indemnity period depends on the nature of the business, the assets it relies on, the availability of replacement equipment, regulatory requirements, seasonality, customer behaviour and the speed at which competitors could take its market share.

Beyond The Basic Policy

Extensions and Dependencies

General Information Only

Chadwicks provides general information about insurance. The cover suitable for you depends on your contractual responsibilities and specific risks and is determined by the policy wording, schedule and endorsements, including all relevant terms, conditions, exclusions and limits. Please review these documents with your broker or insurer before making any insurance decisions.

01

Increased Cost of Working

Sometimes the best way to reduce a Business Interruption claim is to spend money.

A manufacturer may hire temporary premises. A retailer may rent generators. A business may outsource production, hire replacement equipment, pay overtime or use more expensive transport to keep customers supplied.

These costs can fall under Increased Cost of Working.

The purpose is to spend money now to prevent a larger insured loss later.

Standard Increased Cost of Working is generally subject to an economic test. The insurer will usually not spend more to avoid a loss than the insured loss that the expenditure actually saves.

That distinction becomes important when management wants to spend aggressively to protect customer relationships or reputation even though the immediate financial saving may be smaller.

General Information Only

Chadwicks provides general information about insurance. The cover suitable for you depends on your contractual responsibilities and specific risks and is determined by the policy wording, schedule and endorsements, including all relevant terms, conditions, exclusions and limits. Please review these documents with your broker or insurer before making any insurance decisions.

02

Additional Increase in Cost of Working

Additional Increase in Cost of Working can provide wider protection.

Where included, it can fund reasonable additional expenditure that may not satisfy the normal economic test applying to standard Increased Cost of Working. That can be extremely valuable.

A business may decide that retaining a major customer, maintaining its market position or continuing an essential service is worth spending more than the immediate insured turnover saving.

Standard Increased Cost of Working and Additional Increase in Cost of Working are similar, but not the same thing.

General Information Only

Chadwicks provides general information about insurance. The cover suitable for you depends on your contractual responsibilities and specific risks and is determined by the policy wording, schedule and endorsements, including all relevant terms, conditions, exclusions and limits. Please review these documents with your broker or insurer before making any insurance decisions.

03

Suppliers and Customers

A business can insure its own premises properly and still be unable to trade.

A fire at a critical supplier may stop production completely. Damage at a major customer may eliminate demand for the insured's product. A transport bottleneck may interrupt the supply chain even though nothing has happened at the insured premises.

Business Interruption policies can provide extensions for specified suppliers and customers and, in some cases, broader unspecified suppliers or customers.

The important supplier is not necessarily the supplier with the biggest invoice. It is the supplier whose failure could cause fincial loss to your business. A small specialist supplier providing one irreplaceable component may present a greater Business Interruption exposure than a supplier accounting for ten times the annual spend.

The same principle applies to customers. Dependency is more important than size.

General Information Only

Chadwicks provides general information about insurance. The cover suitable for you depends on your contractual responsibilities and specific risks and is determined by the policy wording, schedule and endorsements, including all relevant terms, conditions, exclusions and limits. Please review these documents with your broker or insurer before making any insurance decisions.

04

Prevention of Access

A business does not always need to be physically damaged to become inaccessible.

Damage to neighbouring property, roads or surrounding infrastructure can prevent staff, customers or suppliers from reaching the premises.

A Prevention or Denial of Access extension may provide protection in certain circumstances.

These extensions normally contain specific triggers, geographic limits, sub limits and shorter indemnity periods. The wording needs to be checked carefully.

General Information Only

Chadwicks provides general information about insurance. The cover suitable for you depends on your contractual responsibilities and specific risks and is determined by the policy wording, schedule and endorsements, including all relevant terms, conditions, exclusions and limits. Please review these documents with your broker or insurer before making any insurance decisions.

05

Utilities

Electricity, water, telecommunications and other public services are often critical dependencies.

Business Interruption cover may be available where damage at a utility provider interrupts the insured's operations.

These extensions should not be confused with general protection against load shedding, grid instability or every failure of public infrastructure. These are genrally policy exclusions.

Basic utility extensions generally require physical damage caused by an insured peril at the utility provider's premises before cover responds.

General Information Only

Chadwicks provides general information about insurance. The cover suitable for you depends on your contractual responsibilities and specific risks and is determined by the policy wording, schedule and endorsements, including all relevant terms, conditions, exclusions and limits. Please review these documents with your broker or insurer before making any insurance decisions.

06

Claims Preparation Costs

Business Interruption claims can be complicated to quantify.

The business may need to reconstruct turnover, identify savings in expenses, demonstrate trends, separate insured losses from unrelated trading changes and calculate what the business would have earned had the interruption never occurred.

This can require accountants, forensic specialists and other professional advisers.

The policy should therefore always have an adequate sum insured for claims preparation costs.

General Information Only

Chadwicks provides general information about insurance. The cover suitable for you depends on your contractual responsibilities and specific risks and is determined by the policy wording, schedule and endorsements, including all relevant terms, conditions, exclusions and limits. Please review these documents with your broker or insurer before making any insurance decisions.

07

The Trend Adjustment

The insurer does not simply compare the damaged period with the same months from the previous year and pay the difference.

Yesterday’s turnover is only the starting point.

The calculation may need to consider what the business would probably have achieved had the loss never occurred.

Growth, decline, seasonality, market conditions, new contracts and other circumstances may all affect the result.

This is commonly dealt with through the policy’s trend adjustment.

The aim is to estimate the financial position the business would realistically have occupied without the loss.

General Information Only

Chadwicks provides general information about insurance. The cover suitable for you depends on your contractual responsibilities and specific risks and is determined by the policy wording, schedule and endorsements, including all relevant terms, conditions, exclusions and limits. Please review these documents with your broker or insurer before making any insurance decisions.

If A Major Fire Happens

The Key Questions

  • How long would it realistically take to return to the trading position the business would have reached had the loss never happened?
  • Which expenses would continue while income was reduced?
  • Would you need temporary premises, replacement machinery, outsourcing or emergency transport to keep customers supplied?
  • Could the failure of one supplier, customer, utility provider or business location educe your turnover?
  • How long would planning approval, demolition, rebuilding and reinstatement realistically take?
  • How long would it take to replace, import, install and commission critical machinery or equipment?
  • How much stock would need to be rebuilt before the business could trade normally again?
  • Would you need temporary premises, replacement machinery, outsourcing, overtime or emergency transport to keep customers supplied?
  • What would it cost to keep your most important customers rather than lose them to competitors?
  • How quickly could competitors take your customers or market share while you were unable to trade normally?
  • Once the premises reopened, how long would it take to win those customers back?
  • Could the failure of one critical supplier materially reduce or stop your turnover?
  • Could damage at a major customer reduce demand for your products or services?
  • Could the loss of electricity, water, telecommunications or another essential utility stop the business even if your own premises were undamaged?
  • Could damage at one branch, warehouse, factory or distribution centre affect the turnover of the rest of the business?
  • Is there one machine, production line, supplier, customer or location on which a disproportionate amount of turnover depends?
  • Could the business continue trading from another location, and what would that cost?
  • Would management and key staff know what to do in the first 24 hours after the loss to protect turnover and customers?
  • And ultimately, if the business could not trade normally for 12, 18 or 24 months, would the insurance money last as long as the interruption?

General Information Only

Chadwicks provides general information about insurance. The cover suitable for you depends on your contractual responsibilities and specific risks and is determined by the policy wording, schedule and endorsements, including all relevant terms, conditions, exclusions and limits. Please review these documents with your broker or insurer before making any insurance decisions.