One of the most important aspects of an organisation’s insurance program is Business Interruption (“BI”) cover, which is typically covered within an Industrial Special Risks policy or a Business Pack policy.
Broadly speaking, Business Interruption cover (also called Consequential Loss cover) – compensates a policyholder for interruptions to their business, including increases in costs due to Insured Events such as a storm, fire, burglary, vandalism, or earthquake. As with any General Insurance policy, the purpose of BI cover is to return the policyholder to the position they would be in if the Insured Event had not occurred. This article outlines the different types of BI cover available and key things to consider when selecting a policy for your business. *
1. LOSS OF GROSS PROFIT
One option is to insure your business against loss of gross profit. This is calculated by applying the turnover plus closing stock at the end of the last policy year, less the stock on hand at the beginning of the last policy year and Uninsured Working Expenses. Uninsured Working Expenses are the costs/expenses that vary depending on the level of trading and can include the purchase of raw materials, components, freight, packaging, commissions, discounts allowed and payroll.
For loss of gross profit, there are additional aspects to consider, including:
INDEMNITY PERIOD – this is the maximum length of time the insurer will cover the policyholder for the interruption to their business. Once the indemnity period ends, the insurer will no longer indemnify the policyholder for their loss of business, even if they have not returned to pre-loss trading levels.
Policyholders often underestimate the time it will take to return to pre-loss trading levels, so it’s critically important to consider delays when nominating the indemnity period, including:
- Investigations (e.g. by WorkCover, Coroner’s office, fire department, etc.)
- Development approval from Council
- Delivery time of plant and equipment.
ADDITIONAL INCREASED COSTS OF WORKING (AICOW) – this covers the costs to avoid or limit reduction in revenue and resuming or maintaining normal business operations. This can include leasing of temporary premises, leasing of plant and equipment, overtime payments and temporary employment of additional staff.
AICOW is generally treated by insurers as a ‘rateable value’ on an ISR policy (that is, the agreed premium rate is applied against the AICOW value on items such as the property value and loss of gross profit / gross revenue values), and therefore it has a direct impact on the policy premium.
COVERAGE FOR WAGES – Uninsured Working Expenses (UWE) are important to consider here. These are the costs/expenses that vary in line with the level of trade. The decision to include payroll** within the UWE calculations does not need to be considered in absolute terms – i.e., including it entirely within the UWE (not insuring payroll entirely) or excluding it from the UWE (insuring 100% payroll). This option provides the policyholder a high level of cover and flexibility in terms of employee retention in the event of a loss. Given that payroll is generally treated as a ‘rateable value’ it can have a significant direct impact on premium.
For businesses that have ceased or reduced their trading, there is an option to insure payroll on a Dual Payroll or Dual Wage basis. Using this method, payroll can be insured at varying levels across different time periods. For example, a business with a 12-month indemnity period may choose to insure payroll 100% for the first 12 weeks after the Insured Event and insure a percentage of payroll (e.g. 70%) for the remaining 40 weeks. This method can be effective in reducing the rateable values on a policy, but only where the policyholder understands their staffing requirements following a business interruption. If this method is used, it is important to consider pairing it with Severance Pay cover to account for wages paid in lieu of notice to employees whose services are terminated.
** payroll costs should include all personnel costs (i.e., salaries and wages (including overtime), holiday pay, commission and/or bonuses, payroll tax, superannuation, and Workers’ Compensation insurance premiums).
NOTE: Gross profit is different to insurable gross profit. A key difference is that insurable gross profit does not always consider all the costs of manufacture – fixed costs such as building lease costs which generally do not decrease in direct proportion to the turnover in the event of a business interruption are not factored into insurable gross profit calculations. This cover is typically suitable for businesses with multiple variable costs (e.g., retail, wholesale, import and distribution, hospitality, and manufacturing industries).
2. LOSS OF GROSS REVENUE
For businesses in service-based industries with few variable expenses (e.g., solicitors, investment consultants, and medical and health consultants), it may be appropriate to insure for loss of gross revenue. The insured value is generally calculated by taking the turnover from the last year and applying the expected growth for the upcoming period.
Businesses insure loss of gross revenue for a relatively short indemnity period of 3 or 6 months if they anticipate a rapid return to pre-loss trading (e.g., an office-based business with a catastrophic loss to their premises may secure replacement office space, IT equipment etc. and resume full scale trading relatively quickly). In this situation, it is also important to consider a sufficient AICOW coverage limit to cover increased costs associated with the lease of temporary premises, office equipment and employment of additional staff and/or contractors.
3. ADDITIONAL INCREASED COSTS OF WORKING ONLY
For businesses with minimal exposure to loss of revenue in the event of a catastrophic loss to their premises, a viable option is to insure for increased costs of working only.
4. LOSS OF GROSS RENTALS
This type of cover is designed to respond to loss of rental income to a landlord or property owner. It is important to note that the insured value should include the net rent receivable AND the outgoings paid by the tenant which would be payable by the policyholder if the lease were suspended or terminated.
As with the other coverage options, Loss of Gross Rentals should be considered in conjunction with Additional Increased Costs of Working cover (for items such as advertising costs, contractors’ overtime costs, or rent-free periods for tenants etc.).
When nominating the loss of gross profit or loss of gross revenue values, we encourage you to keep the following factors in mind:
- The Underinsurance / Average / Co-Insurance clause applies to business interruption values as well. In the challenging property market, there may be a temptation to underestimate the business interruption exposure, though this could impact the coverage entitlements if a loss occurs.
- The standard Industrial Special Risks Mark IV wording contains a Premium Adjustment provision which states the premium will be adjusted in the event of a discrepancy between the actual values as calculated at the end of the policy period relative to the declared values provided at the start of the period. The premium adjustment for business interruption values is calculated at 100% of the premium rate for the period in question.
With You All The Way
To find out more about how these policies can be tailored to meet your specific needs, please feel free to reach out at any time.
Client Manager – Corporate Insurance & Risk Solutions
*This article does not examine the policyholder’s loss or damage to their property, which would be indemnifiable under the respective Property Damage section of the policy.