Could your company's balance sheet survive the operational downtime caused by an insurable event like a fire, storm or theft?
Property Insurance claim payouts can help to restore your premises, but how can you protect your financial position (i.e. income) while unable to trade? This is where Business Interruption cover steps in.
What is Business Interruption insurance?
Business Interruption (BI), also known as Consequential Loss insurance, is an essential insurance cover that helps maintain a business’s income should it be forced to cease trading, or reduce trading capacity for a specified period of time, due to an insured event impacting the business’s gross profit e.g. fire, theft or flood.
Common damages that can prevent a business from trading at normal capacity include:
- Physical damage to its premises
- Physical damage to crucial equipment or machinery
- Non-physical damages e.g. road closures affecting access to the premises, or mandatory evacuations due to environmental or biological hazards.
You can choose to take out BI cover by including it within your Business Insurance policy or Industrial Special Risk (ISR) policy.
How does Business Interruption protect my business?
- Gross profit protection - When an insured event occurs e.g. a fire, BI insurance is designed to provide payments covering the gross profits the business would earn at ‘normal’ trading capacity prior to the event (subject to the indemnity period specified on the policy schedule).
- Fixed costs - In addition to gross profit, cover can include payment for the fixed costs a business continues to incur even though it is not trading at its normal capacity e.g. rent, wages, bills etc.
For a full list of expenses covered, review the relevant Product Disclosure Statement (PDS) or consult your insurance broker.
Why should I include Business Interruption in my Business Insurance program?
Sadly, the collapse of businesses due to a forced reduction or suspension of operations, and an inability to survive the loss of income is an all too familiar scenario.
While many Australian businesses have insurance to cover their property for physical damage, far too many do not insure for BI, a serious risk that could impair a company’s revenue stream, making the ongoing costs of doing business unsustainable.
BI cover is designed to prevent financial collapse and help get businesses back to where they were before the event which rendered them incapable of trading at ‘normal’ capacity.
What are some common traps businesses fall into when it comes to Business Interruption cover?
It is common for businesses to misjudge the level of BI cover they require. Below we have identified some areas to watch out for.
If your commercial property sustains physical damage following an insurable event, how long would it take to fully rebuild and resume normal trading – 12 months? 18 months? Longer? Careful consideration needs to be taken when choosing an Indemnity period. It is very common for businesses to underestimate how long it will take.
While the physical reinstatement of a building may take a year, the replacement of machinery or stock can take much longer. Office-based businesses that simply need to have a server or computers replaced could be up and running within a few months. Manufacturing businesses reliant on specialist internationally-sourced equipment, could see a period of several months or over a year without the ability to resume trading at normal capacity.
A miscalculation here can result in a lack of financial protection, and seriously impact a business’s ability to recover to the point they were at prior to the disaster.
a) What happens if the business has recovered before the end of the BI Indemnity Period?
The cover ends once a business is back in the same or similar financial position prior to the loss. The insurance cover period cannot exceed the indemnity period that has been set out in the schedule of insurance.
b) What happens if the indemnity period expires and a business is not yet fully operational?
BI cover is only in place for the period stated in the insurance schedule - from the date a business experiences an insured loss. If a business has not fully recovered by the expiry of the indemnity period then the BI cover will no longer apply.
The risks and financial consequences associated with Underinsurance must be taken into consideration when it comes to BI insurance. An incorrectly estimated Sum Insured set too low can adversely affect your business’s ability to remain afloat should you be unable to operate, or forced to operate at diminished capacity.
Be sure to check your insurer’s Product Disclosure Statement (PDS) to ascertain their co-insurance percentage, and consult with a certified practicing accountant (CPA) or insurance broker to ensure your Sums Insured have been calculated correctly.
3. Incorrect estimation of the Sums Insured
Given the complexity involved with calculating the Sums Insured for a BI Insurance policy, it is incredibly common for businesses to insure for the wrong amount. Many business owners attempt to tackle the calculations themselves without the appropriate guidance from a qualified professional.
Below we have addressed the various sections of BI cover, and what to watch out for, to help ensure you have adequate cover in place:
a) Gross Profit Cover
Depending on the industry, a business’s Gross Profit is measured through their primary source of income.
