Business interruption (BI) insurance is one of the most vital policies a broker can place for a business of any size – yet it’s also one that is commonly overlooked or underinsured, particularly among smaller businesses.

CGU research of nearly 500 small businesses found that one in four would not survive if they had to close their doors for three months, and Vero’s Andrew Geldart reports that about half of businesses that suffer a total loss don’t resume trading, while about a third fail within three years without adequate BI cover.

“Business owners often underestimate the likely impact of an event,” says Philip Johnson, Zurich’s National Property Underwriter. “Most businesses that suffer a major fire but do not have BI insurance fail within a year or two. Following a catastrophe event such as a major storm, flood or earthquake, the incidence of businesses failing is even greater. It takes a while for the evidence of this to be fully apparent as uninsured businesses will strive to work through the problem.”

CATEGORIES OF BI

Johnson and Geldart say that BI most commonly comes as Gross Profit because it suits any business with variable expenses that produces or sells merchandise, and typically covers two aspects:

Reduction in turnover less the uninsured working expenses, and
Expenses increased beyond normal levels to maintain business operations, generally limited to the amount of gross profit saved by incurring the additional expense.

“Gross Profit is effectively the turnover of the business minus the expenses deemed to vary in proportion with a reduction in turnover,” says Johnson, and to determine its insurable value, the business expenses need to be split into those that would:

reduce in proportion to a reduction in turnover (such as purchases or freight),
continue unchanged regardless of turnover (contractual obligations), or
partially reduce if turnover reduced (eg salaries and payroll).

However, Prof Manning points out that some insurers call their traditional insurable gross profit ‘Gross Revenue’ to avoid confusion
between accounting gross profit and insurable gross profit.

Gross Revenue cover is appropriate where business expenses are fixed and don’t vary directly with sales, such as professional services like accountancy, architecture and financial planning firms, says Geldart. To calculate it, any expense normally paid out of the firm’s revenue that ceases or reduces due to the event are deducted, says Prof Manning.

Gross Rentals insurance is similar to Gross Revenue but the wording has been adapted to respond to a loss of rental income for a property owner or landlord. It should also include the outgoings paid by the tenant such as rates, water and insurance, adds Prof Manning.

“It is called Gross Rentals because insurable Gross Profit insures the revenue of the business less any expenses that are either defined in the policy or listed on the policy schedule. Such expenses should always be expenses that are truly variable to sales with the variation occurring in direct proportion to sales,” Prof Manning told IRP.

“For Gross Rentals or Gross Revenue, there is no need to consider the cost of goods sold or uninsured expenses – the full rental or revenue value is insurable,” says Johnson. He adds that when calculating values or sums insured, the possibility of a loss on the last day of the policy should be considered, which will usually be at least 12 months later. The required sum insured should include allowances for business trends for the full indemnity period starting from that day.”

DETERMINING GROSS PROFIT

Insurable Gross Profit should not be mistaken for the accounting Gross Profit.

Insurable Gross Profit typically includes fixed expenses and overheads, payroll and net profit. To be fully insured under a BI policy, only those expenses that are truly variable in direct proportion to sales should be listed as an Uninsured Working Expense and NOT insured. In the case of setting Gross Profit figures, it is always better to overestimate because the Declared Values under an ISR policy are declarations, and as such are adjustable.