Business interruption insurance: why the indemnity period matters

Reopening does not always mean the business has recovered

After a major insured event, the visible damage may be only part of the problem.

A premises may eventually be repaired, but the business can still be dealing with:

• lost customers;
• reduced sales;
• delays in replacing specialist equipment;
• staff recruitment and retraining;
• temporary premises;
• supply-chain disruption;
• landlord or strata approvals;
• rebuilding and fit-out delays; and
• the time needed to return to normal trading levels.

That is why Business Interruption insurance should not be considered only by looking at a dollar limit.

Another important question is:

How long could it realistically take the business to recover?

What Business Interruption insurance is intended to address

Business Interruption cover is generally designed to respond to the financial impact of an insured event that disrupts the business.

Depending on the policy and cover selected, this may involve matters such as:

• loss of gross profit or revenue;
• continuing fixed expenses;
• additional operating costs;
• temporary premises;
• reasonable expenses incurred to reduce the interruption; and
• certain supplier or customer-related interruptions.

The exact basis of cover varies between policies.

It is not simply a reimbursement of every dollar of revenue the business did not earn.

What is the indemnity period?

The indemnity period is generally the maximum period for which the policy will measure and respond to covered business interruption loss.

Common options may include:

• 12 months;
• 18 months;
• 24 months; or
• 36 months.

A longer period is not automatically better.

The more important question is whether the selected period is realistic for the way the business would recover after a serious event.

Why 12 months may not be as long as it sounds

Consider a restaurant that suffers a major fire.

Recovery could involve:

1. insurer and loss-adjuster inspections;
2. site clean-up;
3. builder quotations;
4. landlord or strata approval;
5. reconstruction and fit-out;
6. replacement of commercial kitchen equipment;
7. licences or regulatory approvals;
8. staff recruitment;
9. reopening; and
10. rebuilding customer traffic.

If physical reinstatement alone takes most of the year, a 12-month indemnity period may leave very little time for the business to recover financially after reopening.

The same issue can arise for manufacturers, warehouses, medical or professional premises, larger retail operations, and businesses that rely on specialist equipment.

The financial basis also matters

Business Interruption policies may use terms such as Gross Profit, Revenue or Gross Rentals.

These insurance definitions do not always match the way the same terms are used in ordinary accounting.

Using the wrong basis can create a mismatch between the cover selected and the financial exposure.

A business may need to consider annual turnover, fixed and variable costs, payroll, expected growth, the indemnity period and the likely recovery time after a serious loss.

An accountant or other appropriately qualified adviser may need to assist with the financial calculation.

Common misunderstandings

“My building and equipment are insured, so Business Interruption is less important.”

Repairing physical damage and maintaining business cash flow are different issues.

“Twelve months should be enough.”

It may be enough for some businesses and clearly insufficient for others.

“A higher sum insured solves the problem.”

Not necessarily. The basis of calculation and the indemnity period can be just as important.

“Once the doors reopen, the interruption is over.”

A business may reopen before revenue, staffing and customer activity return to their previous levels.

What should be reviewed at renewal?

It can be useful to reconsider:

• how long full reinstatement would take;
• whether specialist equipment would be difficult to replace;
• whether landlord, council or strata approvals would be required;
• whether alternative premises are realistically available;
• how easily customers could move to competitors;
• how long revenue might take to recover after reopening; and
• whether turnover has materially increased since the last renewal.

If the business has changed, the Business Interruption assumptions may also need to change.

How Wesure can assist

We can assist clients to:

• understand the structure of Business Interruption cover;
• identify the information insurers may require;
• review the selected indemnity period;
• compare material differences between policy options;
• revisit cover when the business changes; and
• coordinate supporting financial information during a claim.

Financial calculations may require input from the client’s accountant or another appropriately qualified professional.

The insurer remains responsible for determining whether a loss is covered and how the policy responds.

Key point

Business Interruption insurance is not only about asking:

“How much cover is there?”

It is also about asking:

“How long could this business realistically need to recover?”

General information only: This article does not take into account your objectives, financial situation or needs. Business Interruption cover, calculation methods, indemnity periods, limits, conditions and exclusions depend on the relevant policy and insurer terms.