Business interruption policies protect the cash flow and profits of the business. The aim is for the insured to be placed into the same position after the loss that they would have been in if the loss had not occurred - this means the claim is adjusted to take into account general business trends.
Business interruption policies protect the cash flow and profits of the business. The aim is for the insured to be placed into the same position after the loss that they would have been in if the loss had not occurred - this means the claim is adjusted to take into account general business trends.
Policies are usually arranged on either a gross profit or gross revenue basis. The former is used mainly for manufacturing and retail, the latter for service and professional businesses.
Business interruption policies protect the turnover of the business, less the savings made after an interruption. For gross profit policies this is net profit plus the costs that continue when the business is not operating. However, the sum insured is usually calculated by deducting the variable costs, that is, those that reduce in direct proportion to the level of activity, from the turnover (known as the difference basis).
Gross revenue policies do not require the insured to anticipate the variable costs as the sum insured is the full revenue. However, neither gross profit nor gross revenue policies will cover the savings a business makes after an interruption.
In addition to cover for loss of profit/revenue, policies provide cover for the increased costs incurred in maintaining turnover/revenue, provided that these are reasonable and economic - in other words, that they exceed the amount of profit or revenue saved.
Cover is usually limited to interruption following insured damage that occurs at premises that are owned or occupied by the insured. There are various policy extensions that amend the premises limitation to include interruption caused by damage at premises used by the insured's neighbours, suppliers, customers, utility providers or other third parties. In addition, the policy can be extended to cover losses caused by events, such as an outbreak of a human disease or a bomb scare that affects the insured's premises.
The purpose of business interruption insurance
The intention of a business interruption (BI) policy is to maintain the turnover of the business during the indemnity period following an insured incident so that the business can resume trading at its anticipated pre-loss trading level. It follows that if there is no business to maintain (that is, if the insured ceases to trade or goes into liquidation) the business interruption policy is unable to respond.
A business interruption cover is a contract of indemnity. In property insurance the insured should be returned to the same position after the insured incident that it was in immediately before it. Business interruption insurance extends the principal, providing cover back to what would have been had the loss not occurred, not just back to where it started.
One of the key features of traditional BI cover is the "trends" or "special circumstances" clause. This allows the adjuster to take into account the upward or downward trends of the business when arriving at a settlement.
Cover trigger: consequential loss
The trigger for a BI loss is found in the preamble to the BI policy - traditionally along the following lines:
The Insurers will pay the amount of the Consequential Loss resulting from interruption of or interference with the Business carried on by the Insured at the Premises consequent upon DAMAGE to Property used by the Insured at the Premises in accordance with the undernoted definitions.
In essence, as long as there is insured damage to property at the premises then all subsequent insured consequential loss is picked up, assuming there is no active, intervening cause, or that the subsequent loss is not too remote to be considered consequent, as per the standard doctrine of proximate cause.
Many terms used in a business interruption policy are defined in it. The standard definition of consequential loss is as follows:
The words Consequential Loss shall mean loss resulting from interruption of or interference with the Business carried on by the Insured at the Premises in consequence of DAMAGE to property used by the Insured at the Premises for the purposes of the Business.
[Each word highlighted in the definition above will be defined in a business interruption policy - see Definitions section, below].
Material damage proviso
There has to be insured damage to property that is being used by the insured, at the premises, in the course of the business to trigger a business interruption claim. Otherwise, claims could be brought for all sorts of unforeseen circumstances that could affect the business (compulsory purchase orders, for example) without any prior insured damage.
For a business interruption policy to operate, the material damage policy has to respond. This is unless it is prevented from doing so because the loss is below an excess or deductible amount. The business interruption policy usually includes a material damage proviso to make this point clear. The main purpose of the clause is to mitigate the policy's potential business insurance claim payment as the business will recover more quickly if the damaged property is reinstated promptly - this is more likely to happen if the damage is insured.
The material damage proviso means that there is cover under the business interruption cover only for the perils covered under the material damage policy.
