Chapter 7: Business interruption insurance


Business interruption insurance (BI) is designed to indemnify you for the business loss of profits and other costs you sustain following an insured event. Naturally all such indemnities are subject the insurance policies terms and conditions. BI was previously seen an adjunct, often an afterthought (if thought about at all), to a main property damage policy. However, in today’s interconnected marketplace, BI’s implicit value has been absolutely recognised.

The growth and the refinement of BI over the years is in many ways linked to the creation of accounting bodies and establishment of accounting standards. While the fundamental need for BI was always there, it was at least a century after the great fire of London in 1666 that this began to be satisfied. People were then very conscious about the benefit of property insurance. There was, however, a growing realisation that full property damage cover was not enough to reduce the risk of business failure following an event causing significant damage building plant and equipment.

BI had its origins both the UK and Europe. Ship-owners found it useful to cover lost profits on freight shipments. Various models were used to determine the basis of cover and quantification of loss. In the early days, a per diem coverage was trialled. As accounting standards were established, insurers’ reluctance to embrace a cover that previously (in their view) was subject to manipulation and abuse, eased. Flat systems were also trialled under which an additional amount, say 10 per cent, was added to stock values as a proxy for loss of profits. In the late 1880s, the term ‘use and occupy’ came into use in the US. This entrenched the notion that a property owner faced interrelated risks arising from both the ownership and use of property assets.

The early in 20th century saw BI cover comprising profits and standing charges. Just before the outbreak of World War II, the US developed the initial gross earnings form with coverage elements including profits, normal expenses and payroll. The first standalone fire-related BI was developed in Germany in the 1950s, then in 1986 the US Insurance Services Office pioneered a version that became the gross earnings form that we know today.

Essential elements of BI
BI is all about providing the necessary protection for you as you embark on the challenge of not only dealing with the initial recovery from a potentially business destroying event, but also the often turbulent time in restoring
your business back to where it was – or where it should have been but for the event. It has traditionally been triggered when property damage caused by an insured event has occurred. The property policy is set out in two main sections. The first details property damage while the second contains language relating to resulting business interruption. The second section is dependent upon and triggered by damage arising from an insured peril in the first section.

In essence, BI provides cover for loss of profits. That means indemnifying you for the ‘losses’ you incur as you restore the business. This leads into consideration of two aspects: breadth of coverage and the period of indemnity. Coverage is often offered on gross profits basis, while some insurers also give you the option of adopting a gross revenue or earnings wording. Under standard form wording, gross profits cover is determined by adjusting gross profit, as normally calculated, so that you only take into account costs that will continue regardless of if the event occurred or not. Complicating this is the fact that some costs will have both fixed and variable components. An example of this would be wages, where a portion may well be fixed while most, if not all, of the variable elements of payroll may not be incurred or abate post event. This type of cover is usually limited by a maximum period of indemnity.

The alternative basis of cover provided is called gross revenue or earnings. This is often more suited to manufacturing facilities. Under this, BI cover is provided with an unlimited period of indemnity. However, cover will cease when the production or manufacturing is restored to pre-loss levels. Naturally, insurers require that all such restoration activities are undertaken with due diligence and despatch. While there is no maximum indemnity period, cover will obviously cease when the total claim amount exceeds the policy limit. Where an indemnity period is selected, it will normally run for 24 to 36 months, or in some cases up to 60 months. Some insurers will offer an extended period of indemnity for a further 12 months. Typically, this is offered in the gross earnings form.

During the restoration period, you will probably incur costs that would not normally arise during normal operations. Examples of such costs include additional marketing expenditure and renting additional storage. To compensate you for this, many BI policies also offer additional cost of working, under which you are reimbursed for these costs.

Any claim made by an insured will be carefully scrutinised by the insurer. They will often employ forensic accountants to go through your claim to ensure it is valid and within the terms of the policy. It is therefore important that care is taken to accurately declare values when you (often with the assistance of your broker) prepare your original insurance submission to the market. If an insurer forms the view that your values are understated, they may seek to apply an average clause if your policy has one. This would have the effect of the insured bearing a portion of any loss claimed in excess of the applicable policy retention.

Insurance can be very complex, and BI is no exception to this. While there are a number of standard forms, even these can be and often are amended by additional policy language. Most businesses are unique in some way shape or form. It is the insured that know its business best and therefore must carefully examine policy language so that the company’s needs are met.

Frequently asked questions

What does a standard BI policy look like

How can you customise a BI policy?

How do you get the most out of your BI policy?

