Common pitfalls when insuring against business interruption
Fire, storm damage and other modern-day risks such as the recent hail events can cause a significant disruption to a business. Steering clear of the most common pitfalls when insuring against business interruption will safeguard your company until it can operate at 100% again.
For any business, an underinsurance shortfall can be disastrous. When clients experience business interruption, they often find their cover falling short, which may mean they are unable to continue trading – and in some instances have little choice but to close their business.
Underinsurance is the biggest reason for unhappiness at the claims stage. Given the substantial risks that a business can face and the real costs associated with an unplanned business interruption, having the proper business interruption insurance in place is imperative.
Herewith pitfalls that clients need to be aware of when it comes to the claims process, and how to avoid them:
Make the correct gross profit calculations
The most common errors when insuring for business interruption occur when the gross profit of a business is miscalculated.
The client is insured against applying the rate of gross profit to the reduction of turnover, not against the total reduction in turnover.
In calculating the gross profit sum, the insured amount should:
• Include VAT.
• Reflect a 12-month period where the maximum indemnity period is 12 months or less, or the appropriate multiple of the annual turnover where the maximum indemnity period exceeds 12 months.
• Cater for trend, which means include a loss that may occur close to or at the end of the insurance period.
Be aware of the difference between financial and insurance gross profit
The financial gross profit often takes into account various direct manufacturing costs, such as wages, factory overheads, and water and electricity. The insurance gross profit takes into account the uninsured costs as chosen by the client. These uninsured costs would be indicated on the policy schedule, and as standard would include “purchases, bad debts, and discount received and allowed".
By calculating the insurance gross profit based on only the uninsured costs, the rate of gross profit would be higher, enabling the client to pay the ongoing expenses such as wages, factory overheads, and water and electricity.
Choose an adequate indemnity period
The indemnity period chosen needs to be sufficient to allow for the building reinstatement, sourcing and ordering, and commissioning of a new plant, equipment or machinery, as well as returning to the pre-loss production and turnover levels – in other words, the recovery period. The length of the period would need to be sufficient to cover from the date of the incident until the business is no longer affected by the disruption.
It is important that intermediaries fully understand the nature of a client’s business. It may even be advantageous to call upon the client’s auditors or accountants to provide further insights into and information about the specific business of the client.
In an environment where fire, storm damage and other unforeseen risks are on the increase and can cause significant interruptions to business operations, being underinsured is simply not an option. Businesses need to be carefully advised about the risks they may be exposed to and the types of incidents or events that could hamper the ability of the company to operate at 100%.