The material damage proviso only requires the insured to insure property in which the insured has a "personal property interest" and which they could reasonably be expected to insure - this was established in the case of Glengate-KG Properties v Norwich Union Fire Insurance Society Ltd (1996).
It is important to avoid creating a business insurance policy or section that only responds to damage to property covered by the insured's main property damage policy or section. The problem with this policy construction was seen in the case of Loyaltrend v Brit (March 2010). In this case the operative clause was specific:
"In the event of Damage for which the Insurers are liable under Sub-Section 1 of this [policy]… the Insurers will indemnify the Insured against any loss of Gross Profit ……."
Such a wording means that, where landlords insure buildings, the tenant's business interruption policy will not respond to damage to the buildings (subsidence, in this case) but only to damage to the tenant's contents, fixtures and fittings and stock.
Damage at the offices of a business, away from the production areas, is treated as though turnover will be affected, even if in practice it will not - this is known as the Blundell Spence market agreement, although policy wordings do not make this clear.
A BI policy operates via agreed definitions, all of which must be understood to ensure the policy will respond to an insured interruption as intended.
All of an insured's business that might be affected by an interruption should be included in the definition of "business". If the particular activity is not identified within the definition then the policy cannot respond to the losses incurred by that part of the business. Many larger or global policies are drafted to give an all-encompassing definition of the business, along the lines of:
All past, present and future activities undertaken or to be undertaken by the Insured.
The BI policy will define "the insured" and it will be important to fully identify all the entities that could be affected by an interruption to the business. Often, policies are arranged on a "group" basis as a loss at one subsidiary could well have a knock-on effect on the profits of another.
Many insureds operate in such a way that value is added to the end product as it travels from operation to operation. A simple example is a UK manufacturer exporting finished goods to a sales operation overseas. If a loss occurs at the manufacturing location then not only will the profits of the factory be affected but also the sales income of the overseas outlet.
Most insurers impose an inner limit to the policy for this interdependency.
The policy should cover all the premises that are owned, occupied or used by the insured within the territorial limits of the policy. Most insurers require premises to be listed. Premises not listed, owned, occupied or used by the insured need to be covered by an extension - see extensions section below.
As with the definition of "business", the premises of larger clients are usually given an all-embracing definition (subject to separate detailed disclosure) along the lines of:
Any premises owned occupied or utilised by the Insured within the Territorial Limits, which has been declared to and accepted by the Insurers.
Indemnity period (IP)
A business interruption policy is unique in that the liability is limited by time (referred to as the indemnity period) as well as by a monetary amount (sum insured or loss limit).
The standard policy defines an indemnity period as:
The period beginning with the occurrence of the Incident and ending not later than the Maximum Indemnity Period thereafter during which the results of the Business shall be affected in consequence thereof.
Some policies amend this definition so that the indemnity period starts either at the time of the damage or when the business suffers an interruption. This is because some types of damage would not immediately cause a reduction in turnover, for example in a subsidence loss the insurers may choose to monitor the subsidence for some time after the damage has occurred This would mean that the indemnity period could end before the subsidence actually causes an interruption, as typically this will occur when the repairs/underpinning is done. The amended definition would be:
The period beginning with the occurrence of the Incident or the interference with the Business and ending not later than the Maximum Indemnity Period thereafter during which the results of the Business shall be affected in consequence thereof.
Incident usually means:
Loss or destruction or damage to property used by the Insured at the Premises for the purpose of the Business.
Maximum indemnity period is usually defined as:
The period beginning at the commencement of the Incident and ending no later than the number of months shown in the Schedule during which the Insured's Business shall suffer Consequential Loss.
If an indemnity period is too short, the insured will not receive a full indemnity.
What the business interruption policy covers
A standard business interruption policy sets a formula for how the loss will be settled. Most business interruption policies are arranged as
- gross profit;
- gross revenue;
- increased cost of working only (ICOW) only.
If the business earns rent or fees, cover could be gross rentals or gross fees.
