Business Interruption insurance (BI) is a complex subject. Depending on the type of your business, generally speaking, BI cover should reflect your anticipated ‘gross revenue or gross profit’ during the selected indemnity period.
The main cover types are:
- Loss of Gross Profit
- Loss of Gross Revenue
- Increased cost of working (ICOW)
- Additional increased cost of working (AICOW)
Indemnity Period
The indemnity period is the length of time for which compensation is payable under a policy. It is the period during which the business results are affected from the date of the loss and ending not later that the maximum indemnity period. When calculating BI sums insured on an annual basis they must be increased accordingly if an indemnity period greater than 12 months is selected. In most circumstances, a minimum indemnity period of 24 months should be considered for SMEs to take into account site clearance, design and planning applications, rebuild time, replacement of plant and machinery, sourcing stock and rebuilding the customer and supplier base.
Gross Profit
The gross profit sum insured is the amount by which the sum of the turnover, closing stock and work in progress exceeds the sum of the opening stock, work in progress and variable costs (also known as uninsured or specified working expenses) and is best suited to businesses with directly variable costs such as manufacturing and retail.
Gross Revenue
Loss of Income sums insured should simply reflect the turnover figure (total sales or fee income) for the indemnity period selected and is best suited to businesses such as accountants, solicitors, hotels… those with few or no directly variable costs.
Increased cost of working
The increased cost of working is often included in a full BI policy and is generally suited to businesses that will continue to earn revenue whether their premises are damaged or not. It covers increased costs incurred by a business to maintain its operations and where such costs will avoid / economically reduce a claim for loss of the insured gross earnings. The ICOW insurance has what is known as an Economic Limit which insurers like to explain as you can only spend £1 to save £1 of turnover (as opposed to spending £5 to save £1). Of course, such expenditures must be reasonable, justified, and agreed upon by an insurer.
Additional increased cost of working
Similar to ICOW but gives a wider cover. This allows increased costs that maintain the business or service, but which do not necessarily reduce or avoid a Loss of Turnover during the Indemnity Period.
Fixed Costs
Fixed costs are those that remain payable during the indemnity period whether the business trades or not and so need to be insured.
Variable costs
(Also known as Uninsured working expenses or Specified working expenses) are costs that will decrease in direct proportion to the turnover in the event of a business interruption and so do not need to be covered by the BI policy. Costs such as the purchase of raw materials, packing, packaging and delivery, salesmen’s commissions, bad debts etc. In the event of a claim, the insurer will deduct variable costs.
Insurance companies and their policies are not all the same, so always refer to your own insurance documents. We are here to help you and help you understand your insurance. If at any time you are unsure of anything regarding your insurance policy and the cover it provides, please do not hesitate to speak to us.
Insurers and Accountants view of Gross Profit
Accountants’ calculation of Gross Profit is often seen as the cost of sales (including manual staff wage roll) minus the cost of production. Accountants consider manual staff wage roll as part of the “cost of sales” and therefore a variable cost.
Insurers take turnover plus closing stock plus work in progress minus variable costs, opening stock, and work in progress. Insurers consider manual staff wage roll a fixed cost on the understanding you would not want to reduce your skilled labor force in the short term and so the value of this needs to be considered when setting your Sum Insured to avoid underinsurance.
Insurance companies and their policies are not all the same, and definitions can vary, so always refer to your own insurance documents. We are here to help you and help you understand your insurance. If at any time you are unsure of anything regarding your insurance policy and the cover it provides, please do not hesitate to speak to us.