What is business interruption and how is it calculated?

public liability insurance

Business insurance comes in many guises, which can make it a difficult topic to navigate for those with little understanding of how different policies apply to different areas of a business.

Here, nationwide loss assessing firm, Morgan Clark explains all and offers advice for business owners who may be looking to make a business interruption claim of their own.

What is business interruption?

The types of insurance and level of cover required will differ from business to business depending on the nature of work carried out, the size of the business, and the customer, amongst other things – but ultimately all types of business insurance exist to protect the business and its stakeholders in a financial capacity in the event of an unexpected disaster.

 One of the most common yet most misunderstood types of business insurance is business interruption,or loss of profit. In simplest terms, this type of cover exists to protect the insured business from any financial shortfall suffered as the direct result of an incident that leaves them unable to trade, or at a reduced level, for a significant period of time.

For example, if a premises were to be flooded and the business was unable to operate as a consequence, business interruption insurance would cover the financial losses incurred until the business was up and running and back up to the pre-incident levels of trading again. It’s a simple enough concept, but this is insurance, so there’s naturally more to business interruption than initially meets the eye. 

Who needs business interruption insurance – and how much?

Business interruption isn’t strictly necessary for all businesses, nor is it a legal requirement, but it can be a lifeline for businesses that rely on their premises or certain physical assets in order to generate revenue.

For example, a large manufacturing business with lots of machinery and stock would be more heavily affected by a flood than say, a freelance designer who needs a laptop or exclusively digital assets to operate.

When it comes to making a decision on whether or not to take out a business interruption insurance policy, the question should be “would an incident at my premises affect my ability to trade?”. If the answer is yes, to any degree, then business interruption insurance would be a worthwhile investment.

Unlike buildings and contents insurance, where the amount of cover required can be calculated relatively easily by a third party such as a surveyor, business interruption is based on future forecasts and therefore requires more careful consideration.

When it comes to calculating how much business interruption cover is needed, basing numbers solely on the previous years’ earnings is unlikely to be sufficient as it does not take account of any potential growth the business may achieve during the course of the policy. If there are plans to expand the business, for example, this needs to be reflected in the business interruption calculations.

What’s more, depending on the type of business, it may be necessary to insure gross profit or revenue, depending on which is more appropriate. Definitions of both can differ from policy to policy, so it pays to check with an insurer before signing on the dotted line.

Another key consideration when calculating business interruption cover is the maximum indemnity period, which is the period of time for which the insurance policy will cover any income losses arising from an insured incident.

A maximum indemnity period is typically set at 12, 24 or 36 months starting from the date of the incident, but when being chosen should always reflect the worst-case scenario – it’s better to be over-cautious than under-insured.

It’s also important to consider not just how long it will take to start operating again, but also how long it will take for sales to return to pre-incident levels; repairing buildings and replacing machinery and stock is one thing, but replacing lost customers and building up the business again can take significantly longer.

Making a claim

Business interruption is a lifeline that policyholders hope they will never need to use, but should the worst happen, business owners will benefit from being prepared. The first step in making a claim should be to carefully check the details of the policy to determine the level of cover, and importantly, the maximum indemnity period.

Next, policyholders should contact their insurer to submit the claim, after which the insurer will begin investigating and requesting evidence and relevant documentation relating to the claim. And finally, the insurer will assess the claim and if deemed valid, will decide on the level of compensation.

At any point in this process, though the earlier the better, it can be beneficial to appoint an experienced claims management specialist to help manage the process and take on the responsibility of dealing with the insurer’s loss adjuster, the party responsible for investigating the claim.

In large and complex cases, involving such a third-party can significantly speed up the claim process and increase the chance of a fair outcome.