The main types of cover are discussed below.
The standard gross profit wording is:
The insurance under Item 1 is limited to loss of Gross Profit due to:
(a) Reduction in Turnover and
(b) Increase in Cost of Working
and the amount payable as indemnity hereunder shall be:
1(a) In respect of reduction in turnover the sum produced by applying the Rate of Gross Profit to the amount by which the Turnover during the Indemnity Period shall fall short of the Standard Turnover
1(b) In respect of Increase in Cost of Working the Additional Expenditure necessarily and reasonably incurred for the sole purpose of avoiding or diminishing the loss of Gross Profit which but for that expenditure would have taken place during the Indemnity Period in consequence of the Incident, but not exceeding the sum produced by applying the Rate of Gross profit to the amount of reduction thereby avoided.
Less any sum saved in respect of such of the charges and expenses of the business payable out of Gross Profit as may cease or be reduced in consequence of the Incident.
The claim is compiled by comparing the actual turnover earned during the interruption with that of the preceding calendar period. Any loss arising is then adjusted for any trends and reduced for any savings made because the business was not fully operating. The loss is always limited by the rate of gross profit.
The rate of gross profit is the proportion gross profit bears to turnover, namely:
So if the rate of gross profit is 50%, no loss above 50% of turnover (adjusted for trends) would be paid.
The above assumes a 12-month period of indemnity so losses for longer periods have to be adjusted accordingly. (Failure to multiply the annual figure by the indemnity period is a major cause of underinsurance).
ICOW - economic limit
Increased cost of working (ICOW) is additional costs spent to maintain the business at pre-loss levels and mitigate the loss of gross profit. The ICOW item is limited to an amount "not exceeding the amount of reduction thereby avoided." The principle here is that, as the cover is all part of the loss of turnover item, the insured cannot spend more than the profit/revenue that would have been lost if additional costs were not incurred. In other words, they cannot spend more than a pound to save a pound.
Ideally, all anticipated increased costs should be agreed with the loss adjuster/insurer before being incurred, although insureds have a duty to mitigate the loss.
The policy does not normally pay for any time/costs expended when actually compiling the claim.
Turnover is usually defined in a business interruption policy as:
The money paid or payable to (or earned) by the Insured for goods sold and delivered or services rendered in the course of the Business at the Premises.
It may be necessary to insert the words "or earned" in the definition. It is possible that with longer-term contracts there may not be any money paid or payable during the indemnity period. Payments may be made in stages outside the indemnity period even though the work was done within this time. In this situation, unless the additional words "or earned" are added, the policy would not respond.
Gross revenue basis
The full revenue without deduction is insured. The standard policy wording reads as follows:
The insurance is limited to (a) Loss of Gross Revenue and (b) Increase in Cost of Working and the amount payable as indemnity thereunder shall be
2(a) In respect of Loss of Gross Revenue the amount by which the Gross Revenue shall fall short of the Standard Gross Revenue in consequence of the Incident.
2(b) In respect of Increase in Cost of Working the Additional Expenditure necessarily and reasonably incurred for the sole purpose of avoiding or diminishing the loss of Gross Revenue which but for that expenditure would have taken place during the Indemnity Period in consequence of the Incident, but not exceeding the amount of reduction thereby avoided.
Less any sum saved in respect of such of the charges and expenses of the business payable out of Gross Revenue as may cease or be reduced in consequence of the Incident.
As with gross profit, the gross revenue earned during the interruption is compared with gross revenue earned in the previous calendar period, adjusted for the trends in the business, any savings made and for any differential in indemnity period. As there are no variable costs these are not mentioned.
Calculating the sum insured and indemnity period
The gross profit basis of cover is generally used for risks where the business has costs that vary in direct proportion to turnover.
Gross profit is defined in a standard (difference basis) policy as:
Turnover plus closing stock and work in progress
Uninsured working expenses plus opening stock and work in progress
Annual figures (usually found in the Report and Accounts) are used.