Recent advances in BI
The demands on business have never been greater. We live in a world where time is very much of the essence, business units in an enterprise are highly connected through IT systems or otherwise, and there is increasing connectivity with (that is, reliance on) business partners both upstream and downstream. The backdrop to all of this is a hyper-competitive business environment that forces companies to adapt to just-in-time production and the abandonment of the safety net that you get with maintaining higher stock levels.

This increasing reliance on external entities creates its own risk. If they don’t deliver, for whatever reason, you will be immediately impacted. If the delay or interruption in supply of essential components or services continues, the impact can be catastrophic. This has given rise to an increase in the interest in contingent business interruption (CBI) and non-damage business interruption (NDBI) products.

CBI cover gives you protection where an event caused by an insured peril results in an interruption in the regular supply of components that your business requires. The key factor here is that it is not your property damage that caused your loss, it is damage to the property of others. A clear example of this are the losses that many businesses sustained as a result of the interruption in supply caused by the Thailand Floods in 2011. Consequential loss levels, which were estimated to be of the order of more than $1 billion, not only put increased focus on CBI, but also on the adequacy of limits some buyers already purchased.

Put simply, all things being equal, greater dependency on others increases your risk and invariably requires higher limits, or as a minimum, a careful re-examination of policy limits currently purchased. One of the issues here is that, short of utilising geographically separated suppliers, your ability to mitigate these vendor risk in any meaningful way is limited. Yes, you can do your due diligence and take a harder stand on contract language, but if an earthquake damages your supplier’s plant, one of your best remedies is CBI cover.

The other area that is beginning to get some of increased attention is NDBI. The share market’s lack of appetite for bad news is often what encourages enterprises to check out this relatively new product. With NDBI, the occurrence of a defined event (unrelated to property damage) will trigger cover. Usually policies will give you the option to choose that events you wish to have covered. These policy coverage triggers can include terrorism, financial failure of a vendor, energy blackout, pandemic and strikes. Unlike traditional BI, which only works on a determination of loss sustained, NDBI can also use a parametric basis with a predetermined payout in place or indeed a hybrid double-trigger approach.

Determining the adequacy of your BI policy document
There are a few steps you should take to ensure that if your BI policy will withstand the ultimate test if called upon to do so.

1. Know your business
Before you even start looking at a policy, make sure you have a deep insight into your enterprise. In particular, determine not only what is going on in individual departments, but also understanding how the activities of all departments mesh together to form the business. Once you have a good handle on that, then identify and determine the extent and degree of your organisation’s reliance on both key vendors and customers
2. Event scenarios
Organise one or more workshops with colleagues to stress-test not only your understanding of how the business operates, but also how the BI policy would apply in certain circumstances. The two main objectives here are to, firstly, determine what type of business restoration period is required in certain circumstances (this applies to both the production and sales areas of the business); and, secondly, identify any policy language that is unclear or disadvantageous to you. Once some business-critical events or unfortunate language is identified, a separate workshop should be organised that would also be attended by representatives from your broker and ideally also your (prospective) carrier. The key point here is to resolve any concerns in your mind and at the same time obtain a clear understanding as to how the carrier interprets its policy language.
3. Legal review
Have your policy reviewed by legal firm that has a strong insurance practice




Chapter 6: Managing a business interruption
Chapter 8: Past the physical

About the author

Eamonn Cunningham

After a thirty year career with Westfield/Scentre Group, Eamonn retired as Chief Risk Officer in March 2016. Eamonn joined the Westfield Group in 1986 and after various positions within Finance was promoted to the position of Vice President, Global Risk Management in 2001 and then to Chief Risk Officer in 2005. As CRO Eamonn was responsible for the direction of the Risk Management practice within the Westfield Group globally. This covers risk management activities in Australia, New Zealand, United States, and the United Kingdom for all risk areas including:
-Life Safety
-Insurance and Claims
-Business Continuity Planning
-Enterprise Risk Management
He is a past Chairman of the Risk Management Committee of the Property Council of Australia and a member of the board of The Risk and Insurance Management Society Australasia Limited. He holds a Bachelor of Commerce degree from the National University of Ireland. He became a Fellow of the Institute of Chartered Accountants in Ireland and an Associate of the Institute of Chartered Accountants in Australia. Eamonn led the team that won the Risk Manager/Team of the year at the Australian and New Zealand Institute of Insurance and Finance (ANZIIF) in 2010. In 2014 Eamonn was inducted into the Business Insurance Risk Manager of the Year Honor Role. He is a Graduate of the Australian Institute of Company Directors

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