Business interruption insurance – the 'often overlooked' insurance
In 2018, business interruption (BI) topped the Allianz Risk Barometer for the sixth year running, as the key concern for businesses globally. Yet, some reports suggest that many businesses either have insufficient BI cover - or none at all.
It’s estimated that 40% of UK SME businesses lack adequate business interruption cover and that only 17% of risk managers are "extremely confident" that their BI values and limits set are adequate. So, why is business interruption insurance often overlooked and what could be the potential consequences for a company director who decides against taking out a BI policy?
A Lack of Understanding
One suggestion is that many company owners just don’t understand what business interruption insurance is, or what it covers. Others may be unprepared for such events and lack requisite business continuity plans and procedures.
A business interruption event may be anticipated or unanticipated, but the most common causes are fire and explosion, according to a report from Allianz Global Corporate & Specialty. Other triggers include floods and natural catastrophes, as well as disruption arising from human or technical error.
BI insurance provides cover for the earning capacity of the business following an insured event which disrupts normal business activities. This ensures the business can continue to operate despite loss or damage to its capital assets. It’s thought that some business owners mistakenly believe other insurance policies will cover loss of earnings following an event, such as buildings and contents insurance. However, while such policies may cover physical damage, they make no allowance for any financial losses sustained as a result of the event which disrupted business operations.
Identifying the correct sum to be insured under a BI policy is rarely straightforward, but nevertheless an important task.
Firstly, it’s necessary to consider how long it would take the business to fully recover, following a major interruption incident – this is the necessary indemnity period. Then, the gross sum insured needs to be calculated. This is usually the sum of turnover, closing stock and work in progress minus any uninsured working expenses, opening stock and work in progress. "Uninsured working expenses" are costs which vary in direct proportion to turnover, such as the purchasing of materials or freight.
Finally, it’s important to make adjustments for any future business and economic trends. These could include projected business growth or expected rising or falling inflation rates.
Underestimating the sum to be insured could lead to a significant financial shortfall following a business interruption event, leaving a business owner out of pocket. Further, businesses may want to consider any increased cost of working. This relates to additional costs likely incurred to help the business recover following a loss, such as renting alternative premises or additional marketing and advertising activity.
A 'Grudge' Purchase?
Another factor influencing purchasing decisions could be that there is no legal requirement to possess business interruption cover. Insurance is sometimes viewed as a 'grudge purchase' and unlike motor insurance or employers’ liability (EL), BI insurance is optional and based on judgement of a business’s requirements and exposure to risk. This involves asking various questions, including, "what types of threats could my business face?" and "could my business continue to operate in the event of a serious business disruption?"
There can be a variety of negative outcomes for businesses following business interruption events. In the worst case scenario a business may never reopen, whilst others remain closed for months. The average period of ‘downtime’ for a small business is more than three months – representing a significant cost in terms of lost revenue and profit, plus the expense of any bank loans required for repairs.
A False Economy
When trying to cut costs and keep spend to a minimum, a business owner may conclude that business interruption insurance is an unnecessary expense. However, by cutting corners in purchasing adequate BI cover, a business owner could fail to see the bigger picture and neglect to take all expenditure into account.
Aside from loss of revenue, a business may still be required to pay ongoing costs including staff wages, utility bills and rent for alternative premises. Saving the cost of a BI policy could result in a paying a hefty price later on.
According to the Chartered Institute of Loss Adjusters (CILA), 43% of business interruption policies have inadequate sums insured. Assessing the correct level of business cover can be complicated so it’s best to contact an insurance professional for advice. Also important is deciding the correct indemnity period – the period during which the insurer will pay losses following the event which gave rise to the claim.
A common mistake is misjudging the time required to get a business back up and running. A 12 month indemnity period may be insufficient time for this and frequently 18-24 months is a more suitable time period. Once a BI policy has been taken out, it’s crucial to review the cover and sum insured on a regular basis to ensure they remain fit for purpose.
More Than Just A Financial Loss
Aside from the financial implications, there are other repercussions following a business interruption event. Prolonged closure of a business could result in customers going elsewhere and advocating other brands, in turn damaging the company’s reputation.
Employees may find themselves out of work for a sustained period of time and have to seek alternative employment. And, there may be implications for meeting certain legal and regulatory requirements.
All these examples support the need for a robust continuity plan, which works hand-in-hand with business interruption insurance. This not only provides reassurance for the business itself, but also its suppliers and customers.
Business interruption is often overlooked as a vital insurance for businesses, due to its status as an optional insurance, coupled with the complexities involved in its calculation. However, it can prove instrumental in the case of a disaster, providing much-needed financial assistance to get a business back on its feet.
Source: Allianz Insurance plc