This is not the same as an accountant's definition of gross profit - a fact which leads to much confusion and underinsurance. In most business interruption sum insured calculations, the difference basis of sum insured calculation is used. In other words, uninsured working expenses are deducted from turnover to arrive at the insurable gross profit figure required for the policy.
For this reason, all fixed costs are included unless specified (some policies use the net profit plus basis - this identifies the continuing costs and adds them to the net profit to arrive at the gross profit sum insured).
Uninsured working expenses (also termed specified working expenses or uninsured variable costs) should only be the costs of the business that vary in direct proportion to the turnover - that is, if turnover reduces by 50%, the cost reduces by 50% also. It should be noted that accountants treat as variable any cost that varies in relation to production levels - for a BI policy only costs that vary in direct proposition to the turnover are treated as variable.
Deducting the incorrect variable expenses means that the insured will be either over or under-insured. The latter is more common as some businesses fail to understand the difference between insurable gross profit and accountant's gross profit. A major problem is that wages are not generally included in the accountant's gross profit but are in the insurable gross profit as they do not vary in direct proportion to turnover because of compulsory redundancy payments and the need to retain key staff.
A series of surveys carried out by the Chartered Institute of Loss Adjusters' (CILA) demonstrates the scale of the underinsurance problem. In its April 2010 publication "BI Wording Review Initial Report", CILA gives much more detail about the issue, as well as suggested solutions.
In what proportion of policies is the Declaration too low?
If a Declaration is too low, how severe is the shortfall?
CILA Conference survey Sept 2008
CILA Conference survey June 2009
CILA Survey 2012
When suggesting possible variable costs, one fundamental point has to be noted - most losses are partial, not total. In most instances, rather than reducing the costs, the insured may need to spend more to keep the business going. Often, very little other than purchases and bad debts will vary in direct proportion to any loss of turnover - and in many package policies these are automatically deducted.
Brokers play a key role in ensuring the sum insured is correctly calculated. This was shown in the case Arbory Group Ltd v West Craven Insurance Services (March 2007 access the resource via i-law). Arbory asked its broker to obtain business interruption insurance. The broker did not explain to Arbory how to correctly calculate their insurable gross profit. Arbory's gross profit should have been about £1m. However, accountant's gross profit was provided (£250,000) and the brokers did not spot this error.
Following a fire at its premises, Arbory was significantly underinsured for business interruption and insurers applied average. Arbory brought an action against its brokers claiming the shortfall and the lost profits.
The court awarded an amount for the shortfall in insurance proceeds plus the loss of profits (which more than doubled the amount recoverable from the brokers). The court found that it was the broker's duty to provide correct advice on the completion of a proposal form.
When considering an adequate sum insured or policy limit, the anticipated turnover for the policy period needs to be identified. This must then be projected forward so as to be adequate for an incident occurring on the last day of the policy and also sufficient to cover inflation up to the expiry of the indemnity period. The annual figure needs to be increased if the indemnity period is longer than 12 months (failure to increase the sum insured for the indemnity period is a cause of under-insurance). If the sum insured is inadequate, average will apply to the loss.
Arriving at the sum insured for gross revenue is much simpler than for gross profit. Gross revenue is the total turnover of the business, without any deductions, for the length of the indemnity period.
Traditionally, most members of the service industry have been insured on a revenue (or fees) basis because the majority of their costs are staff- and IT-related, so there is little to specify by way of variable costs.
Dealing with inflation - declaration-linked basis.
To reduce the problem of underinsurance caused by inflation, policies are placed onto a "declaration-linked basis". The insured declares the annual estimated gross profit/ revenue at inception or renewal; insurers allow a maximum of 33.3% uplift in the estimated sum insured and most waive average. This figure must then be multiplied by the length of the indemnity period - for example, for a 24-month indemnity the annual figure must be doubled.
The premium is adjustable as the insured has to declare the actual gross profit/revenue earned at the end of each policy period and the premium is adjusted (either upwards or downwards) accordingly.