- Manufacturing and retail - Gross Profit factors in the sale of physical stock
- Office-based risks - Gross Profit is the monetary value of fees and commissions earned through the provision of professional services.
Regardless of your industry however, careful consideration always needs to be taken when calculating a Gross Profit Sum Insured.
Business owners should recalculate their insurable values quarterly, and ensure their broker has been notified of any increases/decreases accordingly. Seasonal fluctuations, or a general increase of turnover and clients, can drastically alter your Sums Insured and render your BI cover ineffective in the event you are underinsured and a claim occurs.
A failure to re-evaluate and update your Sums Insured can result in insurer’s applying an Underinsurance / Co-insurance clause which can reduce your insurance claim payout in the event of a catastrophe.
b) Fixed and Variable Costs Cover
In addition to Gross Profit, the correct calculation of your company’s expenses is crucial. Incorrectly estimating fixed and variable costs can lead to insufficient financial cover after a claim, and impede your business’s ability to recover.
As per the calculation of Gross Profit, it is very common for business owners to incorrectly calculate fixed and variable costs without proper guidance.
The difference between a ‘fixed’ and a ‘variable’ cost:
i) Fixed Costs
Fixed Costs are generally static in nature, meaning they are for a regular amount, and occur at a regular interval. Fixed costs may include but are not limited to the following:
- expenses such as supplies and utilities (gas, water, electricity and telephones - both mobile and landlines)
- salaries and wages of staff, salespeople and business owners
- payroll taxes and employee benefits
- rental payments for property, industrial machinery and motor vehicles
ii) Variable Costs
As the name implies, variable costs are irregular and prone to fluctuation.
They may include costs for:
- manufacturing materials, direct labour, packaging and freight
- salaries for plant/factory supervisors
- seasonal utility expenses for a plant or warehouse
(Note: this list does not cover the full scope of variable costs)
To help guide you in setting the correct Sums Insured for your business, Whitbread can provide policy and insurer-specific BI calculators. Speak to one of our specialist commercial insurance brokers for further information.
c) ICOW & AICOW Cover
Confusion often arises between Increased Cost of Working (ICOW) and Additional Increased Costs of Working (AICOW). While similar in nature and purpose, they each offer different forms of financial protection within BI cover. These are explained below:
The ICOW section of BI cover is designed to pay for increased costs incurred, but only if costs are directly related to helping the company get back to full operating capacity faster, reduce the impact of the ‘business interruption’ event on the revenue and are within the Limit of Liability on the policy.
E.g. a business owner chooses to air-freight internationally manufactured machinery, as opposed to sea-freight. While the cost of air-freight is higher, the machinery would be delivered sooner and diminish the amount of time that the business is out of operation.
The AICOW Sum Insured within a BI policy can provide reimbursement for additional costs that do not necessarily reduce the period for which a company is out of action, but are still reasonable costs incurred to help keep the company in business. This includes payments for additional rent of temporary premises, outsourcing production to a competitor or contractor, hire of temporary plant or equipment, and temporary employment of additional staff.
To ensure a policy responds accordingly in the event of a claim, business owners are urged to ensure that they have the right level of cover for each section. If you require help in calculating the Sums Insured for each section, speak to a certified practicing accountant or consult with one of Whitbread's specialist commercial insurance brokers.
How do I know whether I have Business Interruption Insurance?
BI cover can be included as part of your business pack insurance policy, or within other elements of a commercial business insurance program. Consult your business insurance policy schedules to check whether you have this essential cover in place. If in doubt, or if unsure on your existing Sum Insured, please contact your insurance broker.
If you need advice about Business Interruption cover, would like to increase your cover, or find you do not have Business Interruption in place, please contact us to speak to one our specialist commercial insurance brokers who can provide assistance.
This article is not intended to be personal advice and you should not rely on it as a substitute for any form of personal advice. Please contact Whitbread Associates Pty Ltd ABN 69 005 490 228 Licence Number: 229092 trading as Whitbread Insurance Brokers for further information or refer to our website.