Look forward with business interruption insurance

So often when we review prospects' insurable gross profit or revenue sums insured, we find they're very short sighted...or worse looking backwards.

Indemnity periods

The purpose of Business Interruption insurance is to maintain the turnover of the business following an insured incident. Cover is limited by time - referred to as the indemnity period, as well as by the Sum Insured.

The indemnity period starts from the moment a claim occurs and will not cease until either:

• the business recovers to the point that trade levels are back to the same as if the event never took place (including any growth that should have happened during the period of the claim), or
• the day the indemnity period ends, whichever comes first.

The below table illustrates this:

The actual income following the claim is shown by the solid line, and the income level if the claim had not occurred is shown by the dashed line.

You can see that the incident causes a dramatic downturn in income which then recovers over time. At point (A) the income returns to the point that it was when the incident happened. But the policy will continue to pay until point (B) when the income returns to the level that it would have been if the incident hadn’t taken place.

If you’d like to find out more about setting indemnity periods, watch our animated video here.

So why does this matter?

Considering the above, it's essential that we calculate and select both a sum insured and indemnity period which is long enough for your business to recover from any event and allow for any future growth.

How to calculate the sum insured

For the purposes of this article we're talking about business’s who choose to buy either a Gross Insurable Profit or Gross Revenue sum insured.

We might be comfortable with how we make the calculation but in the event of a claim things might not turn out how we'd hoped if we've not allowed for the trends that are present within our business. And this could lead to a catastrophe. Let’s look at a fictional example:

When calculating their gross profit sum insured their broker asks them to look at their last report and accounts to produce the calculation:

The broker for WHS has a client that buys an indemnity period beyond 12 months so that’s a positive. Although, if not made aware by the existing insurance broker, WHS is, unfortunately, going to be hugely underinsured should a claim occur as WHS in the years before 2019 has been growing at 10 percent a year and expect this trend to continue.

The two items in bold/italics should be added together to reach the actual sum insured.

This next table highlights that had WHS renewed at the smaller sum insured calculation, they would be underinsured by 28 percent.

Underinsurance can result in economic loss to the policyholder as insurers will apply an average to any losses. Average works by reducing the amount of the claim by the same amount of underinsurance. In extreme cases, the insurer may consider the underinsurance to be a misrepresentation of the risk - which could enable them to impose additional terms or even void the policy.

Summary

Your insurance broker should be encouraging you to look forward in your calculations from the end of your policy and asking where your starting point is. As both are key when calculating the sum insured, you might have the perfect formula. But feed in the wrong data and you'll find yourself underinsured.

Finally, you may think it strange that I have chosen the dates for the timeline I have when your reading this in 2025. It is in fact deliberate. Following the exponential demand for hand sanitiser in the final three quarters of 2020 and beyond due to COVID-19. WHS’s insurance broker should have reached out and queried if the sum insured needed to be revisited. Although we set it at the start of a policy period, we can amend it during the year to reflect the revised forecast.

Points to consider:

• Does your insurance broker ask for your financial year end when setting the insurable gross profit sum insured?
• Does your insurance broker encourage you to think about trends which are then included within your calculation?
• Does your insurance broker contact you to say they've noticed a development which could cause the sum insured to be reviewed?

If you have the slightest element of doubt over any of the above, please don't hesitate to contact me personally on 020 7543 2819 or email [email protected]