Downwards adjustments are capped at 50% of the deposit premium charged, whereas upwards adjustments are unlimited, irrespective of the 33.3% cap placed on the uplift.
A major issue for insurers is that a standard declaration link clause deletes the condition of average that applies where there is underinsurance. Whilst this is a benefit for an insured, because underinsurance is so common most insurers do not receive the correct premium for the risk. This issue is compounded by the failure to obtain year-end declarations.
Some insurers are amending the declaration link clause so that where there is deliberate underinsurance and/or underinsurance of more than a set percentage, average will apply.
For an insured there are three main issues with declaration-linked policies:
- Rapidly growing businesses - new (start up) businesses often expand at a far greater rate than the 33.3% factor allowed, so a review of the sum insured is required on at least a quarterly basis.
- Declining businesses - if a business is in decline, there is no need for the inflation factor and there may be insufficient return premium available should the decline be beyond 50%. Again, a review of the sum insured is required on a regular basis.
- Covers placed on a first-loss basis - If a first loss basis is used, the inflation factor may be meaningless as the policy limit will be the maximum amount claimable, irrespective of inflation. However, policies placed on a declaration-linked basis do not have average applied (even with a first-loss policy the total sum insured must be adequate or average will be applied).
Setting the length of the indemnity period
The length of the indemnity period is important. It starts at the date that the incident (that is, the damage) has occurred. It is not usually started by the interruption to the business, although in some cases this may be preferable.
This was demonstrated by the Coromin v Axa 2008 Commercial Court decision. In this case the BI policy insured against "loss resulting from the interruption of or interference with the business" so the business interruption indemnity period ran for up to 24 months from either the date of damage or the date of interference.
All cover ceases on the expiry of the indemnity period, so if it is set too short and does not allow for a full recovery of the business then the insured may not receive an adequate indemnity. Premium is based upon the total sum insured - that is, the multiple of annual gross profit/revenue - so the longer the indemnity period, the more premium will be required.
Items to consider when setting an indemnity period
When thinking about indemnity period length, the worst-case scenario should be considered. Recovery actions often take place at the same time (for example, obtaining planning permission whilst getting rebuilding quotations) but some cannot and will drive the required length of indemnity period. Items to consider include:
- Thinking/decision time - there may be a business continuity plan (BCP) in place, but a major loss may cause changes. For example, a business may decide to transfer production to another country.
- Planning consents and enquiries - local authorities can take a very long time to come to a decision on planning consents. Indeed, they may even refuse permission to reinstate as their overall planning has changed the use of the area from commercial to housing.
- Rebuilding/building time - Reinstatement on-site may have some difficulties - caused by, for example, lengthy debris removal/pollution clean-up time, or by the need to source correct materials for listed building reinstatement. If the insured reinstates on a new site with modern materials is often much quicker.
- Lead time for replacement machinery/plant - some machines are bespoke and can take a year to replace.
- Re-training staff - staff may have been laid off so it is important to build in time to train new staff and to re-train existing staff in any new processes introduced when reinstating the business.
- Recommissioning plant/systems - often, trying to integrate new replacement kit with pre-existing undamaged items causes more trouble than starting up a whole new plant or system.
- Regaining anticipated pre-loss trading levels - extra time to regain market position must be allowed for. However, pure "loss of market" is not covered.
- Seasonality - many businesses are dependent on trade from a particular "season" - whether it is Easter eggs, toys at Christmas or the skiing industry. If the loss occurs immediately prior to the season concerned, it could miss not just one, but possibly two seasons, so the indemnity period needs to be 12 months longer than normal.
Increase in costs of working
ICOW is already included as an option in the settlement of a gross profit/revenue loss. Some examples of such additional/increased costs are as follows:
- additional overtime costs;
- the additional rent for alternative accommodation;
- removal or additional storage costs;
- the cost of internal alterations to the alternative accommodation;
- the additional costs of telephone, fax and other communication systems;
- cost of advertising "business as normal";
- additional travel, transport and expense costs;
- additional rates and taxes;
- hire and installation of furniture and other fixtures and fittings;
- additional printing or over-printing costs of stationery, including advertising;
- cost of any additional staff required, albeit on a temporary basis;
- additional costs above normal cost of reproduction of documents when these are required quickly;
- additional costs of outsourcing.
Additional increase in cost of working (AICOW)
There are losses where costs that are not economic may need to be incurred to ensure the business survives. This includes instances where the costs are not economic within the indemnity period (although they may be over a longer period) or where it is difficult to prove the costs are economic - an example being advertising. In such situations, the traditional ICOW item will not be adequate. The solution is to buy additional increase in cost of working (AICOW) cover, usually defined as follows:
The insurance under Item X is limited to the amount of the Additional Expenditure (in excess of the amount payable under paragraph Item1 (b) of Gross Profit, (Gross Revenue, Advance Profit or Advance Revenue) necessarily and reasonably incurred by the Insured during the Indemnity Period in consequence of the Incident for the sole purpose of avoiding or diminishing a reduction in Turnover.
The expenditure still has to be necessarily and reasonably incurred for the sole purpose of avoiding or diminishing the loss but does not have to be economic if it is spent for the sole purpose of maintaining the turnover of the business.
AICOW is purchased in addition to the usual ICOW cover. This is very helpful to loss adjusters as they can then readily agree expenditure of AICOW, within any pre-agreed limit, without worrying whether it will turn out to be economic or not. If it should transpire to fall within the economic limit then the expense can be moved from the AICOW item to the ICOW item, releasing more expenditure, if necessary, to the AICOW item.
It should be noted that the benefit of the AICOW expenditure has to accrue within the AICOW indemnity period. Some businesses may need a longer indemnity period for AICOW - costs could continue after resumption of activities.
AICOW covers are all written on a first loss basis
Such cover is bought by those businesses that cannot envisage a loss of profit or of revenue from an interruption, but do anticipate a degree of increased costs. Large office-type businesses with a good spread of risk (for example, banks, lawyers, accountants and insurance companies) are traditional buyers of ICOW-only cover.
Some ICOW-only policies incorporate some form of restriction of the amount that can be spent - perhaps 25% in the first three months of the indemnity period, which is reflected in the reduced rating for this type of policy. However, this limitation must be agreed with business itself, as cover (albeit more expensive) is available without this limitation.
When designing a business interruption programme, the business and any premises used to generate profit need to be identified. Unless they are correctly specified, the policy cannot respond. For all extensions that amend the definition of premises, the territorial limits must be reviewed for adequacy as suppliers/customers etc that are outside the territorial limits will not be covered.
The following extensions extend the definition of premises. It should be noted that the material damage proviso does not apply as they are not premises used by the insured for the business.
Most manufacturing or assembly businesses will be dependent on a supply chain to produce the final product or service. If the supplier's business suffers damage as insured by the policy, then the interruption could actually be more serious than an interruption at the insured's own premises.
Failure to obtain supplies of a key raw material or service may affect turnover considerably. The business interruption policy can be extended to cover damage at suppliers' premises. The perils covered will follow those insured under the policy, but some insurers may limit the perils covered, depending on the location of the supplier (especially for those based outside the UK).
Suppliers' extension limits are expressed as a percentage of the gross profit/revenue sum insured/limit over the indemnity period, or as a monetary limit. They should be carefully reviewed for adequacy.
If the insured is the supplier of a product or services to a customer's premises, then there will be a "customer's" exposure to the business. If the customer can no longer take delivery of the product or service because of damage, then the insured's business will suffer. This frequently occurs when the insured is a small enterprise compared to the customer.
Customer's extensions are more beneficial to the manufacturer or service provider that has a limited number of customers who each account for a relatively high proportion of turnover.
Third-party storage premises
Third party storage premises are frequently used by businesses. Should damage occur at these premises then turnover may be lost. Insurers will offer an extension to third party storage premises, treating them as if they were occupied by the insured.
Most businesses are dependent to some degree on the supply of electricity, gas, water or telecoms to maintain their turnover. Cover is available as an extension, either in respect of damage to the land-based generating station supplying the service, or in respect of failure of supply anywhere up to the terminal ends of the supply lines to the insured's premises. The latter is the more beneficial (and therefore the more expensive) extension as supply is frequently interrupted due to contractors inadvertently digging up cables and the like and interrupting supply.
Insurers usually limit their liability, sub-limiting the cover and imposing a time deductible.
The following extensions amend the definition of incident.
Loss of attraction
This extension is vital for retailers who rely upon "passing trade" to other larger shops, particularly within a shopping mall and hotels that rely on a local attraction for business. Cover is extended to include damage at the "attraction".
Murder, suicide and human contagious disease
The intention of this extension is to provide business interruption for businesses suffering loss of profit/revenue following either a tragic event (such as murder or suicide) or the closure of the premises by the authorities due to an outbreak of notifiable contagious human disease (smallpox, cholera etc.). Cover can include closure of the premises due to Food Safety Act requirements as well as other more spurious events such as non-potable water, closure of the beaches etc.
It must be noted that:
- The disease cover is only for human disease and excludes avian flu and foot and mouth disease.
- If the disease is not on the list of "notifiable" contagious diseases, the policy could not respond because the authorities would not close the premises. This list is amended by the government and differs between the countries of the UK so many policies list the diseases that are covered.
Denial of access (also called prevention of access)
This extension protects the insured against the resulting interruption loss if access to their premises is prevented or restricted because of damage in the "vicinity" - usually defined as within one mile of the insured's premises. For example, a fire in a nearby building may give rise to:
- debris blocking the safe approach to the premises;
- the damaged building being declared unsafe, causing the local authority to prohibit access to neighbouring buildings;
- a risk of explosion causing the evacuation of the premises.
The cover is limited, as usual, to damage by an insured peril and therefore excludes non-damage incidents such as blocking of roads purely due to adverse weather conditions and incidents such as bomb hoaxes or criminal activities that may cause the police to restrict access within the area. However, "non-damage" cover can sometimes be negotiated for smaller sub-limits at extra cost.
Research and development costs
Research and development (R&D) is clearly part of almost any business. Some R& D is essential for ongoing production, and would be included as part of the cost of the business. However, gross profit /revenue cover is triggered by a reduction in turnover and much R&D will not trigger a turnover reduction within the indemnity period.
However, in the event of "damage" to the business' R&D, the insured will suffer a loss. Examples include:
- additional expenditure incurred in obtaining, occupying and equipping temporary premises and in paying appropriate overtime to staff to quickly reinstate the work lost.
- if research work is suspended or retarded the insured will be paying for unproductive, wasted time to retain their key staff and will then have to incur further salary costs to get back on track.
- If records of partially or wholly completed R&D projects are lost, further time and labour will need to be expended in re-working the projects to verify the results.
Such losses can be covered under the BI policy in a separate first loss amount. The first loss limit recognises the fact that the loss is unrelated to current turnover and therefore needs to be paid in addition to any R&D loss that is related to current production.
Fines and damages
In certain trades, the delivery of goods to the customer by a due date is a very important feature and, in the contract of sale or services, a provision is made for the payment of a fine or damages in the event of non-fulfilment by the agreed date. Although a loss of this nature may be a consequence of damage, it is normally excluded from the cover (liquidated damages).
It is possible to arrange a special sub-limited item on fines or damages for breach of contract. Cover can be included for fines or damages and so forth that the insured would be legally liable to pay for breach of contract. For example, in respect of contracts for the purchase of goods or services that cannot be utilised by the business during the indemnity period.
The sum insured for such an item is calculated on a first-loss basis and should represent the maximum liability that might arise at any one point of time from any one particular incident.
Advance loss of profits or revenue
Advance profits/revenue cover protects the insured for loss of anticipated earnings from a new installation/plant/business process (operating from structures yet to be built) as a result of a delay in the construction/installation/implementation caused by an insured event.
The cover is intended for entirely new streams of business or new locations - development of existing streams of business can usually be catered for in the standard cover, as the anticipated turnover that is declared should include the projected increased turnover for the expansion.
Some additional considerations for global programmes
US Gross Earnings
In the US, the cover is often on a gross earnings basis. The fundamental difference between this and the UK gross profit basis is that the gross earnings form only makes payment up until the business is restored, whereas the UK cover continues to make payments during the indemnity period until the business returns to the anticipated pre-loss trading position. It is possible to extend the US basis of cover by buying an extension called "extended period of liability".
Another important difference is that the standard US form does not allow any business interruption coverage for damage to finished stock - that is, it will not pay for loss of the profit that would have been made had the stock not been damaged. The remedy is to buy such cover under the material damage item.
Terminology also differs. For example, business interruption is usually referred to as "time element" coverage and suppliers' and customers' extensions are normally labelled as "contingent business interruption" whereas ICOW is called "extra expense". Wages are often labelled as "ordinary payroll" and denial of access is called "ingress and egress".
Marine business interruption
Many major global manufacturers have an ongoing marine business interruption risk in that if the components being shipped from place to place get destroyed or lost in transit, then not only is the turnover earned up that point at risk but also the added value from the next part or parts of the operation. This risk may be insured under a marine business interruption policy.
Cyber business interruption
Business Interruption cover typically found in cyber policies
Most cyber policies offer optional cover for business interruption caused by cyber perils. The basis of the business interruption cover in a cyber policy is not the same as it is in a conventional business interruption policy. Cover varies considerably in different policies, there is no 'standard' business interruption cover in a cyber policy.
Cover differs between insurers but can include interruption following loss of data, data breach or liability caused by
- Human error
- Accidental damage
- Hacker attack
- Employee sabotage
- Natural disaster
- System malfunction
- Programming error
Some policies limit cover to business interruption following a third party liability or data breach incident only.
Short indemnity periods are common - three months is typical, although some policies allow the insured to choose their indemnity period. The start of the indemnity period is usually the date/time the interruption to the business commences not the date the damage (e.g. hack) occurs. Some policies do not have an indemnity period but cover the loss during the period of reinstatement of the data system, subject to a maximum coverage period.
There are several different types of business income covered. Some policies cover income generated via use of the internet only, others will cover all income. Several insurers use net profit plus fixed expenses as the basis of cover rather than insurable gross profit. Care needs to be taken that the insured understands the limitations of the cover and calculate their sum insured correctly.
Not all policies include a settlement formula but where there is brokers need to ensure that the insured is happy as these vary considerably between insurers. For example, one policy is triggered only where revenue generated from the internet is reduced by 75% of the average hourly internet revenue generated in the preceding 90 days, another by looking back over the preceding 12 months including the trend of the business.
Most, but not all, policies include cover for increased costs of working (often called additional expenditure) necessarily and reasonably incurred to minimise the interruption. In some policies these are covered under a separate module to the business interruption section so care must be taken when choosing modules to ensure that full business interruption cover is bought.
Most policies require proof of the loss by the insured at the insured's own expense.
The policies are usually subject to a monetary excess. A time waiting period is also common and these range from a few hours to days.
- Business Interruption Policy Wordings - challenges highlighted by claims experience - Insurance Institute of London Research Study Group 265 in conjunction with the Chartered Institute of Loss Adjusters. London October 2012.
- Interruption insurance: practical issues. Gordon JR Hickmott. London, Witherby, 1999.
- LBIA guide to business interruption insurance and claims. London Business Interruption Association. London, 2010.
- Riley on business interruption insurance. Harry Roberts. 10th edition. London: Sweet and Maxwell, 2016.
Chartered Institute of Loss Adjusters (Business Interruption resources)
London Business Interruption Association